“The Other S&P”

Summer 2007

There is an old axiom on Wall Street which suggests that investors should “sell in May, and go away”, or at least to do so until after Labor Day.  This is based upon the premise that Wall Street shuts down on June 1^st and that all of those concerned spend the entire summer lounging on the beach and partying at night in the Hamptons.  The idea is that no one will be trading stocks during the summer months and that investors would be better served to convert to cash on June 1^st and then to wait until fall to invest back into the equity and bond markets. While there always will be certain years where this holds true just by random chance, we think that the catchy phrase greatly under-estimates investing activity in the rest of the world.  There are too many brilliant, highly educated and highly motivated Asians, Europeans and Africans to assume that they will cease to work very hard just because their American counter-parts want a long, leisurely vacation.  The world equity markets have responded to Mid-East turmoil, inflation, earnings announcements and interest rate speculation just as we would have expected them to have responded.   Because we are in the summer months in the Northern hemisphere does not mean that the world of investing ceases to exist.  Therefore, our work persists daily to try to identify trends and fairly priced investments to help your portfolios grow.

First, we’ll review the results of the second quarter as well as the year to date.  It was a very good quarter for the US equity markets.  For the second quarter of 2007 the Dow Jones Industrial Average was up 8.5%.  The NASDAQ composite Index was up 7.5% and the Standard and Poors 500 Index was up 5.8%.  For the first six months of 2007, the Dow is up 7.59%.  The NASDAQ is up 7.78% and the S&P 500 is up 6.00%.  These are very good returns for a six month period. If we could just double these gains for the entire year, life would be good.  Unfortunately, it is never this easy so we will continue to maintain our balanced and even approach to investing and re-configure the portfolios as necessary.

The markets did develop a healthy appetite for increased volatility during the quarter.  There were several days of over 1% increases in the indexes followed by drops of over 1% on any sort of cautionary news that the markets chose to absorb.  What was fascinating was the drop in the price of high quality bonds during the month of June.  Bonds are nothing more than an investor loaning money to a corporation, to a local school district, to a bank for home loans or even to the state and Federal government.  We truly have been in a twenty five year bull market in bonds where the prices of bonds have risen fairly consistently and the yield or the interest rate, has dropped to historical lows.  For those of us of a certain age, we absolutely break into laughter when the news media becomes catatonic when reporting that the cost of 30 year mortgages has risen to over 6%.  We remember when a 30 year mortgage was 12 to 14% a year!  Simply put, interest rates are probably too low and need to rise to a higher level.  It is possible that the month of June may have been the starting point for this return to normalcy in interest rates.

The sell off in bonds was triggered by the reality that inflation is alive and well.  The entire world is acutely aware of what the cost of energy has done over the past few years.  This rise in energy costs has now spread to food.  The cost of food has risen dramatically and will probably continue to rise.  Workers have finally started to be able to demand, and to receive, increases in wages.  All of these factors are causing concern for the Federal Reserve whose primary task has evolved into controlling inflation.  Everyone had assumed that the Federal Reserve would start to cut interest rates in the second half of 2007.  With the inflation concerns, it is becoming apparent that an interest rate cut or two becomes much more problematic.  Thus, bonds sold off in a rather dramatic fashion in June.

To put the bond sell off into perspective, the proxy for the long-term US Treasury bond, the iShares Lehman 20+ Treasury Bond, lost 3.6% in the first week of June.  Since May 8^th when bonds started their sell off, the above proxy had lost an incredible 6.7% of its value.  This percentage drop in the bond market would be the equivalent to a 900 point drop in the Dow Jones Industrial Average!  Discussing bonds is like watching paint dry so we will summarize this discussion on bonds with two comments.  It would appear that interest rates are not going to go down unless there is some shock to the US economy perhaps due to terrorism or energy shortages.  The irony of a drop in bond valuations is that investors have always been lulled into complacency and told or assumed that bonds are safe investments.  The past two months in the traditionally staid and dull bond market, indicate that all investments carry a degree of risk, even bonds and CDs. 

Where do we go from here?  Corporate earnings have continued to amaze and excite investors.  Corporate buyouts by private equity firms, purchasing public companies from the shareholders and taking the companies back to privately owned and managed entities, have fueled a sort of “merger mania”.  Interest rates would appear to be settling into a range.  Inflation continues to lurk in the rear view mirror.  The US economy is doing very well as is the world economy with India and China still leading the way with massive public works projects for the Beijing Olympics in 2008.  Investing is truly very similar to riding a roller coaster.  There are hills and valleys on every coaster, but it always has been a great ride when you get to the end.

I try to end these communications with something to stimulate your thoughts.  Do you ever wonder where your tax dollars go?  Did you ever wonder how much of your money goes to the pensions of convicted felons?  Consider these tidbits:

• Dan Rostenkowski, D-IL, was the former chairman of the incredibly powerful Ways and Means Committee in the House of Representatives.  He was convicted, fined and served 15 months in prison for having “ghost” employees on his payroll and embezzlement of public funds to buy gifts for family and friends.  He receives $126,000 a year in federal pension.

• Randy “Duke” Cunningham, R-CA, resigned after pleading guilty to accepting $2.4 million in bribes.  Mr. Cunningham is serving an eight year sentence but still receives $64,000 a year in congressional and military pensions.

• James Traficant Jr., D-OH, was convicted of taking bribes and filing false tax returns.  He is serving eight years in prison but still receives $40,000 a year pension.

• Robert Ney, R-OH, (we seem to have our share of high quality individuals in Ohio), was convicted of illegal activities with a lobbyist such as accepting skybox sporting event tickets and a golf vacation to Scotland.  This poor gentleman has to wait nine more years until he turns 62 to collect his $33,000 a year.

• William Jefferson, D-LA, was indicted on racketeering, soliciting bribes and money laundering.  The indictment was 94 pages long and if convicted on all 16 counts, Mr. Jefferson could serve up to 235 years in prison.  If convicted, he would still be eligible for an annual pension of $40,000 a year.

We appreciate the opportunity to work with you and your businesses and families to assist you to achieve your financial and personal goals.  If there have been any changes in your financial circumstances or needs of which we should be made aware, please contact us immediately.  If you would like a copy of our latest Form ADV, Part II, please contact us.  Our Privacy Policy is enclosed for your review.

Also, we greatly appreciate the many referrals that many of you have sent to us.  We enjoy working with our clients and their families and greatly appreciate the confidence so many of you have shown in us by referring us to your family and friends.  We thank you for this continued vote of confidence.  Please mark your calendars for our Client appreciation Event on September 12^th.  We look forward to visiting with you and any friends that you may wish to bring along.

We are half way through another year.  We will stay focused on the long term objectives of our clients’ needs.  Always remember, that investing is a marathon, not a 100 yard dash!