What are the holidays without a little holiday cheer? Investors had much to be thankful for in the 4th quarter of 2006. In the U.S. we continue with strong corporate earnings along with moderating inflation, lower treasury yields and lower commodity prices; all of which spurred a few of the major averages to hit record highs during the quarter. Because of this, investors were able to settle in comfortably with the idea of slowing economic expansion. The market friendly economic data allowed the Federal Open Market Committee to leave the overnight federal funds rate at 5.25%. With the Fed on hold and inflation apparently under control, investors seem to have faith the economy will have a ‘soft landing’. In this installment of Karp Capital Focus we reflect on our recommendations of the past year and look ahead to what’s in store for investors in 2007.

Here are the performance numbers for the major indices for 2006. (Total Return)

Deck the Halls

Data from the economy shows growth is slowing in the U.S. When taken into consideration with the bond market, characterized by an inverted yield curve, this suggests a possible recession in 2007.

For the last month, gasoline prices have been on the rise while Treasury Inflation Notes have been falling and recently leveled off after hitting a high in June.
Rising labor costs, currently at an 8 year high in terms of real wage growth, are also a concern because they cut into corporate profit margins. And so the rising cost of labor has been a central focus for the Fed.

Because the economy is still digesting the rate hikes of 2005 and 2006, we think it’s premature to speculate the Fed will cut rates in the first or second quarter of 2007. At present, the Fed is in the midst of a delicate balancing act; adequately raising rates to forestall inflation while being careful to avoid the onset of a recession.

It Is A Wonderful Life

Setting the data aside, there is evidence stock prices will continue to rise in 2007. The supply of stock has been decreasing, while private equity firms have been on a buying spree of public companies. Given the forecasted economic and political landscape, we believe the market could experience a low, double-digit gain for 2007. Finally, we would be remiss if we did not mention that the third year of a presidential administration has historically been the strongest of the four-year presidential cycle. With the split in congress, it’s doubtful any laws will pass that might curtail economic growth. However, this isn’t to say the markets won’t pull back before climbing in the New Year. The dollar continues to weaken and the political saber rattling with China and Iran should give the markets cause for concern.

When taken together, these very real concerns should continue to fuel the volatility of the markets. In fact, the dollar recently hit a 20-month low against the Euro and has been falling steadily against the Yen. To allay these concerns we choose to hedge our stock exposure by positioning the EURO (symbol FXE) and Gold in our portfolios as opposed to cutting our equity weighting; all of which leads us to our tribute to the late Milton Friedman.

Milton Friedman, a retired professor of economics at the University of Chicago and one of the world’s leading proponents of the importance of the free market, died Thursday, Nov. 16, 2006 in San Francisco at the age of 94. He was the premier spokesman for the monetarist school of economics and a pioneer in promoting the value of free market economics. His influence was far reaching, impacting the likes of Ronald Reagan and Margaret Thatcher. Leaders were won over by Dr. Friedman's idea that the supply of money was the key factor in determining economic growth and the rate of inflation. In addition, he helped pave the way for the abandonment of fixed exchange rates in 1971. What’s more, Dr. Friedman can be credited in the development of FOREX derivatives that allow businesses to hedge currency fluctuation. The move from regulation to markets laid the foundation for derivative contracts in heating oil, gasoline, crude oil, and natural gas. While Dr. Friedman will be sorely missed, his visionary principals will continue to live on as we reduce the risk to your portfolio without reducing your exposure to stocks.

Have Faith In The Consumer

Consumer spending accounts for 70% of the U.S. economy. Given the strong employment picture, we believe the economy will slow down but will not slip into a recession. Currently, the unemployment rate is at 4.5%. This is below the level considered full employment. Given that residential real estate prices continue to slide, Wall Street is concerned about the consumer. We think real estate prices will continue to weaken, triggering a change in the consumers’ mindset. They will start to look at their home as a place to live rather than a cash machine. This in turn might persuade the consumer to focus on saving and investing. At present, we have a negative savings rate in this country.

Investment Strategy Revisited

For investors that are new to Karp Capital I thought this would be a good opportunity to review our strategy and investment policy. As we say goodbye to 2006 and head into 2007 we are looking to minimize taxes and reposition accounts for trading opportunities. Most of our realized capital gains this year were from trading our core holdings. We tend to add to our favorite holdings as they approach our buy points. We also rebalance positions if the holding becomes over-weighted given our established asset allocation for the client. This strategy created capital gain distributions in many of our portfolios while experiencing few offsetting losses.

