THE MARKETS
A slew of negative news couldn’t hold down stocks last week as the Dow Jones Industrial Average had a minor loss while the NASDAQ ended the week in positive territory. Things looked bleak on Wednesday as both indexes dropped to yearly lows on the heels of the WorldCom blowup. However, an impressive turnaround accompanied by heavy trading volume late Wednesday sparked hopes that a rebound was at hand. For the week, the Dow lost 14 points (-0.2%) and closed at 9239. The NASDAQ flirted with its September 2001 low on Wednesday but managed to gain 22 points (+1.5%) for the week and settled at 1462.
Accounting blow-ups are losing their shock value, as investors have largely brushed aside the Xerox and WorldCom news to focus on mixed but generally encouraging signs from the consumer economy. WorldCom, which had been the subject of an ongoing SEC investigation, disclosed earlier in the week that it incorrectly characterized debt as a capital expenditure, meaning stated profits were in fact much lower than investors were led to believe. This is a problem. Xerox, which will need to restate its Profit & Loss a second time after absorbing a $10 million SEC fine for its first mis-statement, is getting a big-time haircut; the shares are trading in the $5-$6 range. But the bad news has not spread much beyond the Xerox and WorldCom shares. Earlier in the week, DuPont Corporation guided analysts toward a higher than expected quarterly profit. At the other end of the manufacturing economy, basic materials stocks rose on improved expectations from Alcan, the number two North American aluminum maker.
Investors had been hoping for a positive end to what has been an ugly quarter, while acknowledging that even a huge surge won’t rescue the quarter from another very poor three-month performance. The bulls are reassuring one another that the worst of the accounting mess is behind, that a strengthening economy will support solid sequential profit gains across traditional corporate America. The bears are waiting for another accounting shoe to drop, and hoping they don’t get Imelda Marcos’ closet-full.
THE COMPASS PORTFOLIOS
The Compass Portfolios finished out the quarter significantly ahead of the major market indexes. To state that the 2nd quarter of 2002 was ugly would be an understatement of epic proportions. The Dow Jones Industrial Average finished the quarter down 11.16%, the S&P 500 down 13.73% and the NASDAQ 100 down an unbelievable 27.57%. The Compass Portfolios continue to hold significant cash and money market positions which buoyed client positions during the recent downturn, as compared to the overall markets. While each client portfolio is managed independently and so each portfolio will perform differently, we strive to mimic the performance of the model. Client statements and model portfolio performance data will be sent out early next week.
In a related development, Starting July 1st, 2002 The Appleton Group will be listed in Morningstar’s database of separate account managers. We look forward to telling our story to as wide an audience as possible, and we consider it a great privilege to work with such an influential and renowned organization. The Appleton Group’s model portfolio results will be compared to separate account managers across the country, allowing our clients and friends the opportunity to view relative statistics on model performance, volatility, investment style, investment risk, fees, style consistency, and much more.
THE ECONOMY
While the Fed kept the benchmark Federal funds rate target at 1.75% and retained its neutral policy bias — which sees risks evenly balanced between inflation and slow economic growth — it did take a slightly more dovish tack on the economy. (Policy “doves” believe that fostering economic growth takes priority over controlling inflation.) Though the Fed stood scrupulously clear of developments in the financial sector, it did acknowledge that “both the upward impetus from the swing in inventory investment and the growth in final demand appear to have moderated.”
This statement vindicated market observers who had been expecting policymakers to take a more dovish slant. The FOMC still expects the rate of increase in final economic demand to pick up over the coming quarters, buttressed by strong productivity growth. Most important, the Fed said “the degree of the [economic] strengthening remains uncertain,” though it did stop short of dropping any hints about stepping back from the neutral policy bias while most recent real economic indicators continue to point toward a consolidation of the recovery. The roll call of the vote by committee members to leave policy unchanged was unanimous.
Personal income rose a healthy 0.3% in May. Personal spending slipped 0.1% in the month, against expectations of a flat reading and April’s 0.5% gain. Still, the headline number is not as bad as it seems, given the effects of cool weather on apparel sales last month. The difference between the two numbers means that Americans have decided to save (and eventually invest) more. The bigger news was that consumer confidence slipped to 92.4 in June, not the 90.8 previously reported (the prior-month figure was 96). On the industrial side of the economy, the Chicago purchasing managers’ index for June came in about as expected, at 58.2 — down from 60.8 reported for May, but still well north of the 50 demarcation, above which signals expanding manufacturing activity.
