Concerns over surging oil prices coupled with weak earnings news from the technology sector sent stocks to their lowest levels of the year. After recording a new yearly low on Thursday, the Dow managed a small gain on Friday to end the week fractionally in the plus column. For the week, the Dow gained 10 points (+0.1%) and finished at 9825. The NASDAQ, which dropped to its lowest closing level since August 2003, lost 19 points (-1.1%) for the week and settled at 1757. For the year, the Dow is down 6.0% while the NASDAQ has lost 12.3% of its value.
Reduced earnings guidance from Cisco Systems and Hewlett Packard contributed to the week’s volatility, as did the Federal Reserve’s decision to continue its campaign of interest rate hikes. Volatility also increased with two out of the five trading days showing triple-digit moves in the Dow. For the week ending August 11th, U.S. equity mutual funds had outflows of $1.25 billion compared to outflows the previous week of only $120 million. The markets continue to be concerned about the sustainability of 20% corporate earnings growth, the continued new highs in the price of oil, and uncertainty over the upcoming presidential election. On the plus side, mortgage rates continue to be near historic lows, fueling the continued housing boom.
THE COMPASS PORTFOLIOS
The defensive positions we initiated some four weeks ago continue to serve our clients well as we have experienced much smaller losses in our managed accounts compared to the overall markets. While every market trend plays out differently, the volatility we have been seeing has been consistent with that of mid 2001, late 2002 and the summer of 2000 (coincidently the last election cycle). During those periods, the markets demonstrated higher-than-normal volatility and price weakness, but portfolio losses were largely kept to single digits through our active wealth management process. So far, the current market is playing out in a similar fashion with an increase in volatility, a mild downward trend, and portfolio losses being kept largely to the mid single-digit range.
Investors familiar with our weekly market comment will notice updated current model allocations (on the left) as well as up-to-date 3-Year Morningstar Rankings and our very useful Best/Worst case portfolio performance charts (both found on page 2). Together, this data helps investors know what to expect during periods of time in which the portfolio management discipline is performing normally, as is continues to do. Normal means exposing investors to reasonable amounts of risk with the goal of being rewarded with higher portfolio values over time. It is important to recognize the role that risk plays, and our desire to place a portion of our assets at-risk. No risk in a portfolio is easily achievable, and results in great certainty: very little portfolio growth. There are institutions that serve these investors very well, such as banks and certain insurance company products. At the other side of the spectrum lies a portfolio that exposes investors to very high risks in the hopes of very high returns. This scenario is unfavorable to most investors as well as it seems that the rewards are rarely worth the cost. Very much to the left of the middle is our portfolio management discipline that elegantly exposes investors to measurable, largely predictable risks in exchange for more than a bit of market appreciation when such an environment presents itself. Without these manageable risks, the rewards of participating in sustained market advances can never materialize, and can ultimately result in an investor’s failure to meet financial and non-financial goals on-time. In short, we believe it to be a prudent course of action for all investors to objectively ascertain for themselves how much risk to endure, how much upside potential is likely to materialize given the risk, and whether the risk is worth the cost. We believe investors will be pleased with the result along the way, especially over the course of an entire market cycle.
This Tuesday’s consumer price index (CPI) reading will perhaps be the most closely watched report of the week. Last week, the Federal Reserve indicated that it believed the spike in consumer prices during the second quarter was an anomaly and that a return to only mild inflation was the most likely outcome. The markets have been reacting as if higher inflation were likely to continue. Tuesday’s CPI reading will help gauge which institution has it right, and whether the Fed’s campaign of rising rates will be short-lived or whether a more extended campaign will be required.
Reports also due out this week include the updated housing starts and building permits data, industrial capacity and utilization data, leading economic indicators, and initial jobless claims, among others.