HO HO HUM

Looking back on 2005 the stock market meandered most of the year, stuck in a tight trading range. Most of the gains of the year occurred in the last quarter. Investors were awestruck by natural disasters, political and corporate improprieties, rising oil and energy prices and the lack of progress in Iraq. In addition, all eyes were on "The Fed" for the majority of the year. The Federal Reserve boosted short term interest rates for the 12th consecutive time as evidence grows that the central bank intends to slow the economy down to prevent inflation from rising. If that were not enough, the so called end of the year "Santa Claus Rally" never happened. The only present under the tree during the quarter was the S&P 500 hitting a 41/2 year high. Where is the enthusiasm for the economy and the outlook for business?

At Karp Capital we choose to look at the U.S. Markets and the World Investment Climate as a market of contradictions. This plays right into our investment strategy. We expect the general market to be slightly higher. Earnings growth has been strong in 2005 with double digit gains in per share earnings. Most of Wall Street has been lowering earnings expectations. We believe double digit earnings will continue for our focus market sectors.

A Market of Contradictions

Analysts expect Gross Domestic Product (GDP) growth on average to be 3.4% for 2006. In fact, we have had 10 straight quarters of at least 3% annual GDP growth and 14 straight quarters of the S&P 500 posting over a 10% earning growth. The S&P 500 is trading at the lowest multiple to earnings in 9 years. Liquidity Tracker reports U.S. public companies announced $456 billion in stock buybacks this year, breaking the previous record set in 2004. Corporate America feels their company stock is undervalued. There is little evidence of a pick up in core inflation. The 3 month change in the core rate is about where it was at this time last year. The dollar continues to be strong against major foreign currencies. Recently the dollar hit a two-year high against the Japanese yen. This is an indicator that global economic communities have confidence in the U.S. Economy.

More good news... We have low unemployment. More people are working than ever before. Consumer confidence has rebounded dramatically since Hurricane Katrina. The consumer makes up 70% of the economic spending. In addition, Mid Term Elections are historically a good time to be in the markets. During the second year in a presidential term fiscal issues are clarified and stocks tend to trend higher. Stocks look more attractive than other investments give the current data.

Where are we going? We believe the indexes will struggle as long as there is no clear direction in the economy. The battle is between the two camps on whether an inverted yield curve (when short term rates exceed long term rates) signals an economic recession. In one camp, the indicators show it is "different" this time. Yields on government bonds seem to be suggesting the recent inflation scare is receding. The other camp looks at history. Gold prices are surging, and are at a price not seen in 20 years. Gold is typically considered to be a hedge against inflation. At Karp Capital our stance is the Fed will continue to raise rates, the yield curve will invert and the overall economy will slow down. An inverted yield curve is not the only sign of an impending economic slowdown. The most common indicator is a tight money supply . If you compare today's rates against historic rates... today's rates are low.

Stealing the Show —Given the current low unemployment rate, the Fed is focused on controlling wage inflation. The key rate is for unemployment to hold at 5%. If we see this rate drop we will definitely see further tightening. Also, the Fed is concerned if energy prices stay at the current price levels there's a potential that we can see higher core inflation. It is our view, given this backdrop, Mr. Bernanke, the new Fed Chairman, will over shoot on tightening the rates. The Fed has never orchestrated a soft landing for the economy. During the last 5 interest rate cycles they have misjudged the strength of the economy. We have a long road in front of us.

Bond Market—As I mentioned in our last newsletter, the market is not paying us to take on risk. We will continue to invest in short term bonds and focus on municipal bonds. Bond returns will be competitive with the returns of the major indexes. Foreign investors are willing to save outside their country. Treasury Bonds provide liquidity and safety. China has a trade surplus with the United States of approximately $200 billion. They receive dollars for goods and services and in turn buy U.S. Treasuries. We believe China and other foreign central banks will continue to have this trade surplus with the U.S and will continue to buy our treasuries. In addition, as long as the Yuan, the Chinese currency, stays low against the dollar, U.S interest rates should be low by historical standards. If you own bonds you should ladder for cash flow. A prudent ladder would be 2 years, 5 years, 7 years and 10 years.

Themes for 2006—Overall, investors are taking on too much risk in their investments. They are anticipating the Fed policy of rate tightening to be nearly over. This is evident because investors are paying more for low quality stocks vs high quality stocks. This is the time to reduce the risk in your portfolio (this includes Real Estate). We recommend investors focus on Large Cap Growth (companies and mutual funds that focus on quality, predictable earnings). We hold stocks with significantly above average sales growth and earnings growth rates. Growth companies perform better than value companies as short term interest rates rise and corporate profitability slows. Our sector focus includes the following: Healthcare, Utilities, Energy and Commodities. Our overweight position in the energy sector continues to help the performance of our portfolios. Over the last quarter we have seen the future prices at the same level as the spot prices. This is an indicator that energy prices are expected to stay at these prices for the foreseeable future.

Gold and inflation—I will be adding gold to our portfolios. Historically, gold has been used as a hedge against inflation and a safe haven when investors feel that economic conditions are deteriorating. There have been structure changes in the global economic community. The world economies are awash in cash. I believe the continued rise in gold will be due to the fact that countries with a large trade surplus with the U.S. are looking to diversify from their ever growing treasury portfolios. Given this backdrop, I believe gold will continue its climb.

Action Plan—As I have mentioned in my last 3 quarterly newsletters, now is the time to refinance. Short term interest rates are now above long term rates in a few maturities. When I first approached our clients it was right before rates were at historic lows. If you have an equity line, convert it to a fixed rate loan. If you have an adjustable rate loan don't wait until your next adjustment period. Refinance now. Also, I have been getting the question, "How do I take advantage of the cresting real estate prices and lower long term rates?" Most people have the majority of their assets in Real Estate and are under funded in their retirement plans. As I mentioned earlier, either reduce your exposure by selling a portion of your real estate, or refinance, pull out cash and lock in some gains. I have a strategy to help fund your retirement. I will custom design a mortgage to help you reach your financial goals.

Over the last year I've had numerous strategies that have been very profitable. There have also been some losers, that is part of managing money. The key to long term performance is risk management, asset allocation and having a well defined investment plan. By establishing these basic principles we have conviction when we invest. This allows us to help the clients of Karp Capital Management reach their financial goals.

Have you ever felt...

• I spend too much time managing my money and not doing the things I truly enjoy.
• I am close to retirement and need help getting my personal finances in order.
• I am turned off by the never-ending hype of products and services by Wall Street.

If you answered yes to any of these questions it is time to create and implement a clear, concise investment plan. Make a conscious decision to manage your finances on your terms.

Please keep in mind we appreciate your support at Karp Capital and are flattered when you refer your family and friends. If you have any questions on the analysis above or know someone that would benefit from working with us, please call me at 877-900-Karp. Working with Karp Capital, there is only one boss...you.

Peter Karp

Karp Capital Management
Registered Investment Advisor
2269 Chestnut St. #308
San Francisco , CA 94123
(P) (415) 345-8185; (F) (415) 869-2832

peter@karpcapital.com

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