Thursday, October 05, 2006

New High for the Dow

There has been much ink spilled this week about the Dow Jones Industrial Average making a new all time high. Frankly, it's just a number and it doesn't mean all that much. The components of the Dow have changed pretty dramatically since 2000 so the average making a new high now is not comparing apples to apples. More like apples to kiwi.

More important to us is the relative performance of the various asset classes in which we invest our clients assets. Our large cap emphasis has paid off recently and we expect that to continue. We have also been underweight the commodity indexes and that has certainly turned out to be a good move with the GSCI taking a pounding over the last couple of months. Unfortunately, our crystal ball isn't perfect so we do have exposure to commodities and that has hurt our performance somewhat during this time, but overall we've had a good 3rd quarter.

The market is starting to anticipate a rate cut by the Fed and that has been the driving force behind this stock rally. The economy is slowing with housing leading the downturn. No surprise there; we've been talking about that for a while too. However, we still believe the housing market will not take the whole economy down for the count. Just this week, the Mortgage Bankers Association reported that mortgage applications jumped impressively over the last month. Refinance applications were up more the 17% and purchase applications were up about 7%. Lower rates are having the expected effect. There's probably some more pain to be seen in the housing market, but so far the correction has been rather orderly.

As for the Fed, we don't expect them to cut rates anytime soon. The yield curve is still inverted and all Treasury rates are less than the Federal Funds rate, but with the way the banking system works today, we don't think that means as much as it once did. The market is setting rates and the Fed, while not irrelevant, is certainly less important than it once was.

We continue to see a lot of positives about the stock market. Sentiment is still pretty negative and valuations, while not cheap, are certainly reasonable. And large cap stocks are still the cheapest part of the market. Falling commodity prices seem to be saying that inflation is moderating and that should be positive for stocks and interest rates.

We'll be publishing our Tactical Update next week.

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