THE MARKETS
The gains for the New Year were wiped out as the Dow Jones Industrial Average went into a tailspin after topping out at 8842.62 on January 14th. The ensuing seven trading days saw the Dow finish lower on six occasions while losing over 700 points. On Friday the Dow dropped below 8200 for the first time since October 18, 2002. For the week, the Dow lost 455 points (-5.3%) and closed at 8131. On a percentage basis, the NASDAQ fared much better as it posted a loss of 34 points (-2.5%) for the week and finished at 1342. U.S. equity mutual funds had outflows totaling $3.1 billion for the period ending 01/22/03 as compared to inflows of $314 million the previous week.
Fourth-quarter reported earnings have not been too bad. But the market has continued to slide as the reporting season progresses. It’s not the recent earnings performance that has investors concerned, but rather the tepid guidance that corporations have been giving for the near future. A few companies have warned that coming quarters will be weak. Some have set a new policy of not providing guidance to analysts and investors. But much of the nervousness has been the result of “poor visibility” on future sales and earnings.
In plain English, these companies are saying that there are too many uncertainties (consumer confidence, capital spending and international tensions, for example) to predict with any confidence what will happen in their businesses. That’s keeping many buyers on the sidelines. And the weaker dollar means that foreign investors will not soon be taking up the slack, since their U.S. investment returns will be trimmed when converted back into their own currencies.
THE COMPASS PORTFOLIOS
The downdraft in the markets triggered downgrades on Friday and again over the weekend. Portfolio positions are in the process of being trimmed back with great reluctance, generally through the use of stop-loss orders. A stop-loss order is entered in order to trigger a sell if and only if a specific security drops to a specific price. This technique is especially useful because it allows the market itself to dictate whether a sell order is actually executed. Given the quick deterioration of institutional support, I believe the action is warranted. Portfolios are now approximately 80% invested, and the recent activity should be considered a “tapping of the brakes.”
THE ECONOMY
After a dismal 2002, one would think capital spending by U.S. companies would turn higher this year. Expectations are widespread for an ongoing rebound in profits and cash flow, along with the continuation of favorable interest rates and an increasing willingness by banks to lend, suggesting that more funds should be available in 2003 for companies to spend on property, plant, and equipment. However, recent guidance by Microsoft and Intel indicate that capital spending and new funds for research and development are not yet in the works.
One reason growth may not come up to snuff is that the pullback in investment spending over the last couple of years, combined with higher-than-normal depreciation rates, hasn’t eliminated excess capacity in many industries. This overhang should limit any sharp jump in investment spending in 2003.
In fact, despite the investment restraint, production capacity grew last year, as many companies apparently believed an imminent cyclical recovery — which never materialized — would leave the capacity overhang as little more than a temporary problem. One need look no further than the Federal Reserve’s industrial-production report, which pegged capacity growth in manufacturing at 1% over the past year, while growth in high-tech capacity reached nearly 9%.
