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Quarterly Letter to Clients

July, 2005

Indices at quarter-end (June 30, 2005):

Dow Jones Industrials: 10,274.97 2Q'05 -2.18% YTD -4.71%

Standard & Poor's 500: 1,191.33 2Q'05 +0.91% YTD -1.70%

Nine in a row. Fed tightenings, that is. The latest move brought the Fed Funds rate to 3.25%, and I’m still guessing that 4% is the target. The Fed has also tried to jawbone down the red-hot housing market, by stating that Fannie Mae and Freddie Mac should be limited in the amount of mortgages they can purchase. But rates are still historically low, and Greenspan’s moves have not yet significantly impacted the bond market or the housing market, though cracks may be beginning to show.

While I feel a little confused that the bond market has not yet reacted to the Fed, I take some small comfort in the knowledge that Mr. Greenspan also seems addled by the lack of reaction.

So far this year, the markets haven’t been exactly inspiring.

Five years ago the markets were like a balloon releasing its air, bouncing all over the place, ceiling to walls, then finally laying flat on the floor. Which is where they remain today.

Recently I saw a report that highlighted just how difficult this business has been. In a nutshell, it said that stocks have shown negative returns for the five-year periods of 1998-2002, 1999-2003, and 2000-2004. The bottom line is that, on average, stock investors have been hard-pressed to make money since 1999. Three bad years, one good year, and one neutral year hardly make for exciting reading.

And this year hasn’t helped that record. After six months of churning, the S&P 500 managed to briefly edge up to even before again slipping back into negative territory. The Dow and the NASDAQ have yet to climb out of the hole. Every time it looks like we might get up some steam, we seem to hit a wall and fade. Oil prices always seem to be the culprit.

While 2004 was also flat, in the fourth quarter we had the election to snap us out of the malaise. But what catalyst do we have this year? I see nothing on the horizon that might move the market in either direction.

So if you’ve been feeling that your portfolio is kind of stuck in the mud, take heart that your home price has risen so smartly. (Just don’t get too smug about it.)

Although it happened early in the period, the biggest news of the quarter (and perhaps the year) was the downgrade of Ford and GM debt to “junk” status. Some 20 years ago, these two credits were rated AAA, the top of the scale. Until recently both have hovered at the bottom of the “investment-grade” range (BBB-). It’s interesting to me that Kirk Kerkorian finds this an opportune time to invest a billion dollars in GM. It’s also interesting that he already has a nice profit in the position.

Over the years, one of the recurring themes you may have noticed in my letters is that I worry. I worry enough for all of us. But I also have a generally upbeat view of the future. After all, if you are only worried, with no optimistic balance, you would never invest in anything, and you would probably be worried that the money you had stashed in your mattress would disappear in a fire.

So my positive half leads me to sharpen the pencil at times like these, to look harder at securities that I might like to own, and that may have been marked down. I admit to a growing fondness for dividend-payers, a rather new infatuation for me, although I have long sought bonds and convertibles for just that characteristic.

Although it has been frustrating of late, this is a long-term game, at least the way I play it, and we must be patient through times like this. A steady hand on the tiller will ultimately serve us well.

Jim Pappas