1st QUARTER 2006 MARKET COMMENTARY & OUTLOOK
APRIL, 2006
Over the last three months, the market’s views on the economy have been varied, as illustrated by the equity market performance, which throughout the quarter behaved as if it were taking two steps forward and then one step back. Overall we are nicely ahead but not without some retrenchment along the way. The lack of clear direction for the markets has to do with the crosscurrents that continue to be seen in the reported data.
On the positive side, oil prices which were of great concern just three short months ago, have come down from the high levels we saw at the beginning of the new year. In addition, we continue to experience solid earnings reports and generally optimistic outlooks from companies. For the quarter, the Dow Jones Industrial Average was up 4.0% while the broader S&P 500 Index was up 4.2%. These positive results were challenged by select economic data that are often considered early indicators of inflation and also by a new Federal Reserve chairman who has changed course from his predecessor. At year end, the Federal Reserve seemed to signal that we were near the end of the rate increases (in what is termed a “neutral stance”). In the comments after Chairman Bernanke’s first meeting, the tone has changed to one that appears poised to continue raising rates, signaling continued concerns of inflation. This change in tone has resulted in an upward shift in the entire bond market yield curve, which overall remains extremely flat. As interest rates rose through the quarter, the Lehman Aggregate Bond Index declined .65%. While we do expect longer rates to rise somewhat, we believe they will remain low relative to historical rates due to continued strong demand for our debt by foreign investors. We are not overly concerned by the flat yield curve.
The possibility of a Federal Reserve rate above 5% would be unsettling to the markets. Higher interest rates increase the costs of borrowing for both businesses and consumers. All else being equal, higher rates lead to lower profit margins for companies and an added burden on consumer spending. In addition, changes in interest rates affect both the stock and bond markets. A rise in rates results in a decrease in prices on bonds already issued and at the same time puts pressure on the equity markets as investors become concerned about company earnings in a slower growing economy. In addition, higher rates begin to provide an attractive alternative to the equity markets. Further, the next few weeks will be very telling as companies begin to report second quarter earnings. The earnings reports and management commentaries will provide a window for us to evaluate the effect of higher interest rates on profit margins and the overall outlook for company earnings.
Themes in the markets and the economy evolve over time. One theme that seems to be emerging with little fanfare to date is the possibility of policies that hint of trade protectionism. The U.S. economy and U.S. consumer spending have been strong over the past three years. As producers need capital goods and industrial supplies to support the demand, our imports grow, and yes, our trade deficits rise accordingly. The combination of a rising deficit and issues surrounding outsourcing of labor and homeland security has given rise to trade policy issues that could be interpreted as protectionist. While we believe that these issues need to be addressed, creating barriers to free trade would not serve the economy or the markets well. Closing our borders to product imports would not save or create jobs for American citizens. The United States has long been a strong proponent of global free trade. We trust that in the future rational strategies that allow for continued free trade will prevail. If, however, some of the discussions now taking place were to become policy, our outlook on the economy and the markets would become more cautious.
That said, overall, we are optimistic about the remainder of the year. We expect measured growth to continue to sustain the economy. As has been the case for the last few years, the key to success in the equity markets will be to focus on companies and sectors of the economy that are able to demonstrate growth prospects and improving levels of profitability. A rising tide will not lift all boats; selection remains the key to superior investment performance.
On another note, we are pleased to announce the following changes among our staff. Jeff Malbasa has been promoted to the position of Director of Operations, replacing Lissa Farkas, who resigned to allow herself the opportunity to stay at home to take care of her young family. Kara Downing was promoted to Investment Analyst, replacing Jeff. Further, Erica Aber is being promoted to Manager of Special Projects.
Cori Landphair and Tony Basalla will be joining us in mid-April, both as Assistant Portfolio Managers. Cori will work with Jason Weybrecht and Molly Balunek, and Tony will work with Matt Olver and Deb Boerger.
Roselyn Stovall is leaving us mid-month to enter a new stage in her career with a work schedule more appropriate for her and her family. We want to thank Ros and Lissa for the care and concern they have given in their services to you, our clients. We will miss them, and think of them often with great appreciation for the opportunity to call them colleagues.
Finally, we want to let you know our annual client conference will be held the evening of Thursday, May 25. We will send you more detailed information in the coming weeks. As always, we appreciate the opportunity to be of service, and we value our relationship with you.
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