THE MARKETS

Tough talk pushed stocks down to October levels as Wall Street braced for a war with Iraq. Friday saw the Dow close at 7864, the lowest close for the Dow since October 14, 2002 when the index settled at 7877.50. For the week, the Dow Jones Industrial Average lost 189 points (-2.35%) and closed at 7864. The NASDAQ also posted a loss for the week as it gave up 38 points (-2.88%) and finished at 1282.

Sentiment in the institutional investment community is currently weak as U.S. equity mutual funds continued to experience large outflows. For the period ending February 5, 2003, cash outflows totaled $4.3 billion on top of outflows of $216 million the previous week. A significant portion of the mutual fund cash outflows appears to be foreign based, as non-U.S. investors respond to a weaker dollar, a lack of visibility in corporate earnings and the impending war with Iraq.

THE COMPASS PORTFOLIOS

No changes to our portfolios last week. We continue to be cautions, as reflected in the increased cash positions in our clients’ portfolios would suggest. As we have stated over the past several weeks, the markets are at a critical juncture and we are walking the fine line between doing too much and doing too little. At the core of the Compass Wealth Management Process is a focus on investment risk management, which helps to limit the amount of downside risk we are willing to endure. Not responding assertively to market uncertainty and weakness would mean exposing our clients to the possibility of unlimited investment losses, an unacceptable and ill-advised investment strategy. Being overly defensive means ignoring historical truth: the U.S. equity markets have been a source of great wealth creation over the past three centuries, even against the occasional backdrop of wars, political uncertainty, and economic uncertainty. Given the current market levels of today and impending (???) resolution to the Iraqi situation, we believe our current posture is prudent.

THE ECONOMY

Last week’s updates on manufacturing and construction spending both point to economic recovery, albeit slow and sporadic. The Institute for Supply Management index slipped slightly in January to 53.9, but still officially reflects expansion (any reading over 50). Economists had expected little change from the surprisingly strong 55 level in December.

The December update on construction spending showed a gain of 1.2% after increasing a revised 0.9% in the previous month. The rise is better than the 0.5% forecasted and represents the fourth straight increase in spending and leaves this measure rising in eight out of twelve months in 2002.

The productivity of U.S. workers abruptly reversed in the final quarter of last year as the economy slowed, the government said on Thursday, but productivity gains for the whole year were the largest in over 50 years. The Labor Department said the productivity of workers outside the farm sector dropped 0.2 percent in the fourth quarter after a rocketing ahead 5.5 percent in the previous three months of the year. The number was worse than market expectations of a 0.4 percent increase and was the first decline since the second quarter of 2001. For 2002 as a whole, however, productivity soared 4.7 percent — the fastest pace since 1950 and more than four times the 1.1 percent gain posted in 2001.

New weekly claims for jobless benefits in the United States edged down a bit last week, the government said Thursday, as the labor market struggled to recover from heavy job cuts in 2001 and 2002. The Labor Department said the number of Americans filing new claims for unemployment benefits fell to 391,000 in the week ended Feb. 1 from a revised 402,000 the prior week. Economists, on average, expected 390,000 new claims, according to Briefing.com. The nation’s unemployment rate now stands at 5.7%, down from the 6.0% mark hit late last year.