THE MARKETS
Negative corporate and international news continued to depress stocks last week as both the Dow Jones Industrial Average and the NASDAQ recorded new lows for the year. For the week the DJIA lost 220 points (-2.3%) and closed at 9254. The NASDAQ, which is closing in on the September 2001 low lost 64 points (-4.3%) and settled at 1440.
A better-than-expected earnings announcement from Dow component Proctor & Gamble and a bout of profit-taking by bears lead to fireworks on Tuesday, but the rest of the week was simply fizzle. A string of technology company earnings warnings swept across the entire market throughout the week, sparing few sectors and proving that bearishness continues to trump bullishness. Advanced Micro Devices and Apple Computer both warned that their results would not match analyst expectations. Good earnings news, on the other hand, bolstered only a handful of groups. The recent report of strong housing starts and an upbeat earnings forecast from Lennar Corp. lifted homebuilding stocks and a few “big box” home center retailers, such as Lowe’s and Home Depot. But other consumer stocks were drowned in the market’s negative mood. The late hour at which some companies are warning about earnings is not really surprising; many businesses close more than half their sales in the quarter’s final weeks. The negative outlook for technology and communications final demand may undermine some sales that appeared firm a week or two ago. Investors are now hoping that the extreme lack of spending in the technology arena will not disrupt purchasing decisions across the industrial landscape.
The markets are clearly pricing in fear of a double-dip recession, a reversal in the hard-won profit recovery now underway, and possibly a fresh terrorist attack or widened war. Most economists do not believe the economy will fall back into recession. While troubled, the consumer is not about to succumb to morbid fears and disengage from the economy. Nor do we believe the economy will undergo a miraculous surge, pulling it out of the current twilight state. As the recovery grinds forward, the bearishness deeply dyed into the market will hinder but not halt the economy.
THE COMPASS PORTFOLIOS
We continue to be defensive given the current market. Although money market, high- quality bond and CD yields are at historically low levels, they all serve as excellent vehicles for preserving principal. Given the continued weakness of the equities market, being defensive is an appropriate and prudent posture. Clearly, the long-term prospects for growth of principal are not to be found in fixed income instruments, and so we eagerly anticipate future opportunities in the equities markets.
A quick word about asset allocation: The Compass Portfolios utilize two distinct methods of managing investment risk. First, non-systematic risk, the risk that an individual stock will “blow up” and destabilize a portfolio (i.e. Enron, Tyco, Xerox, Williams Companies, Ford, Bristol-Myers Squibb, Cisco, etc), is managed through the use various kinds of mutual funds. While there have been a handful of stocks that have held their value, the risks of owning an individual stock in this market, no matter the past quality of the returns, is significant. We therefore strongly hold to the philosophy that “broader is better,” and while opportunities in individual stocks will undoubtedly pass us by, the rewards simply do not justify the risk at this time. The second investment risk that we address is the risk of an entire market collapsing, as has been the case with the NASDAQ. When an entire market collapses (even for a brief period of time), most equities in that market will be affected, and the results can be catastrophic. Many of The Compass Portfolios address this risk by periodically and systematically reducing invested positions (by selling) when the market turns and further declines are likely. With both types, the goal is to manage (but not completely eliminate) risk because in order to achieve your long term need for capital growth, some risk must be assumed.
THE ECONOMY
The biggest economic story may continue to be the stock market; further weakness will intensify concerns that the market could hurt the entire economy, while a long-overdue rally might improve prospects that consumers will continue to spend. In light of the global uncertainties, corporate scandals and fresh questions about the economy’s strength, the upward move 10-year bond last week was fully justified. It is becoming increasingly likely that interest rates should stay low; perhaps they might slide even further.
The Fed probably is out of the equation for quite some time; it could be September before the central bankers raise rates – or it could be much longer, perhaps not until the Nov. 6 FOMC meeting, the day after the congressional election. In any event, a move later this month or in August now seems unlikely. It appears likely that we’re looking at a very accommodative Fed for months to come.
What has been weighing most heavily on the markets this week, however, is the fear that the intrepid consumer is finally faltering. Terror fears and job losses contributed to the drop, to 90.8 from a prior 96.9, in the University of Michigan consumer confidence index for June. That is somewhat old news, in that the data was released Friday before last. But the fear was made manifest Thursday when a leading auto analyst downgraded GM and Ford on fears of sliding vehicle demand and price cuts. The disconnect continues to widen between the staunchly bearish stock market and the clear evidence in the economic indicators that the economy continues to recover. On Thursday, the Commerce Department reported that leading indicators for May improved 0.4%, double the consensus call for a 0.2% gain. And the Philadelphia Fed index surged to its highest reading in years, to 22.2 from a prior 9.6, and double the consensus call of 11.0.
WORDS OF WISDOM
“Asset allocation gives you peace of mind knowing that you’ll never make a killing in the market, in exchange for the luxury of never getting killed by the market.”
-Nick Murray
