Date(s) - 11/09/2006
November 9, 2006
P.L.A.E. Restaurant, Amelia Island Florida
Let’s formally begin by thanking everyone for attending this seminar and I hope everyone is enjoying the fellowship here tonight.
Before we get into the investment portion of our seminar, let’s briefly discuss our firm’s portfolio management services and how they relate to financial planning. We’ve tried to distinguish our efforts as your investment advisor compared to our efforts as your CPA-Financial Planner. In addition to our portfolio management services, we stressed the importance of the financial planning process and how we should embrace the “net worth” concept as the true measure of success in achieving our goals. This is why A.B., Terry and I are always working together to help each investment client achieve their overall financial goals.
Now, let’s start the investment portion of our seminar by going over the investment climate in general. Let’s repeat what we have done in the past by discussing what we reviewed during our last seminar in 2005 as far as our investment strategy for 2006 and then discuss what we should expect for 2007.
As you may recall, we continued to believe that we were in an earnings driven bull market. We felt that as long as earnings continued to rise, our high-yield value and growth type of investments in stocks would trend higher for 2006, which they have done thus far this year and expect the trend to continue for the remainder of this year and throughout 2007.
As far as the bond market is concerned, we paid close attention to the benchmark ten-year Treasury note with the expectation that the Federal Reserve Board would continue to drive up short-term borrowing costs to a five-year high. As the Federal Reserve stopped raising interest rates in the second quarter, rising bond yields began to stabilize and reversing their trend. In fact, throughout the third quarter, falling Treasury bond yields fired up investor’s appetite for a wide range of interest –sensitive stocks, from banks and utilities to real estate investment trusts. By the middle of October, this impetus for the run-up in stocks seems to have faded due to a small “correction” in our Treasury bonds.
As far as oil prices are concerned, our biggest concern continues to be the intensifying critical relationship of the narrowing gap between supply and demand. During 2006, energy prices have continued to go up and averaged their highest levels in history before they started coming off their highs recently in the third quarter.
In addition to the above factors, the housing market has been hurting lately, especially in parts of the country (such as the coasts) where prices climbed too fast. The Dow Jones U.S. Home Construction Index made what appears to be its low for the year in July. Since then, the stocks in that index have bounced up about 20%. Even though homebuilder stocks are very volatile, the pattern is encouraging and hopefully home construction and house prices should stabilize nationally during 2007.
Yet, despite all of these negative factors (and many more), the stock market was beginning to act as if it never wants to stop going up. The Dow Jones Industrial Average crossed its old January 2000 peek, finished above the 12,000 level and surpassed it several times. The broad Standard & Poor 500 Index surpassed its highest level in more than five and a half years (February, 2001) and the technology focused NASDAQ Composite Index is currently up for the year. The stock market is determined to make 2006 a rare phenomenon. We’ve just wrapped up another astonishing month for the stock market – the ninth winning month this year out of 10 for the S & P 500 Index. The last time the S & P posted nine up months in the January – October stretch was 1996, and before that, 1964. So the persistence of the rise is truly extraordinary. Having defied history before the election, the stock market hardly took a pause for breath.
And now that the midterm elections are over, the financial markets are bubbling with speculation about the impact of the big Democratic gains in Congress. As investors, it’s crucial for us to put aside our emotions about the election results – and think calmly and clearly. Whether you were pleased or saddened by the election’s power shift, the bottom line is that we’ve now got a divided government. It will be very difficult for either party, Republican or Democratic, to impose its agenda on the nation. For the next two years, it would appear that passage of any radical legislation is very unlikely. More specifically, punitive, business – hurtful legislation is not likely to pass, especially since President Bush still holds the veto pen. Anything is possible but we doubt that the financial markets will see any significant weakness.
