As we now realize, the first quarter of 2005 was not a stellar period for investors…so the saga continues and patience wears thin. Meanwhile, home prices skyrocketed along with a few select commodities, which tempt investors into often paying irrational prices in the search for higher returns. Our immediate outlook is, unfortunately, for more of the same over the very near term. (See Harlan B. Cadinha’s Market Overview enclosed.)
Cyclical economic and monetary forces, which normally precipitate cyclical market moves have become increasingly negative. While Federal Chairman, Alan Greenspan takes money and liquidity from the system, the price of oil promises to take away spending power from consumers. Regulatory policemen are “raiding” Wall Street, costing shareholders billions of dollars. Clearly, the cyclical perspective reveals the well-marked tracks of the bear. Investors who chased the highflying commodities are starting to feel the pinch of correction. Our portfolios by and large are well structured to survive the cyclical bear, and in most instances outperformed comparable market benchmarks for the quarter. The nominal results, nevertheless, are nothing to write home about…
History tells us that upside excesses are usually corrected in a cyclical bear market. The signs of trouble brewing are evident in the single-family home market as “Fannie and Freddie,” the two mortgage lending giants, came under government scrutiny. The oil market, as well, shows signs of hoarding and inventory buildups along with speculative buying. Accordingly, a $35-40/bbl oil price this year will not surprise us. There is little doubt that the cyclical bear is alive and well in the markets.
Having said all of that, we still need to examine the secular (long-term) case in order to put things in proper perspective.
Economic growth and solid corporate financial results continue unabated. In fact, corporate balance sheets sport twice the level of cash than normal. Inflation may appear to be heating up, but under close examination, we find the inflation thesis totally dependent on higher home prices, higher oil prices and a weaker dollar. Our hunch is that these will not continue.
Democracy in the Middle East is becoming a fact of life, and the world somehow feels a little safer as a result of America’s efforts.
At home, we are enjoying the lowest dividend and capital gains tax rate in over half a century.
Unlike many of our trading partners, we are beginning to address our societal weaknesses, and while distasteful, this process is healthy. Social Security and Medicare will be a problem unless we “fix” the system.
Unlike many of our trading partners, we have yet to address our convoluted and stifling tax code. Germany has dramatically cut corporate taxes in order to foster growth. Russia, Czechoslovakia, Poland and China have all settled on an upper tax rate of 20% or lower. Americans will need to realize that in order to be competitive, we too must restructure our tax code. This debate is right around the corner, and the battle looms on Capitol Hill.
These secular characteristics are clearly bullish, and while the bear does his cyclical damage, the bull is becoming more evident. They are indeed strange bedfellows, but this is not the time to ignore the bullish signals. It is a time to remain disciplined and balanced with an eye on true value. We continue to direct our efforts at employing the appropriate portfolio risk for each client. This focus has helped keep client wealth intact through many previous cycles.
As I did 17 years ago, I am enclosing an excerpt from a book written by Claude Rosenberg, which illustrates various market phases and the propensity for clients to be caught “zigging while cycles are zagging”. In the words of the author, “It would have taken one very flexible (and very fortunate) manager to shift profitably through the full spectrum of changes that occurred over the 17 years.” While reviewing this, please keep in mind that five years ago the Dow Jones Industrial Average was 11,900 or 13% higher, while the NASDAQ was 5,000 or 155% higher. In short, keeping your capital intact is still our primary objective. Better days should be around the corner.