THE MARKETS
The bulls were able to put together a winning week feeding off of a positive fed meeting and news that 3rd quarter Gross Domestic Product grew at a 7.2% pace. This was the highest growth rate since 1984. The market action was broad based as several of the major averages posted new recovery highs. For the week, the Dow Jones Industrial Average was up all five trading days gaining 219 points (+2.29%) and closing at 9801. The NASDAQ gained 67 points (+3.59%) and closed at 1932.
The majority of S&P 500 companies have reported their quarterly results, and Standard & Poor’s estimates that final third-quarter operating earnings on the index will be up 23% from a year ago. This data primarily reflects the effects of a weaker dollar (which helps exporters) and continued cost cutting measures. Although Standard & Poors expects the torrid pace of the profit advance to slow, they still see good earnings growth for the remainder of this year and next. Valuation is always a legitimate concern, and investors will need to consider the degree to which improved expectations are already being priced into the markets.
THE COMPASS PORTFOLIOS
No changes to our models once again. The supportive trend certainly was evident last week as portfolios have been propelled to new highs. Our reallocations earlier this year away from fixed income securities and toward equities has kept portfolio performance at increasingly effective levels. Being rigidly invested in a particular allocation at all times ignores the real possibility that a significant portion of an investor’s assets will be unproductive at best, and could potentially expose the client to significant risk. As a prime example, Standard & Poor’s currently recommends holding 25% of an investment portfolio in cash, a very defensive stance despite increasing evidence of an expanding economy. Higher cash positions are often used to reduce volatility, not exactly what you want in a year which has seen the markets rise 19% or more when volatility is most welcome. This significant defensive position would have been prudent during the bear market (when the economy was demonstrating contraction), but not during an increasingly improving economy. The strength of the Compass Wealth Management Discipline lies in its ability to be flexible, responsive to changing market and economic conditions, and prudent in its use of assertive and defensive postures.
I would like to briefly address the increasing mutual fund scandal gaining press coverage. You may be aware that several mutual fund companies have either been indicted for or have been alleged to have put the interests of fund managers and/or fund executives ahead of their obligations to their shareholders. If true, these institutions have certainly violated their fiduciary oath which mandates that shareholder interests come first. Many of you are aware that The Appleton Group has been structured to address conflicts of interest by eliminating commissions paid to our firm, eliminating any financial relationships with mutual fund companies/brokers/custodians, and by relying on objective and unbiased research to generate portfolio management decisions. One other way we further eliminate conflicts of interest is by using index mutual funds that trade on an exchange. You see, mutual funds essentially take care of their own trading and pricing which can lead to the kinds of abuses now being uncovered. The overwhelming majority of the funds we use are priced every second on an exchange, reflecting up-to-the-minute data and eliminating the possibility of improper trading. Any traditional funds we use are carefully selected and regularly scrutinized to ensure they meet our clients’ requirements. We pledge to our clients our very best efforts to ensure continued objectivity, care and diligence.
THE ECONOMY
Briefly, at the Oct. 28 policymaking meeting, Alan Greenspan’s Federal Open Market Committee opted to keep the benchmark Federal funds rate anchored at 1% and maintained that policy accommodation could remain in place for a “considerable period.” The move also reassured investors that there would be no rhetorical U-turn, signaling a possible change in the Fed’s “accommodative” stance — at least until the FOMC’s next meeting, on Dec. 9. Whether such optimism is sustained through the interim will depend in large part on some important economic reports in the pipeline. The policy statement issued at the conclusion of the meeting demonstrated Greenspan’s complete mastery of strategic minimalism, aimed at avoiding undue market disturbance.
The markets warmly received the FOMC’s words. While Treasuries enjoyed a sharp relief rally in the wake of the as-expected statement, and stocks also managed to build on earlier gains, closing solidly higher.
In 2004, the Fed should shift to a tightening bias by the first quarter, with a start in the tightening cycle around midyear. The Fed may still have some time before policy accommodation for a “considerable period” becomes a “finite horizon.” But forthcoming data could stretch the central bank’s credibility, should it wait too long.
