Back to Quarterly Letters

Back to Quarterly Letters || Previous Letter || Next Letter

Quarterly Letter to Clients

April, 2006

Indices at quarter-end (March 31, 2006):

Dow Jones Industrials: 11,109.32 1Q'06 +3.66% YTD +3.66%

Standard & Poor's 500: 1,294.83 1Q'06 +3.73% YTD +3.73%

January was an eventful month at the Fed; they raised rates for a 14^th consecutive time and Alan Greenspan retired after 18 years in the top slot, yielding his position to Ben Bernanke.

It was a pretty good month for equities, too. So were February and March, as stocks elbowed their way nicely higher. Bonds weren’t quite so fortunate during the first quarter, as rates edged up in response to the constant Fed pressure.

Speaking of interest rates, and pressure, as the quarter drew to a close, the Fed once again raised them, this the 15^th consecutive quarter-point boost. The Fed went further, hinting that more rate increases are in the offing. One wonders if – or when – the markets will catch on to the fact that interest rates have moved up. The rate curve remains very flat, though the long end does seem to be showing some signs of normalizing (read: rising).

The gain in stocks during the quarter was certainly welcome. All of the broad popular averages hit 5-year highs, though the high water mark set in 2000 remains just a little out of reach. Nevertheless, we cannot help but be pleased to see some upside after these last few years of lethargy.

The stock market is overcoming a downturn in housing—widely anticipated, and finally upon us—and the apparent demise of the American automobile manufacturer. (I, for one, while recognizing their problems, am not yet ready to count GM and Ford out.) It is also ignoring the war in Iraq and the steadily increasing price of oil. And the rise in the price of gold reflects concerns about our currency. Given these things, the strong economy and high level of consumer sentiment is surprising.

Some people would have you believe that tax cuts are the factor that has driven the economy, and they have doubtless helped. If true, perhaps we should cut taxes to zero and really have some fun. But, joking aside, we have to recognize that a large part of the resilience in the economy is probably due to the deficit spending that our government appears to be addicted to. All of that excess cash sloshing around is good for business, as long as the public continues to believe that there is no inflation. It is also a factor in keeping rates low (and bonds high), as money competes for yield. Eventually, a future president will try to rein in debt and right our financial ship, and we will pay the price for our excesses. But for now, enjoy the ride.

For quite some time now it has been a market led by small- and mid-sized companies, as the stocks of our nation’s giants (outside of energy) slumbered. They remain somnolent for the most part, although, as always, there are some notable exceptions, the aforementioned oil being a prime example.

Thus, while holders of Exxon and it’s peers have been happy, those who held companies like GE, Home Depot, AT&T, Intel, Coca-Cola, Microsoft, IBM, all of the major pharmaceuticals, all the major foods, etc., etc., are perhaps wishing they held gold stocks. The Street has long expected that the large-caps will resume their market leadership. To that I would say, “maybe, but don’t hold your breath”. Better to balance your holdings across a wide spectrum, of industries and sizes, and to include bonds and convertible issues.

What can we expect going forward? There is a slight seasonality to the markets, and we have just finished the strongest season. So we can expect a less ebullient market in the second quarter. I remain positive in my opinion of the year yet to unfold, though I do not look for double-digit gains this year or next. Bonds will almost certainly be muted. Our balanced approach should serve us well.

Jim Pappas