Date(s) - 11/02/2005
P.L.A.E. Restaurant, Amelia Island, Florida
Let’s formally begin by thanking everyone for making every effort to attend this investment seminar. I hope everyone is enjoying the fellowship here tonight and hopefully all of us will leave here with a little more knowledge about investments and how they relate to financial planning.
Before we discuss investments, it’s important that we briefly distinguish between our efforts as your investment advisor compared to our efforts as your CPA-Financial Planner. As your investment advisor, we strive to manage investments which would provide us with a stated rate of return based on the level of risk each of us chooses. Whereas, as your CPA-Financial Planner, we strive to embrace the concept of net worth in the overall financial planning process as our measure of success. The concept of net worth is really a much greater challenge for us because there are quantitative as well as qualitative considerations in both our personal and business lives that we must consider in our financial planning process.
So, what do we do about it? First of all, we start young by understanding the financial planning process. We develop business and personal goals to help us accumulate enough wealth throughout our life to raise a family, go through private tuition and college, retire comfortably on some pre-determined level of lifestyle as well as preparing our marital estate in such a fashion where it will pass on to our intended beneficiaries, with the least amount of total taxes as well as administrative costs that could be depleted from the estate.
Once you accomplish all of that, then you get to not only manage your investments but maintain some pre-determined level of expected income from your investments based on your lifestyle. Some investors may choose to retain the services of outside “investment advisors”, for whatever reason, to manage their assets and have seminars just like tonight. While other investors choose to manage their own investments by following the financial news, get excited by every rally and fearful with every correction. Most of these types of investors are essentially victims of the markets and are almost completely ruled by their emotions. Obviously, there are exceptions, especially to those types of investors who truly enjoy investing their assets and we certainly encourage this. It’s up to you, of course, which group of investors you choose to belong to. Several years ago, the AICPA launched a big campaign to encourage all CPA’s to obtain their Personal Financial Planning Specialist designation in an effort to distinguish the CPA Financial Planner with other investment advisors who have various backgrounds such as banks, brokerage firms or insurance firms. This is the primary reason we, as a firm, decided to incorporate the investment advisory services into our practice.
As far as the investment climate is concerned, let’s start by going over what we discussed at our last seminar in 2004 as far as our investment strategy for 2005 and then discuss what we should expect for 2006.
As you may recall, we were fairly optimistic for 2005. We felt that several critical uncertainties about the economy were lifted for us to have a good year for stocks. President Bush was re-elected along with a supportive Republican-majority Congress. The price of oil had reversed course and was beginning to decline or stabilize. The payroll job numbers were beginning to show strength in the economic recovery. The Federal Reserve gradually nudged up interest rates by quarter-point increases as we expected. All in all, we felt that these signs pointed to a solid economic recovery and would benefit the major stock averages for 2005.
Throughout the year, we’ve tried to keep you abreast of the market with our quarterly newsletter that accompanied each of our quarterly portfolio management reports. As an update to our last letter, dated October 3, 2005, stock prices plunged during the week ended October 7, 2005 as investors panicked over hawkish, anti-inflation noises from several high ranking Federal Reserve officials. We don’t really know for sure, but if they’re correct in their assessment, it could spell higher short-term interest rates than what we expected and an early end to the bull Market. Then, stock prices continued to go down during the following week ended October 14, 2005. However, on Friday, October 14, 2005, Wall Street put on a nice relief rally, despite a government report showing the biggest jump for consumer prices in more than 25 years. During the following week ended October 21, 2005, wholesale inflation jumped by the largest amount in 15 years due to soaring energy prices from the hurricanes. For the week, stock prices tried to climb out of their hole, but with mixed results. Both the Dow and the Standard & Poor 500 Index posted modest losses but NASDAQ gained for the week. Then the same thing followed during most of the week ended October 28, 2005 until Friday. The latest picture of the growth rate of the economy was released by the Commerce Department on Friday. Economic growth of 3.8 percent reflected an even better performance than the 3.3 percent growth rate from April through June.
Now, we feel very good about the year end rally but the real question is the direction of the market for 2006. So let’s review some of the positives as well as the negatives for the economy.
As far as the positives are concerned, the nation’s job market showed surprising strength in September and October despite the loss of hundreds of thousands of jobs in retailing, hotels and restaurants because of the hurricanes. Government employment reports suggest the economy is likely to recover from hurricane season despite higher energy prices of recent months. However, this will keep the Federal Reserve focused on containing inflation by continuing to lift short-term interest rates, which is currently at 3.75%. This was the 11th consecutive increase since the Fed began gradually raising interest rates in June 2004.