With regard to our core strategy, Sector Rotation, a number of clients have asked why we hold a cash position ranging from 3-10%. One reason we need the cash is to take advantage of trading opportunities. We have seen this more and more as market volatility has increased. Also, we use the cash to rotate into new attractive sectors. The cash allows us to reduce portfolio risk and strive to increase returns. As we stated in our last issue of Karp Capital Focus, “We are sitting with the lowest allocation of cash for our clients for the year. Stay invested.” (Read more on asset allocation Strategy)

The Results Are In

Looking back on our predictions for 2006, we’re pleased to report we were correct more often than not. Sometimes our timing was a little off but this did not hurt performance for our clients. At the end of 2005 we initiated our buy of Gold given our view of rising inflation, a weaker dollar and geopolitical tensions. As of the end of 2006, gold crested on the NY Mercantile Exchange at $638 an ounce. Our favorite sectors were Energy, Utilities and Commodities. All of our sectors performed well except for our healthcare weighting. In fact, our focus sectors were ranked number 2, 4, and 6 as ranked in the Standard and Poor’s 500 respectively. Also at the end of 2005 we suggested limiting your exposure to residential real estate. This worked out well with the National for Sale supply doubling over the last 8 months (source NAR). The Fed did throw us a curve ball when they stopped tightening interest rates during the 3rd quarter of 2006 at 5.25%.

Investment Recommendations

We have every reason to believe consumer spending will continue. This, coupled with more imports than exports supports our view of a weak dollar and a strong Euro. As a result, we would continue to buy the Euro (as well as Gold) on dips. Our recommendation to growth investors remains unchanged; having 25% of their portfolios in international stocks and bonds. Our favorite sectors for 2007 are Telecom, Industrials and Healthcare. We are selectively adding large cap technology to our portfolios. Recently, clients have been asking us about index portfolios. As the markets continue to hit highs and more stocks are on the new high list, indexing becomes a viable strategy. It is essential that these portfolios adhere to asset allocation and rebalancing given an investor’s risk tolerance. Keep in mind the indices are not professionally managed. We have been working on a few index portfolios over the last quarter and they are ready for prime time.

Action Plan

NOW is the time to fund your IRA. Contributions can be made to your IRA for the tax year 2006 up until April 16, 2007, not including extensions. Traditional and Roth IRA contribution limits are $4,000 for each tax year (2006 and 2007). If you are 50 or above, your maximum contribution is $5,000. (Click here if you are a client of Karp Capital)

Business owners should review their corporate retirement plans. Would you like to further reduce your taxes and save more money for retirement? Of Course! Did you put away the $44,000 and “catch up” (Age 50+) of $5,000 into the retirement plan in 2006? (Click here for 2007 plan limits)

We will help you review your plan to make sure your plan is in compliance and also make certain you and your employees have the right plan for your company. Your plan should fit your needs and not the other way around. When was the last time your plan was reviewed? (Click here for the next step in retirement planning)

At Karp Capital we’re here to listen to the concerns of our clients, give sound advice, and execute their financial plan. These attributes make a good advisor a great advisor. If you appreciate this style of financial management and would like to work with an advisor who can satisfy your investment concerns, you have found a home at Karp Capital.

I want to wish everyone a VERY HAPPY AND HEALTHY 2007.

Please remember that we appreciate your support and are flattered when you refer your family and friends. If you know someone who might be interested in our commentary on the market, please share this newsletter with them. If they would like to receive our quarterly commentary please direct them to sign up for the email edition at www.karpcapital.com. In addition, if you have any questions on the analysis above, or would like to review your portfolio’s performance, please call me at 877 900 Karp. Working with Karp Capital, there is only one boss….YOU

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Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of this report and are subject to change without notice. Such options and estimates, including forecast returns, involve a number of assumptions that may not prove valid. Further, investments in international markets can be affected by a host of factors, including political or social conditions, diplomatic relations, limitations or removal of funds or assets, or imposition of (or change in) exchange control or tax regulation in such markets. The past performance of securities or other investments does not necessarily indicate or predict future performance, and the value of investments and income arising there from can fall as well as rise; the investor may get back less than what was invested; and no assurance can be given that any portfolio or investment described herein would yield favorable investment results. We or our associated persons may act upon or use material in this report prior to publication. This document may not be reproduced or circulated without our written authority. Securities offered through Financial Telesis, Inc.