2nd Quarter 2004 Review

From the Desk of Ron Rowland

The best way to make money is to not lose it. This may seem trite, but it is a lesson many investors learn the hard way. Recovering from a loss is much harder than making the money in the first place. Let me explain.

Suppose you invest $100,000 and you make a 25% gain in your first year. Now you have $125,000. In the second year you lose 25%. You are back where you started, right? No. You have $93,750 ($125,000 x -25% = -$31,250). Not only have you failed to break even, you have actually lost 6.25% of your principal. To regain your principal plus the $25,000 profit that you lost, you must make a 33% gain on your remaining balance.

The gain needed to recover from a loss increases exponentially as you lose more money. If you lose 10%, you need 11.3% to get back to even. Lose 20%, and it takes 25% to recover. Lose 50%, and you need a 100% gain just to get back to where you started.

As we all know, the markets provide a variety of ways to lose money. Many of them seem attractive at first. As investors we must be able to resist temptation and make sober, logical decisions. This is what we strive to do at CCAM. When we take risks with your money, we do so only because we are convinced it is the best way to achieve your investment goals.

We can never eliminate risk completely, nor would we want to, for without risk there is no opportunity. Of course, you could keep all your money in a bank account or other "risk-free" investment. But then you create risk of a different kind. Risk-free investments don't offer much return. Between inflation and taxes, the real value of your investment will slowly decline over time.

Quite a dilemma, isn't it? We walk through this minefield every day at CCAM. We do everything we can to make money and avoid losses. Sometimes our work is frustrating because we see other investments doing better. Nevertheless, we have a method that has worked very well over many years. Despite the occasional boring stretches and bumps along the way, we stay on the road to your destination. This is what you pay us to do, and we know you expect nothing less. We appreciate your continued confidence and loyalty.

The Quarter in Review

Every quarter is challenging in its own way. Markets do not always respect calendar boundaries, but we have to draw a line somewhere. Hence your quarterly reports show what happened from April 1 through June 30. Give or take a few days and the picture can be quite different.

For example, consider the Russell 2000 Index of small-cap stocks. For the second quarter it was up slightly, +0.2%. Now shift your time period forward by 5 days. For the three months ended July 6, the Russell 2000 lost -5.6%.

The technology-heavy Nasdaq 100 Index surpassed the Russell 2000, however. While the previous example showed the Russell Index taking three months to lost -5.6%, the Nasdaq 100 managed to lose the same amount in only five days. Again, however, this happened in July so it doesn't show up in the quarterly numbers.

Most people would not guess that five days could make such a difference. It can, and it did. The second quarter of this year began with a big rally, plunging to a despairing low in mid-May, and then recovering with a substantial rally in June. Then stocks fell again in the first week of July.

Our job at CCAM is to guide your assets through this maelstrom, hopefully capturing some profits but at least not losing too much. We try to accomplish this in different ways for our various programs. Generally speaking, we kept a substantial cash position throughout the quarter and focused on two sectors of the market that seemed the strongest: energy and transportation. We had mixed success as even the strongest sectors were subject to big swings in value. Finding good entry and exit points has been difficult.

While this quarter has endured some bumps, we are not discouraged. Our methodology has proven itself over the years, but it is not perfect. We have been through volatile quarters before and have many times gone on to post banner results. The lesson is that our strategy takes time to work. Success or failure cannot be judged by any one month, quarter, or year. As noted above, the market picture can change dramatically in a matter of days. We do our best to be on the right side when this happens.

CCAM News

Changes to Moderate All Star Investment Selection Criteria - The goal and objective of the Moderate All Star Program remains the same, which is to outperform the S&P 500 over a full market cycle with a risk level that is lower than that of the S&P 500. We felt that in order to meet this objective that we need to have slightly more flexibility than our old investment selection criteria allowed us. Instead of restricting our purchases to only funds with historical volatility of less than 110% that of the Wilshire 5000 or S&P 500, we are easing our criteria to allow us the ability to invest in funds with volatility outside this range from time to time.

Fidelity Short-Term Trading Fee - For quite some time, Fidelity has imposed a short-term trading fee on its retail accounts for no-transaction fee funds, but the institutional accounts (the type our clients utilize) have not been subject to such a fee. This will be changing in September. The trading fee for our clients will only be imposed on positions that are not held for 60 days. The fee schedule is 0.5% of the transaction with a $30 minimum and a $200 maximum. The short-term trading fee will not apply to Fidelity or money market funds, and it is expected that Rydex, ProFunds, and Potomac trades will not be subject to it either.

Updated Form ADV Part II - On an annual basis, we update our Disclosure Document (SEC Form ADV Part II). As a client, you may want to obtain a copy of this form on an annual basis as well. We would be pleased to send you a copy if you will simply let us know that you would like to receive one. You can call your account executive at 800-767-2595 or send us a letter at PO Box 203427, Austin, TX 78720 to request your copy.

New Employee - I am pleased to introduce to you to the newest member of our staff. Shellie Ormerod joined us in May. She spent the last five years working for AIM Investments here in Austin. Shellie earned her degree from Texas A&M in College Station. Shellie is an instrumental addition to our operations department.