THE MARKETS
Renewed fears over the possibility of another terrorist attack kept investors on the sidelines as prices declined on shrinking volume. Both the Dow Jones Industrial Average and the NASDAQ were under pressure, as investors remained skittish ahead of the looming holiday. For the week, the DJIA lost 249 points (-2.4%) and closed at 10,104. The NASDAQ returned to its losing ways, closing down on four of the five trading days. For the period, the index was down 88 points (-4.7%) and closed on Friday at 1,661.
The market’s stop-and-start pattern reasserted itself early in the week, as the recent rally gave way to a bout of profit taking. Monday is typically a light day for economic releases; but the government did issue its leading economic indicators report, and it reinforced the view that the current period marks a not-quite recovery from a not-quite recession. Separately, a respected market strategist recommended selling tech stocks on strength (better late than never), arguing that recent gains outstripped near-term fundamentals. Our prescription to avoid large cap growth stocks (i.e. Microsoft, Cisco, Sun Microsystems, etc.) made earlier this year is proving prophetic, and reinforces the value of being on the right side of this difficult market.
A weekend’s worth of accusations regarding White House foreknowledge of the 9/11 events added to last week’s investor anxiety. In a market where the bear perennially lurks, Vice President Cheney’s suggestion that further attacks are all but certain was a short-seller’s dream.
THE COMPASS PORTFOLIOS
The only change to our portfolio strategy during the past week was a general reduction in the small cap growth area. We continue to underweight all growth segments of the market, especially large cap technology issues due to the segment’s lack of institutional support. For the year, only the S&P component of our models have underperformed its benchmark, and we continue to be defensive during this difficult market.
As many of our clients are aware, the Compass Portfolios are designed to be defensive during periods of market deterioration and offensive during periods of market advance. We are still clearly in a bear market, and how investors respond to these difficult times is as important as how we respond during periods of growth. Our models indicate that a base may be forming, but we are reluctant to allocate capital to the market if the risks appear to outweigh the potential rewards. We will continue to manage risk, and look forward to future opportunities for growth in the market.
THE ECONOMY
April retail figures, confirming that the consumer is still vibrant, have pretty much demolished any lingering fears of a double-dip recession. Most economists, including former Fed Governor Lyle Gramley, have revised upward their second quarter GDP estimates. Gramley now expects an expansion in excess of 3 percent this quarter, and he’s still comfortable with a forecast of 3 percent-plus growth for the second half. And the former Fed governor points out that in virtually every postwar recovery, economic growth has exceeded expectations. The only downside to this increasingly positive economic outlook is that Fed officials will have to begin tapping on the monetary brakes this summer. Gramley thinks they will wait until Aug. 13, although a move can’t be totally ruled out at the June 25-26 policy session. Many Fed hawks note that the federal funds rate was set at 1-3/4 percent late last year when the economy appeared to be in a serious recession. That hardly is the climate now, and with tentative signs of global growth keeping the price of oil near contract highs, the Fed can’t afford to get too far behind the monetary curve.
The Commerce Department reported preliminary first quarter gross domestic product growth of 5.6%, down from the previous figure of 5.8% and the consensus forecast of 6.0%. Personal consumption was revised lower to 3.2% from 3.5%. Fixed investment, both exports and imports, and government spending were also revised down. The good news in the report was corporate profits rose 0.9% in the first quarter from the fourth quarter, after declining 10.6% in the fourth quarter.
The government also released data on the housing market Friday. New home sales unexpectedly climbed 1.0% to a 915,000 pace in April from a revised 906,000 pace in March (previously 878,000). Declines were evident in all regions except the Midwest. Economists had expected a decline in total sales after the elevated levels of activity seen during the unusually warm and dry winter. The news boosted shares of home builders.
