THE MARKETS
After finishing in the red for the last five weeks, the Dow Jones Industrial Average put together a decent rally and ended the week in the plus column for the first time since the week ending June 18th. Volume continued at a robust pace averaging 1.5 billion shares per day which is the highest it’s been since May 2004. For the week, the Dow gained 177 points (+1.78%) and closed at 10139. The NASDAQ also finished the period with a gain which was the first winning week since the end of June. For the period, the NASDAQ gained 38 points (+2.1%) and closed at 1887. For the year, the Dow is down 3.0% while the NASDAQ has lost 5.8% of its value.
For the week ending July 28th, U.S. equity mutual funds had outflows of $187 million compared to inflows the previous week of $900 million. The percentage of bullish investors is neutral at 51.1% down slightly from last week’s neutral 52.6% reading. Readings over 55% are regarded as a bearish condition. It is important to note that the sizable decline of trading volume on the New York Stock Exchange several months ago has improved, with a more normal average of 1.5 billion shares trading hands during the month of July. Momentum indicators (which helps to determine the percentage of stocks either under accumulation or under distribution) remain neutral for all indexes with the exception of the NASDAQ which is still reading as mildly bearish.
THE COMPASS PORTFOLIOS
The narrow trading range has continued during the summer months, and is reflected in our neutral asset allocation. We have responded proactively to the recent retest (the third of the year) of the bottom of the trading range we have written about over the past several months. Our growth components (tracking the NASDAQ 100, the S&P 500 and our two small cap indexes) have been reduced substantially, while the majority of our dividend paying components have remained in place and have performed flawlessly. Our management discipline allows us to keep the positions that are rewarding us for the risk of owning them, while at the same time reducing (or eliminating) the positions that have not (at least not yet).
My son Will is learning to swim. At 2 ½ years old he’s learning how to stay afloat, an important skill to have, especially in deep water. For Will, deep water is anything over 12 inches or so, so for him floating is a great skill. He has help, though, from a special swim suit that has a floatation device built right in. He loves it because he can learn to move around in the pool with Papa and get used to the sensation of having water all around him. He might get a bit of water in his mouth, but he can’t sink to the bottom. The biggest downside to his swimsuit (aside from looking a bit like the “Michelin Man”) is that without it he has developed a false sense of security. He hasn’t made the connection that when he’s not wearing this particular suit he has to work to stay afloat, otherwise he’s no more buoyant than a rock. This is a problem, and it happens to be the same problem all investors have. Our management discipline is a floatation device of sorts, as it allows us to tread water very elegantly as the flat market continues. If the goal is to eventually ride a wave when one comes along (as occurs at the start of a new bull market run), we will occasionally have to float, and be prepared when the trading range breaks out.
THE ECONOMY
The American economy moved ahead in June and the first part of July, but the pace of growth varied by geography, the Federal Reserve said on Wednesday in its “beige book” economic report. “Federal Reserve districts reported that economic activity continued to expand in June and early July, although several districts reported that the rate of growth moderated,” said the report, an anecdotal look at conditions across the nation, as seen by the Fed’s dozen regional banks. Growth was described as ranging from “modest” to “solid” in half of the regions, while five Fed banks said growth rates had “slowed somewhat.” Another Fed bank, in Boston, cited “mixed” reports from its business contacts.
Employment costs rose 0.9 percent in the second quarter, a government report showed Thursday, less than the rate of increase in the previous quarter and in line with economists’ forecasts. The Labor Department report showed the pace of increase down from the 1.1 percent rise in the first quarter. Benefit costs were up 1.8 percent in the period, down from a 2.4 percent increase in the first quarter. Wages and salaries gained only 0.6 percent in the period, unchanged from the first quarter gain. The report is closely watched by economists and the Federal Reserve as an indication of inflationary pressures caused by the improving economy. Benefit costs rose 7.2 percent for the most recent 12 months, up from a 6.3 percent gain the previous year.
