THE MARKETS
Tech stocks, led by Intel, sent indices reeling last week as all of the major averages took significant hits. Volume swelled on both the NYSE and NASDAQ signaling that we may be near a bottom. For the week, the Dow Jones Industrial Average lost 336 points (3.4%) and closed at 9589. The NASDAQ was down on three of the five trading days. For the week the index lost 80 points (-4.9%) and closed at 1535. Mutual funds had cash outflows of $1.9 billion for the period ending June 5th compared to inflows of $730 million the previous week.
Prospects for reduced revenue guidance from Intel hung over the markets Thursday, resulting in losses that more than rolled up all of Wednesday’s gain. Growing tensions in Kashmir and Palestine, the expanding tax fraud inquiry at Tyco (the CEO makes $300 million last year, and can’t find the spare cash to pay tax on his Monet painting!), and a sense that the recovery is gasping for the oxygen of corporate profits all played a role in the market’s steady deceleration. But the Intel story was the one most immediately connected to what the market recovery lacks right now: evidence of recovering demand and resumed revenue growth. Though Intel is a technology bellwether, it is also a Dow component and one of the most widely held equities. The lone hope for reversing the negative sentiment came with the release of May nonfarm payroll Friday morning, showing a gain of 41,000 jobs ahead of expectations, although not enough to completely offset the losses stemming from Intel and Tyco.
THE COMPASS PORTFOLIOS
There have been no changes to our models during the past week. We continue to be defensive in the current market, as we are carrying significant cash, money market and fixed income positions in our clients’ accounts. We continue to favor value over growth, and generally have limited positions in both the large-cap and small cap market segments. Due to the increasing evidence of a continued economic recovery, we have been hesitant to completely eliminate these positions; however, we continue to monitor trends carefully and will take any further action necessary should the trend continue.
By maintaining the significant cash and money market positions in our clients accounts, we have enhanced buying power when, at some future point in time, the markets begin to respond favorably to the economic recovery. The Compass Portfolios are structured to make “Buy Low/Sell High” a systematic process, and having extra cash on hand makes this possible. We will certainly participate to a nominal degree in market declines; however, the large defensive positions we hold at this time significantly soften the blow, and give us extra leverage to buy more shares when the opportunity presents itself. Cold comfort in this market, I know, but managing investment risk now offers us the luxury of being able to manage the risk that an investor may outlive his/her money in the future.
THE ECONOMY
The U.S. economy added a nominal 41,000 new jobs during May, following a 6,000 job increase in April. This back-to-back increase in jobs was the first since the beginning of the recession in March 2001. The consecutive monthly increases may confirm that the labor market data has slowly but surely joined the rest of the economic data, and that a convincing recovery is in the works.
Perhaps the most encouraging component in the May report was the drop in the unemployment rate to 5.8% from 6.0% in April. The unexpected drop in the unemployment rate suggests that the labor market recovery may happen earlier than initially expected. In the meantime, consumers will likely spend at a 3.0% to 3.5% pace, with economic growth advancing at a fairly robust 3.0% pace over the next two quarters.
The rise in payrolls isn’t altogether shocking. Consumer sentiment jumped higher last month despite all of the uncertainties plaguing the financial markets. And because consumer sentiment is predominantly a function of employment status, a rise in payroll additions was almost a certainty. Even more promising are the associated gains in incomes and consumer expenditures. By definition, as employment rises, so does income, which is the primary determinant of spending.
Things are indeed looking brighter on the demand side of the labor market as corporate profits have reversed a five-quarter slide, productivity is sky-rocketing, and aggregate demand, both foreign and domestic, has picked up considerably. Evidence from the manufacturing sector suggests that it probably won’t be too long until additional workers are needed to run the plants and factories that have been re-started in recent months.
Alan Greenspan and Company will do very little with this report. The Fed generally waits until unemployment begins to fall before it adopts an interest-rate tightening campaign. Atop the list of Fed fears, however, is the potential of falling behind the curve, so action may be required sooner, rather than later.
Looking ahead to the week of June 10, several economic reports are expected. On Wednesday, June 12, the U.S. export price index for May is due, as is the U.S. import price index for the same month. On Thursday, U.S. retail sales for May are anticipated, as well as the producer price index (PPI) for May, an important gauge of inflation at the wholesale level.