Now that we’ve reviewed 2006, let’s take a look at the direction of the market for 2007. First of all, if you read our quarterly newsletter, you would realize that we are hopeful that Ben Bernanke and the Federal Reserve Board’s tight – monetary policy should start reversing its course by cutting short-term interest rates very soon, perhaps as early as the first quarter of 2007. According to a recent report, the economy has slowed to a snail’s pace, growing in the just-finished quarter at the slowest rate in more than three years. On Friday, October 27, 2006, the Commerce Department reported that economic growth during the July – to – September period clocked in at an annual rate of just 1.6 per cent instead of the 2.1 per cent forecasted. This sub par performance mostly reflected the deepening housing slump. Then, for the week ended November 3, 2006, investors’ expectations about economic growth were turned inside – out by the hot – and cold employment data that sent stocks lower and sparked the biggest rise in Treasury yields in more than a year. Analysts felt that uncertainty, more than outright bearishness about the economy’s prospects, were putting the market in a transition period. Bond traders said the data – especially the falling unemployment rate – drove home the point that inflation is still a concern – and that Federal Reserve officials won’t cut interest rates soon. However, this data mitigated concerns that a sharp housing down turn will sink the economy.
As far as we’re concerned, we haven’t changed our strategy or our outlook for the market. We feel that the market is undergoing a normal, and very healthy, midcourse “correction”. We don’t expect a repeat of the 2006 pattern from this point forward. Down months will become more frequent, and volatility (in both directions) will likely pick up. Nonetheless, the sweeping move we’ve seen thus far does imply that the bull will remain in the driver’s seat through at least 2007, supported by steady- if somewhat more modest – corporate profit growth, as well as lower inflation and interest rates. The challenge, at this point, is to find individual stocks and mutual funds that are still priced cheaply enough to allow for double-digit appreciation.
At this time, let’s review what our quantitative standard measures of success.
First of all, we’ve established that our goal should always be to beat the broad Standard & Poor’s 500-stock index year after year. However, depending on your individual goals of risk vs. reward allocation, one should use patience in evaluating the desired results depending on the make-up of the individual portfolio. Sometimes, a three or five year time frame would be a much better indicator of achieving the desired results. This would specifically apply to a portfolio that is made up of growth and value equity stocks as the majority of our portfolios fit into this category. However, as we come close to retirement, our fixed income strategy has to be an integral part of our goal. Our fixed income strategy, even though it is expected to provide us with less after tax yields, its purpose is to provide us with some reasonable measure of income that we can fairly rely on during our retirement years. We developed our fixed income strategy through the purchase of equities such as preferred stocks, REIT’S, Limited Partnerships as well as bonds.
Each client has their own individual quantitative as well as qualitative goals but I felt that this model equity portfolio would provide us with the basic make-up of all of our portfolios so we can use for purposes of tonight’s discussion. As you can see, we’ve made a few changes in the set up of the model portfolio to make it more informative and useful for our purposes. Keep in mind that this model portfolio does not replace each client’s individual goals but merely serves to identify the population of stocks that we own for purposes of tonight’s discussion.
Currently, as the model portfolio reflects, we are currently invested 80% in equities and 20% in fixed income, with the majority of the fixed income being in long-term U. S. Treasury bonds. As far as the equity portion of our portfolio is concerned there were very few deletions. We sold all of our positions in Waste Management and Tricon Global Restaurants because they approached their full value. We reduced our position in U.S. telecoms and added more foreign telecoms such as Deutsche Telecommunications, which provide us greater dividend yields.
However, most of our efforts were spent in raising cash for the purpose of adding positions to our portfolio. Even though we added some new names such as Anheuser Busch, Zimmer Holdings, Dell, Dow Chemical, Washington Mutual, Willis Group Holdings, Rayonier, Carnival Corp., Walgreen’s and Home Depot, our biggest concentration was in natural resources and petroleum. We added to our position of natural resources with such names as Buckeye Partners, Chesapeake Energy Corp, Enterprise Products Partners and Energy Resources Fund. We also added to our position in the petroleum sector due to the recent slide in crude oil prices. We took advantage of some excellent values by adding such names as China Petroleum, Conoco Phillips and Occidental Petroleum.
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.