THE MARKETS
The Dow Jones Industrial Average bounced back from an oversold condition last week and managed to barely hold above the 10,000 mark. Friday’s drubbing (-85 points) came on the heels of a spike in the jobless rate to a 7 1/2-year high. The NASDAQ, led by weakness in the tech and chip stocks continued its slide for the third week in a row. For the week, the Dow Jones Industrial Average gained 96 points (+0.97%) and closed at 10,006. The NASDAQ lost 50 points for the week (-3.01%) and ended the week at 1,613, a seven month low.
The percentage of NYSE stocks above their 200-day moving average slid to 61.4% from 62.1%, while those above their 50-day continued lower to 54.6% from 57.8%. The percentage of bullish investment advisors eased to 51.1% from 52.78%. Readings over 55% are regarded as bearish. This indicator continues to reflect a complacent stance, which is a negative for the market going forward. However, mutual funds had cash inflows of $3.6 billion for the period ending May 1st, compared to outflows of $3.3 billion the previous week.
THE COMPASS PORTFOLIOS
Downgrades to our Dow Jones Industrial Average and S&P 500 models last week reflected the lack of institutional support and the shift in momentum. We have raised a significant amount of cash in a defensive move to protect against further deterioration. The prescription to reduce or eliminate NASDAQ positions made during the week of February 4 has held, and has proven to be of great value. The only remaining fully-invested positions in the Compass Portfolios are in the small-cap value and small-cap growth segments.
Recent market activity strongly reinforces our belief that investment risk must be addressed in ways that are consistent not only with an investor’s personal goals but that reflect the current investment climate. Managing the risk of a single asset sharply declining in value is easily addressed through The Compass Portfolios, as we employ a broadly diversified approach to portfolio construction. Simply put, an investor is rarely (if ever) rewarded for accepting a risk that can be diversified away (i.e. Enron, Xerox, Cisco Systems, Williams Companies, Lucent, etc), which can be accomplished through Strategic Asset Allocation. The risk that an entire market may significantly decline in value must also be addressed, as we do through Tactical Asset Allocation. This risk management technique allows investors to systematically participate in market segments when the likelihood of market advance is high, and to reduce or eliminate exposure when the likelihood of market decline is high. Combining these two risk management techniques is elegant, to say the least, as it allows investors to simultaneously participate in the equity markets and manage investment risk.
THE ECONOMY
The U.S. economy added 43,000 new jobs during April, following another downward revision in the previous month. Non-farm payrolls fell by 21,000 in March from an initially reported 58,000 increase. Equally disappointing was the stronger-than-expected jump in the unemployment rate, to 6.0% from a 5.7% posting in March. The current machinations of the labor market are consistent with an economic recovery from recession. One of the key components of the release – temporary unemployment – managed to post an impressive gain of 52,000 workers in April, following a revised 69,000 increase in March. This incredible surge is common during the initial periods of economic recovery. Before employers fully commit to the extremely costly action of hiring full-time employees, they generally seek part-time help. This way, in the event that the economic recovery falters and workers are not needed, they are dismissed without benefits and there is minimal cost to the bottom line. Conversely, if the recovery gathers steam and proves permanent, then employers can proceed with hiring plans and employ either “temps” or conduct a formal search for workers through traditional channels. Claims for unemployment benefit insurance have exceeded 400,000 for six consecutive weeks — a level that economists usually associate with recession.
The unexpected spike in the unemployment rate greatly diminishes the odds of a near-term Fed rate hike, since the Federal Reserve generally begins its tightening campaign immediately after the peak in the unemployment rate. With the unemployment rate still rising and the corporate profit picture in the dumps, the Fed might not see fit to further constrict growth (especially investment spending) by raising rates.
The dismal outlook for tech spending has recently been validated. It was supported by some of the biggest CEOs in Techland. Said Michael Dell, CEO of Dell Computers, “The economy feels like it’s gradually improving, but we don’t see a huge rebound as it relates to information technology spending.’’ Corning CEO James Houghton said that this was “the worst period this company has faced since the Great Depression. Or even before. Even during the Depression sales never went down 50%.” We cannot see how, or why, the Fed would raise rates in this environment, especially with inflation seemingly under control.
