Second Quarter 2002

From the Desk of Ron Rowland

Congratulations! You are all above average investors. I'm conducting a study of the 14,000 + mutual funds in the Morningstar database (not including money market funds). I believe that collectively, the combined, asset weighted return of all these funds represents the results of the "average" investor. Even though this average investor composite has 31% of its assets in bonds and more than 4% in cash, it is still showing nearly a 10% decline for the past three years. When the timeframe is extended to five years, the return becomes slightly positive, although less than money market returns. Bonds have been one of the better performing asset classes for the past three and five year periods, so if we modify the composite to represent the average "equity" investor, by including only the 9840 equity funds, the results get worse. And if we look at only aggressive equity funds, the results approach disastrous. However, I believe your investments (with CCAM) have done much better, making you all "above average" investors. My detailed findings will be revealed in an upcoming "Special Report."

Although the market is poised to rally, it will take a long time to repair the damage and declare an end to the bear market. The road to recovery will consist of many rallies, followed by an equal number of declines. Although many of these rallies will be tradable, we still need to show our respect to the bear. You may notice a difference in our trading strategy in the upcoming months. We will probably be selling positions earlier than usual in order to lock in profits, and you may see some "paired" trades where we own funds that are both long and short the market, in an effort to extract some low risk gains from a trendless and/or volatile market.

The Quarter in Review

The major indexes trended lower throughout the second quarter. The Dow Industrials, which had been relatively strong in the first quarter, peaked toward the end of March and has basically been heading lower ever since. The Nasdaq Composite peaked in early January after having turned in a good fourth quarter performance following the September lows. The Dow simply took a little longer to give in to the bearish market direction already established by the Nasdaq.

In recent weeks, the Nasdaq has been in the process of testing its September lows, but the Dow has not made it back down to that level as yet. The Russell 2000 small cap index, which maintained good relative strength through April and into May, finally began following the large caps and headed lower in mid May. Along with the Dow, however, the Russell 2000 has some distance to go before reaching its September lows.

However, it remains unclear how important those September lows are, precipitated as they were by an event of extraordinary proportions that had nothing to do with markets and earnings and concerns about corporate governance. It can be argued that the Dow and Russell are already testing their "real" lows, reached over a year ago, in March of 2001. In that case they may not need to go much lower - if any - before putting in a meaningful bottom. In the case of the Nasdaq, the September low happens to coincide with its 1998 low, which tends to give a good bit more weight to the argument that the Nasdaq is indeed testing an important level, regardless of September 11.

The good news in all this is that the U.S. stock market seems to be in the process of finding an important bottom. Other technical indicators support this view as well, including high levels in the CBOE Market Volatility Index (VIX) and its brother, the Nasdaq Volatility Index (VXN). If this proves to be the case, we can look forward to higher prices ahead or, at the very least, a limited amount of further downside from here.

On the Home Front

With the economy sending fairly positive signals, tensions seemingly easing in Kashmir and the Middle East, and interest rates at historically low levels, the single biggest worry in the market may be questionable accounting practices. Over the last few months, the Business section has looked more like a series of Wanted posters hanging in the Post Office. Where pro forma earnings were once unknown, then praised, they now often draw the same response from investors as dragging fingernails across a chalkboard. It is our hope that with the WorldComs and Enrons and Global Crossings exposed, we are getting the worst news out of the way. Do not doubt that stricter and more regulated accounting practices are in the cards. This could help investor confidence, even if only psychosomatic.

With the downturn in the economy, perhaps a kind of natural selection is already weeding out those companies who have been cooking the books, leaving the fittest to survive. In a sense, the exposure of more companies and more insider trading abuses is a good thing since it leaves one less hiding in the bushes waiting to pounce. After all, as bad as it seems, chances are more likely that it is only a handful of companies who have been rampantly breaking the law. The quicker these crooks and thieves are caught, the quicker we can get this awful period behind us.

International News

Recently, views from financial commentators have been expressing that the international situations in the Middle East, Afghanistan, Kashmir, etc., are having at most a negligible impact on the markets. We couldn't disagree more with those sentiments.

Twice in the 20th century, America attempted to apply what was, in essence, an isolationist policy in the face of massive world tumult. The first major event was World War I, which America did not join until 1917, or three years after it began. The second failed isolationist attempt was World War II. Even then, America was forcefully drawn into the conflict, this time two years after Hitler invaded Poland. In both cases, the outbreak of war had immediate negative impacts on the U.S. equity market.

Since then, as the world's largest economy, America has learned the futility of attempted isolationism. As a result of the tensions between India and Pakistan, the violence in the Middle East, and the dynamic political situations in South America, the U.S. markets have experienced negative repercussions. The effects can come from a number of different sources, whether through weakness or strength in the dollar, increased defense spending, or trade. At the least, international troubles can add another piece of uncertainty to a market that is already rife with fear.

One of the only sectors that stands to gain from international turmoil is defense and aerospace, where increased defense spending has certainly commenced. However, as we have witnessed, even the defense sector is not a “given” in this market environment.

