THE MARKETS
The oversold conditions which we discussed last week led to an impressive rally as the three major indexes all gained for the week. For the period the Dow Jones Industrial Average gained 414 points to close at 10,353. The S&P gained 52 points to close at 1107, and the NASDAQ posted gains for the first time in four weeks as the index gained over 8%. For the week, the index was up 141 points (+8.8%) and closed on Friday at 1741.
Activity by bottom feeders have led to modest rebounds in bellwethers IBM, General Electric, and Microsoft, all of which have buoyed from recent sell offs. Utility stocks, considered by many to be safe investments due to their high dividends, continue to come under pressure as Reliant Energy, Dynegy Corporation and CMS Energy each disclosed inappropriate energy trading activity and ill-gotten profits. Better than expected results from Dell Computers, however, did lead to late-week strength in computer and chip stocks. For the week, mutual funds had inflows of $3.9 billion, a reversal from the previous outflow of $1.2 billion.
THE COMPASS PORTFOLIOS
Early in the week we restored positions in large value equities on a break through near-term resistance for the Dow Jones Industrial Average. While the prospect for much headway appears limited at this time, we are currently at the low end of a trading range on the Dow, and our models indicate adequate support to warrant investment. We will monitor this recommendation carefully, and we will take steps to safeguard positions should the need arise. We continue to recommend holding small-cap positions, both in value and in growth, each of which has demonstrated adequate support.
Recent bounces off of lows on the NASDAQ and the S&P 500 may end up being useful, as it appears that a more solid base may be forming. We can probably all agree that long-term growth is desirable (!), and while these market segments tend to offer the greatest prospects, more work needs to be done before we allocate capital here.
We are currently reluctant to allocate additional capital to fixed income positions, as interest rates have begun to climb, a negative for bond funds and preferred stock. If the economy is truly in a recovery phase, higher interest rates are likely, which will make for more attractive prospects at a later time. Generally speaking, we recommend normal weightings in this area.
THE ECONOMY
The preliminary University of Michigan consumer sentiment index for May rose to 96.0 from April’s 93.0. Economists polled by Bloomberg were expecting a reading of 93.0. The current conditions index rose to 103.2 from 99.2, and the expectations index increased to 91.3 from 89.1. The stronger-than-expected figures come on the heels of recent upbeat retail sales data pointing to continued strength in consumer demand.
The Commerce Department reported that the US trade deficit narrowed to $31.63 billion in March from February’s upwardly revised $31.75 billion. Economists polled by Dow Jones Newswires had expected a deficit of $32.0 billion. Imports grew 0.3% while exports increased 0.6% for the period.
Semiconductor Equipment and Materials International (SEMI) reported that the book-to-bill ratio rose to 1.20 in April, reflecting $120 in new orders for every $100 in billings. SEMI noted that semiconductor bookings have now improved for five consecutive months.
Real GDP rose at an annual rate of 5.8 percent in the first quarter, the largest gain since the final quarter of 1998, led by inventory investment and government spending. The GDP figures included good news on the inflation front, as the GDP price index increased less than one percent at an annual rate. Also, recent increases in productivity should feed through to business profits, reversing the sharp decline in profitability that occurred last year.
Participants in the financial markets have apparently concluded that the Fed will leave monetary policy unchanged at least until the August FOMC meeting, if not longer. Economists expect the rise in interest rates over the next year or two to be relatively moderate, with the federal funds rate rising to about 2 ¾ percent at year’s end, and to a little above 4 percent by the end of next year. Where do the risks lie in this forecast? Perhaps the most serious risk at the moment is an escalation of tensions in the Middle East that sends oil prices skyrocketing. Barring such an event, the economic outlook appears quite encouraging – moderate growth, strong productivity gains, increasing corporate profits and low inflation.