In contrast, the pessimists feel that the soaring profits that U.S. Corporations have enjoyed for almost four years may be about to fall to earth. Surging energy costs exacerbated by twin hurricanes along the U.S. Gulf Coast are combining with a tightening labor market, slowing productivity and rising interest rates to threaten the longest period of profit growth since the mid-1970. According to a growing group of economists, corporate earnings, which have increased an average of 15 percent annually since the end of 2001, may shrink in 2006.
However, not everyone is pessimistic. Henry McVey, Chief U.S. investment strategist for Morgan Stanley & Company in New York, predicts earnings of U.S. corporations will rise sharply the rest of this year and in 2006, partly because energy companies will benefit from higher oil and natural gas prices. McVey feels that even though interest rates, labor costs and commodity prices are all rising, they won’t be enough to impede economic growth materially.
As far as the bond market is concerned, we want to pay close attention to the benchmark ten-year Treasury note. As Inflation fears appear to re-surface, it is important that we see bond yields begin to stabilize because rising bond yields continues to be a big concern for the stock markets. However, bond yields appear to be close to an important peak. During the past month, Treasury prices staged an impressive rebound, damping recent bearish sentiment among investors. However, despite the rebound in Treasuries, the bond market remains locked in a debate over what the recent increase in energy prices means for growth and inflation. Many economists were prompted to slightly increase their federal funds forecast with rate increases occurring at the next four Federal Reserve Board meetings between November 2005 and March 2006. Also, next year we’ll have to see how Ben Bernanke, if confirmed by Congress, will lead the Federal Reserve Board as the top official in closest control of interest rates. Hopefully, Bernanke will be confirmed fairly quickly since he was previously confirmed as the top White House economic advisor. Overall, many analysts feel that as long as ten-year Treasury note yields around 4.5%, it should provide further momentum for lower yields, which would be good for stocks and bonds.
As far as oil prices are concerned, it’s mind-boggling how quickly and radically the oil picture has changed. In late 1998, oil briefly touched $10 a barrel. Two years ago, it traded at around $30. Today oil is more than double its price of a year ago and more than six times higher than its late 1990’s low. Rising demand, which points to strong global growth, isn’t necessarily bad if supply is sufficient. Our biggest concern is that while oil prices have exploded over the past six years, the critical relationship behind the uptrend, a narrowing gap between demand and supply, is intensifying. So we’ll have to wait and see how everything unfolds.
Also, you really don’t know how the politics of the situation will affect the markets. Even though we all have our own political views, and I certainly don’t want to impose my viewpoints but I consider myself, as your investment advisor, an economic conservative as opposed to a social conservative. So, we should all be concerned about how much the economy affects the politics of the market. We have to be very cautious until some of these uncertainties are lifted.
For the market at large, we continue to believe that we are in an earnings driven bull market. However, this bull is quite different from its predecessors in the fact that earnings power, not P/E expansion is the primary driver of the total return.
As long as earnings continue to rise, we feel that our high-yield value and growth type of investments will trend higher for 2006. Relative to the blue chip Standard & Poor 500 Index, the technology-freighted NASDAQ moved up for the week ended October 21, 2005 as well as for the week ended October 28, 2005 to a twelve week high. That’s encouraging news because it means that behind the negative headlines, investors are recovering their appetite for risk-taking measures. This is essential if Wall Street is to put on the traditional year-end rally. So, we remain hopeful that a good bounce is in the works.
Before we formally close this seminar, it’s important that I explain to you why Farmand Investment Services, Inc. was established.
For the benefit of those who never heard me explain this, my interest in investments started on June 2, 1984. That was the year my son, Steven, was born and also the time that financial and tax planning became a primary focus in my career. This was also the time when real estate was beginning a downward trend for various reasons. During 1987, Congress pretty much re-wrote the 1954 Internal Revenue Code by passing the 1986 Reform Act on August 16, 1986, which was the date my son, Wesley was born. This caused Real Estate to not only go down, dramatically, but also slowly recuperating and taking at least ten or more years just to re-cover. That’s when I realized that you should never put all of your eggs in one basket. That’s also the time that diversification of your investments became a primary factor in developing a strategy for our style of investing. As much as I loved real estate, I realized, then, that it’s just one asset level of a total diversified portfolio.
At that time, investments became less of a hobby to me and more of a specialty within our firm’s existing clients. Since then, I developed a disciplined strategy for investments and tried to use my background to make it tax-efficient for myself as well as our firm’s clients.
Farmand Investment Services, Inc. was formed on December 14, 2001 and here we are today.We hope you enjoyed this seminar as well as the food and we wish you a great holiday season and a prosperous New Year. And now I will open up the floor for any questions or comments before we go over our equity model portfolio.