CCAM News

CCAM is often involved in the Austin community, most recently sponsoring 2 holes at a charity golf tournament, benefiting the Lance Armstrong Foundation. The Lance Armstrong Foundation, located in Austin, Texas, is dedicated to assisting cancer patients through all phases of diagnosis and treatment. You may recognize Lance’s name as a cancer survivor who came back to win three consecutive Tour de France victories - and who is favored to win again in 2002, which is now underway!

Opportunity Knocks

Exchange Traded Funds, ETFs as they're commonly called, are a relatively new investment vehicle that has recently grown in popularity among mutual fund investors. We have been managing ETF accounts for more than a year, and we want to be sure you are familiar with the advantages of investing with them.

Similar to mutual funds, ETFs are designed to track the performance of a certain basket of stocks. However, ETFs for the most part are fixed portfolios that are not actively managed, thus have lower operating costs without having to pay large manager salaries. One big advantage is the fact that ETFs trade throughout the day like a stock, instead of just once at the end of the day like a mutual fund. This gives an investor more control over what purchase or sell price he can execute at, taking advantage of that day’s movement, which could increase returns.

Although there are now many more mutual funds than ETFs, the selection of ETFs has grown tremendously in the last few years. At last count, there were 114 ETFs available, and the amount of assets invested in them have nearly doubled in the last year and a half to over $110 billion while most mutual fund assets have declined. Almost all major indexes are now tracked by ETFs, including the S&P 500 (SPY), Dow Jones Industrial Average (DIA), Nasdaq 100 (QQQ), and small and mid cap growth and value. Later this month, fixed income bond ETFs are expected to make their debut in U.S. Markets. Most importantly, ETF’s have proven very reliable in tracking these indexes accurately.

Another advantage of ETFs is their ability to be more tax efficient than mutual funds for buy and hold investors. As was painfully obvious to many mutual fund holders last year, taxable distributions were still handed out even as prices of the shares dropped. This was due mostly to other shareholders' redemptions that left the capital gains taxes to be distributed to the remaining investors. One person’s ETF transaction doesn’t affect the entire portfolio because of the inherent liquidity; therefore, the tax consequences can be kept more under control in taxable accounts.

To learn more on ETFs and CCAM's ETF investment programs, please contact your Account Representative.

What is a 529 plan?
A 529 plan is an investment plan operated by a state designed to help families save for future college expenses. As long as the plan satisfies a few basic requirements, the federal tax law provides special tax benefits to you, the plan participant.

What's so great about 529 plans?

• Income tax breaks
• Tax free growth
• Federally tax free growth on distributions (under current tax laws)
• Donor stays in control of account
• Professionally managed accounts makes saving easy
• Rollover of account to different states' program allowed once per year
• Changing beneficiary (child) to another qualified beneficiary with ease
• No age restrictions or income limitations

Contributions to 529 plans are not tax-deductible, but investment returns are not subject to current taxes, and distributions aren't taxed, either, if they are used to pay the expenses of someone attending college or technical school. Forty states already have 529 plans, and the other 10 will have them by the end of this year. In addition, nearly all offer a host of investment options managed by brand-name investment firms, like Fidelity, T. Rowe Price, and AIM.

The plan that is run by Fidelity, which markets it nationally as well, has a variety of investment options, from all-equity to all-fixed income, with eight age-weighted asset allocation funds in between. In every case, and as with most other plans, the 529 portfolios are funds of funds, comprised of a variety of underlying mutual funds. Contributions are a maximum of $233,240, whether made in a lump sum or spread out over a period of years.

If you simply want to take back the money, you pay a 10% penalty on investment earnings and ordinary income tax on those earnings. There are exemptions from the penalty if the beneficiary dies, becomes disabled or receives scholarship aid.

The great news is that anyone may contribute to a 529 plan. You don't even necessarily have to live in the state of the plan that you choose. You could live in Louisiana and contribute to a plan based in Virginia for your grandchild who lives in Georgia and who ends up going to college in Florida. If you are thinking of going back to school, most plans will even allow you to set up a 529 savings account for yourself.

Recommended websites:
Fidelity Investments.
SavingforCollege.com

Or contact Fidelity Investments:
In-State Program: 1-800-522-7297
Out-of-State Program: 1-800-522-7297

New Star on the Horizon

For the past seven years, CCAM has offered a conservative investment program - Flexible Income. Over the past few years, Flexible Income has attracted attention as an alternative conservative investment, as many investors have been disappointed with the markets and their conservative investments. Much like the stock market, the bond market also consists of numerous groups, or sectors. CCAM's Flexible Income program takes a rotational approach to investing among the various bond and income producing groups such as corporate bonds, government bonds, high yield bonds, zero coupon bonds, convertible bonds, international debt, utilities, real estate, preferred equities, money markets, and others. Utilizing our unique, rotational approach, CCAM seeks to provide consistent returns and reduce the risks associated with holding the individual instruments outlined above. The program seeks to outperform the Lehman Brothers Aggregate Bond Index and the Vanguard Total Bond Index (VBMFX) over a full market cycle with a comparable risk level.

Visit the news archives for previous Quarterly Updates