Falling oil prices and an oversold market helped push the Dow Jones Industrial Average to its highest level in six weeks, but volume remained weak suggesting a lack of conviction by market participants. The recent rally which got its start on August 13th has pushed all of the major indexes with the exception of the NASDAQ Composite back over their respective 50-day moving averages. These levels leave most indexes in the middle of their annual trading range. For the week, the Dow gained 85 points (+0.80%) and finished at 10195. The NASDAQ put in back-to-back winning weeks for the first time since the end of May gaining 24 points (+1.30%) and closed at 1862. For the year, the Dow is down 2.5% while the NASDAQ has lost 7.1% of its value.
Low volume continues on Wall Street as New York Stock Exchange trades have recently been averaging only 1.2 billion shares per day. This level is approximately 20% below normal, sharply below the normal 1.5 billion shares per day seen over the past several years. The markets have rallied on low volume in the recent past, most notably from late March through early April and again from late May through late June. Both advances failed to hold their gains. Low volume rallies tend to be suspect, and the current advance will get a real test after labor day when many money managers return from extended summer vacations. Meanwhile, U.S. equity mutual funds had inflows of $555 million last week compared to outflows of $2.2 billion the previous week. Market sentiment is improving slightly as the percentage of bullish investors fell to 39.6% from 43.6%. Readings under 40% are regarded as a bullish condition.
THE COMPASS PORTFOLIOS
What a summer it’s been, as the markets have see-sawed back and forth only to end up nearly where we began back in early June. While the result has been less-than dramatic, the path taken on the journey to our starting point has been interesting to say the least. On the one hand, corporate earnings have been flat-out stellar with most companies reporting 20 – 25% improvements over the same period a year ago. Interest rates continue to be near 40-year lows despite the Fed’s best efforts, inflation remains tame (at least by statistical standards), and unemployment has dipped solidly below 6.0%. So why haven’t the markets responded? Well, in short, they did. Last year. The market is designed to forecast improving and deteriorating conditions well in advance. The escalation of stock prices seen last year was in anticipation of improving earnings, continued low interest rates, and benign inflation. The current market is attempting to do the same, looking out into late 2004 and well into 2005. The “wisdom of the crowd” (the effect of billions of votes cast every day either in favor of a company or against a company) creates not only an efficient and liquid market but also creates a very useful mechanism for forecasting future trends in corporate earnings. What is the market saying now? Perhaps “bi-polar” is a useful term, often displaying short bursts of optimism followed by equally dramatic bursts of pessimism. Side-by-side, they make for a very interesting character, but for sustained progress to be made we need for one side to win out. As always seems to be the case, the current trend (or lack of one) seems to be the only characteristic that counts. After all, human nature is one that embraces familiarity, and the current flat market seems as though it will drag on forever. While this is exceedingly unlikely, it is important to always be ready for change, as our discipline allows us to be. We stand ready to reposition assets should the opportunity to do so present itself. In the meantime, we continue to focus on more predictable elements of the portfolio (such as dividend paying securities and money market assets). Summer is almost complete, and if the Wisconsin weather is any indicator, change may be just round the corner.
The mild decline in last week’s oil prices help to return the focus to employment, inflation and the factors driving Fed policy. Despite the near flat 32K rise in July payrolls, the funds futures market puts the probability for a 25 basis point tightening in September at 84%. This week’s employment report will steer market expectations for the Sept 21 FOMC meeting as Fed speak hasn’t yet suggested a pull back from a pre-election hike in overnight policy rates.
Friday’s employment report is crucial for the Fed and market policy expectations. After the severe weakening in payroll growth since April and the very disappointing 32K July gain, the August growth signals near term direction — and going in to an election. The market is banking on a rebound to 150K which is three times the size of the June/July average.