2nd Quarter 2005 Review

From the Desk of Ron Rowland

With the end of June, we are halfway through 2005. Some would say the markets have been unusually difficult this year, but the truth is that markets are always difficult - some periods more so than others. That's why so few investors are able to succeed consistently over long periods of time.

So what constitutes success? This is where the concept of a "benchmark" comes in. A benchmark is nothing more than a passive yardstick against which we measure our performance. Each of our programs has a different benchmark depending on its objective and risk patterns.

What gets confusing for many people is that a benchmark is a moving target. Stock market averages are exactly that - averages. It is entirely possible to drown in a pond with an "average" depth of six inches, because the hole in the middle could be much deeper. So when you read that the stock market has historical average returns of +10%, for example, it does not mean +10% each and every year. Some years are well above average. Some are much less.

We wish we could outpace our benchmarks every year, every quarter, every month, and every day. That is, however, not a reasonable expectation. Our added value comes incrementally, and we can capture it only when our clients give us enough time to do so.

Our belief is that those who take a long-term view of their CCAM investments will find, over time, that patience is well rewarded. What counts are long-term results that allow you to reach your financial goals. We are pleased to have delivered such results.

The Quarter in Review

"After having the wind at their backs late last year as stock prices soared, investors now must feel as if the wind is gone and they are carrying their boats across a desert." The Wall Street Journal, July 1, 2005

The fact that WSJ chose to begin its quarterly wrap-up article with such a poetically discouraging sentence tells us what kind of year 2005 has been so far. In fact, while 2005 has most certainly been difficult, we've seen much worse. Even in the desert you can find an occasional oasis.

Most market indexes rebounded in the 2nd quarter, bringing their year-to-date returns close to break-even. As of June 30th, the S&P 500 with dividends was down -0.9%, and the broader Wilshire 5000 index was flat at 0.0%. Large-cap stocks have lagged for most of the year.

In the big picture, three intertwining factors appear to be driving the stock market: oil, interest rates, and corporate earnings. Conventional wisdom tells us that higher energy prices are harmful to both the economy and corporate profits. While this is probably true in the long run, in any given day or week the relationship between oil and stocks can do anything. Even this year we have seen times when the stock market rallied in the face of rising oil. Outguessing this pattern in the short term is difficult, to say the least. This is one of the reasons we expect continued volatility, both for stocks and oil.

The Federal Reserve continued its policy of raising interest rates, and analysts were desperately searching for the slightest hint that the rate hikes may be over. The Fed has offered little comfort and indeed seems a little annoyed that its policy is not having the desired effect of driving up long-term interest rates. Alan Greenspan himself called it a "conundrum." Some experts suggest the Fed will begin cutting rates by the end of the year. This may be wishful thinking, though stranger things have happened.

Companies will be reporting their 2nd quarter earnings over the next few weeks. Results are expected to remain strong, but the growth trend could be disappointing. Slower economic growth - a result of expensive energy and rising interest rates - could bite into earnings, though some sectors could continue to do well.

The energy sector is obviously very hot this year. Higher prices are both increasing the value of reserves in the ground and creating demand for the services necessary to find new supplies. Even though much of the increased activity will continue even if energy prices stay flat or back off a little, this sector has cycled up and down in line with crude oil. This should create periodic trading opportunities for our sector programs.

Real estate is another leading sector. Explosive housing demand and low interest rates have created a boom that many fear will end badly. Certainly there is a great deal of speculation going on - we've seen stories of inexperienced people buying houses in hot areas merely to "flip" them a few months later. This is probably not a good sign for the sector, and we think the more prudent way to participate is through real estate funds that offer liquidity and diversification.

Retailing, health care, and utilities funds were also among the leaders for the quarter. Technology funds had a good run in the 2nd quarter but appeared to be topping out as the quarter ended. Losers for the 2nd quarter included consumer staples and natural resources (other than energy).

Looking forward, we expect interest rate and energy trends to be major influences on what the markets do for the rest of this year. An interest rate cut, or even a sign the Fed will hold rates steady, would likely ignite a major rally. A significant fall in crude oil would also help, though it would have to drop a long way and stay there for months to have a lasting effect on the economy.

On the other side of the coin, oil that stays in the $60 neighborhood will not be helpful to the stock market. Ultimately, as commodity traders put it, the solution to high prices is high prices. New supplies are years away, but global economic weakness could reduce demand and bring energy prices down.

With such a precarious balance, we anticipate continued volatility within fairly tight ranges for most markets and sectors. This is definitely not a buy-and-hold market, but it is not easily traded either. Even experts will face a challenging environment for the foreseeable future.

CCAM News

Fidelity's Check Writing Policy - As a reminder, Fidelity's check writing policy is that a check will be returned if there is not enough cash in the account on the day the check is presented. Therefore, it is imperative that you contact CCAM before writing a check. We must ensure that there is enough cash is in the account in order for your check to be honored. This applies even though you may have stock, mutual fund, or money market positions in your account.