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Born on the Fourth of July I hope everyone had a festive and safe holiday weekend. I have been digesting the economic events and data over the last six months this past holiday weekend and have a few thoughts on the markets and our investment strategy. First I want to review the data from the first six months. In absolute returns, the S&P 500: -1.70%, the Dow Jones Industrial: -4.71%, and the NASDAQ: -7.8%. The best performing sectors were energy: +18.84% and utilities: +13.16%. The best performing stock strategies were low price to earnings: +7.30% and dividend yield: +2.35%. The major U.S. Stock indices declined due to concerns over rising oil prices and growing fears of inflation. The bond market had positive performance. The three month T-Bill: +1.29% and the long term treasury: +9.40% for the first 6 months of 2005. International stocks posted slightly negative returns in U.S. Dollar terms, with the dollar appreciating versus foreign currencies. |
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Now for Analysis I believe we have 3 main issues to address- The Fed, The Global Financial Community and Oil. Are we entering an economic slow down? I am a big believer that the bond market is a forecaster for the economy. Given that the Fed has raised rates at nine consecutive Fed Meetings, the yield curve is becoming inverted. An inverted yield curve is when short term interest rates, yield more than long term interest rates. This condition is negative for the economy and the banking system. As the Fed raises rates, the operating margins of banks get "squeezed". It costs banks more to borrow money short term thus they make less when they lend the money long term. Alan Greenspan knows the possible damage of an inverted yield curve. In the last 100 years we have had an inverted yield curve eight times. Six times we slipped into a recession. The Fed is trying to orchestrate a "soft landing" for the economy. There is a lag between setting monetary policy and the real outcome in the economy. In the interim we can have an economic slowdown. I hope the Fed does not over estimate the strength and resilience of our economy by continuing to raise short term rates. On June 30, 2005 the Federal Reserve raised the federal fund rate by 25 basis points to 3 ¼ percent. By the way, banks raised the prime rate (the rate they charge their best customers) to 6 ¼ percent. The prime rate one year ago was 4 ¼ percent. The fed states "the stance of monetary policy remains accommodative and coupled with robust underlying growth and productivity is providing support to economic activity." They further state "the pressure on inflation has stayed elevated but long term inflation expectations remain well contained." This response indicates that the Federal Reserve is not done raising rates. The next Fed meeting is August 9 th. The market has been anticipating the Fed would stop raising rates in November. I believe the market reaction is premature. Recently, the dollar hit a nine month high against the Euro and Japanese Yen and productivity is increasing per worker. These two indicators have been the focus of Alan Greenspan and the Fed. They have the green light to raise rates. It looks like the long end of the yield curve might pull back sending long term rates higher. The long end of the yield curve is used to determine mortgage rates. Foreigners have had a huge appetite for our treasuries. I sense the tide is turning. Given the events of the last three months foreigners are starting to buy Hard Assets. IBM sold their PC business to Lenova ( China 's state-owned PC manufacturer). Last month the Chinese bought the largest tar sand company in Canada . A consortium of Bain Capital, Blackstone Group and China 's Haier America made a bid for Maytag. Also, this month CNOOC ( China 's state-owned oil company) made a competing bid for Unocal (a U.S. oil producer). Soon we will see if we truly have a free market economy. I want to make a few comments on the price of oil and how it affects our view of investing. Globalization is not going away. China and other emerging economies are going to compete with the U.S. on the Global Energy Market. Just the marginal demand from China will push up energy prices over the years to come. The United States can only stem the price increases by conservation, investment in alternative energy and new exploration. Oil is currently sitting at $60.00 a barrel. I have a sense it is likely to move higher than lower in the near future. The good news is the consumer is already adjusting to the higher prices. After the first big jump in oil prices this past spring consumer confidence numbers dropped precipitously. Recently the confidence numbers have rebounded to 3 year highs, yet oil prices continue to climb. What matters is not the price but the rate of the price change. The pundits say that as gas prices climb it acts as a tax on the consumer. This is true but as unemployment falls, disposable income rises. If unemployment continues to fall this so called tax could be absorbed. Also, keep in mind that gasoline consumption peaks about 2 weeks before the July 4 th and again around Labor Day. Gas demand will drop and so will the price. Gasoline prices will not wreck the economy alone. The activity of the fed and slope of the yield curve shapes Karp Capital's money management strategy and financial advice. I have not changed my position this year. The next six months should be like the last six months.
Now is the perfect time to re-position your investments for the next upturn in the market. The S & P 500 is trading at approximately 15 times estimated earnings. The stock market is at the deepest discount relative to bonds in approximately two decades. When the Fed stops raising key interest rates, this could be the catalyst for the stock market to have a significant move to the upside, allowing price/earnings ratios to finally expand. You need to be prepared and patient. Some Action Items for Clients: Please call me, if we have not already scheduled your mid year review. Given the current historical low interest rates, please call me to review your current real estate loans. If you have an adjustable rate loan (one month, 6 month or LIBOR) do not miss this opportunity to lock in a low fixed rate. When the Fed raises rates, your payment on adjustable and equity line loans will go up. I will custom design a mortgage for your financial needs. If you have any questions on the analysis above, or know someone that would benefit from a clear and concise investment plan, please call me at 415-345-8185 or 877-900-KARP. I look forward to hearing from you.
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