THE MARKETS
The flood of earnings announcements released last week did little to clarify the present state of the economy, and more importantly the future direction of the equity markets. Less-than-stellar results from Exxon-Mobil, AOL Time Warner, AT&T, JDS Uniphase, WorldCom, and Verisign set the tone for moderate declines in all three major indexes. The Dow Jones Industrial Average and the NASDAQ traded lower this week as large-cap stocks continued to be under pressure. Even an upbeat GDP report (+5.8%) on Friday, which was the largest gain in over two years, couldn’t stem the slide. For the period, the DJIA lost 347 points (-3.4%) and closed at 9,911. The NASDAQ, which has been down 6 of the last 8 days, lost 133 points (-7.4%) and ended the week at 1,663.
The percentage of NYSE stocks above their 200-day moving average slipped to 62.1% from 65.7%, while those above their 50-day fell sharply to 57.8% from 68.9%. The percentage of bullish investment advisors eased to 52.7% from 54.8%. Readings over 55% are regarded as bearish. This indicator continues to reflect a complacent stance, which is a negative for the market going forward. Mutual funds had cash outflows of $3.3 billion for the period ending 04/24/02 compared to inflows of $7.9 billion the previous week.
THE COMPASS PORTFOLIOS
Our quantitative models have been heroically maintaining prescriptions made several weeks ago. The models do show deterioration in large-cap value (Dow Jones Industrial Average) and large-cap blend (S&P 500), both of which maintained their “LONG” recommendations with strongly deteriorating conditions. While official downgrades have not yet occurred, it is our belief that support levels have been broken, and a repositioning to a more defensive posture will be made early next week. Overall, market internal data have been encouraging; however, the shift in momentum and institutional support requires steps to protect investment positions until a more supportive investment environment presents itself. Our minimal positions in NASDAQ and other growth securities continue to serve us well, as do the inverse-funds in the Compass Plus portfolios.
Simply put, current market conditions are extremely difficult for investors who expect a quick recovery to pre-2000 market levels. As a fellow investor, I share my clients’ hopes and desires for the future, and I am confident that the U.S. economic recovery will eventually take hold; however, historically low interest rates on fixed income securities and credit quality concerns leave investors with few options for either income or growth.
What’s left? Stagnation, unfortunately, which for the time being leaves many investors frustrated and looking for immediate alternatives.
We stand eager to participate in gains when they come, and to manage the risks of the equity markets in the meantime.
THE ECONOMY
The important statistic of the week came on Friday as the Gross Domestic Product (GDP) for the first quarter came in at a higher than expected +5.80% annualized rate. Good news, until the University of Michigan’s consumer sentiment index (released later Friday morning) fell unexpectedly, which led to broad selling into the close of the day. If the recession really ended in January, the market’s performance during the economy’s early expansion phase has been atypical. The S&P 500’s recent decline would mark the first time in the postwar period that stocks failed to gain in the three months following a recession. Indeed, until this year, the market had risen in the first three months after each recession since 1900. But the main reason for the recent breakdown of the relationship between economic expansion and stock prices is the delay in the recovery of corporate profits. The end of a massive inventory work-down is benefiting GDP, but earnings won’t be helped until production shows meaningful improvement. Profits of U.S.-based companies are also being held back by a lack of pricing power, as weak economies abroad and a strong dollar contribute to intense global competition (just ask the paper and tissue industry). At the same time, the labor market is tight for this stage of the business cycle, and energy and security costs are up.
Lastly, consumer spending remained healthy during the first quarter, climbing 3.5%. Real final sales came in at a better-than-anticipated pace of 2.6%. Government spending rose 7.9% while business investment fell 5.7%.
