Investors stayed on the sidelines last week ahead of the June 30th Fed meeting. It was the same old story: interest rates, oil prices and Iraq keeping stocks locked in a 300 point trading range for the last three weeks. Friday’s 38 point spurt boosted the Dow to the high end of the range as the index ended the week in the plus column for the fourth week in a row. For the period, the Dow Jones Industrial Average gained 6 points (+0.06%) and closed at 10413.
The NASDAQ got hit hard on Monday losing 30 points (-1.5%) as technology stocks came under pressure. However, the index managed to get most of it back over the next four days but still ended the period slightly in the red. For the week, the NASDAQ lost 14 points (-0.70%) and closed at 1986.
The lack of investor conviction can be seen in the decline of NYSE volume which currently averages around 1.2 billion shares per day, down sharply from 1.6 billion shares in early May. For the week ending June 16th, U.S. equity mutual funds had positive inflows of $1.4 billion.
THE COMPASS PORTFOLIOS
No changes to our model portfolio allocations as we remain more invested now than we were at the end of May. The markets have successfully retested their annual lows over the course of the past month, indicating a strong level of support at approximately Dow 10,000 and NASDAQ 1900. It does appear, however, that the summer malaise may be in full swing (if there is such a thing), and that investors may enjoy a very quiet three month holiday. We, however, will not as we will continue to work daily to execute the discipline that has served us so well. Daily measurement of institutional support is required, and is a critical component of our wealth management discipline. In flat markets, the likelihood of a market breakout becomes greater with time, and ensuring that our clients’ portfolios are allocated properly is the key to success. By closely monitoring the investment landscape, we can make subtle adjustments as needed, and be positioned properly when a sustained market move does eventually manifest itself.
It is becoming increasingly likely that when the Federal Reserve’s Open Market Committee meets next week, short-term interest rates will be hiked by only 0.25%. The market’s policy expectations have been quite volatile over the last few months as stronger employment and core inflation continue to influence the our collective belief on the size and scope of the eventual Fed tightening. Last Friday afternoon’s July funds futures contract priced in slightly more than full expectation for a 0.25% tightening as a larger 0.50 hike carried a modest 54% probability. The futures contracts price the August policy rate (the Fed’s next meeting) at 1.51% and the eventual December rate was pricing in a 2.25% rate from the current 1.00% funds rate target.
Some economists are voicing the opinion that higher interest rates may actually be a net positive for the markets. While higher interest rates make some home loans, consumer loans, and credit card debt more expensive, higher rates are not all bad news. Higher rates bring increased income from money market accounts, certificates of deposit, and new purchases of bonds, for example. By some estimates, the average American household has more assets than liabilities that are interest rate sensitive — so a rate increase could actually be a net positive for the average consumer. In other economic news, underfunding at U.S. companies with severe pension shortfalls fell slightly last year to $278.6 billion, but was still much worse than five years ago, the U.S. pension agency said Thursday. The Pension Benefit Guaranty Corporation, which insures the private pensions of about 44 million Americans, said aggregate underfunding was down in 2003 from $305.9 billion a year earlier. However, the number was up dramatically from just $18.4 billion reported in 1999, before an economic recession and stock market declines hurt many companies.