3rd Quarter 2005 Review

From the Desk of Ron Rowland

Recently, I read the annual Forbes magazine list of the 400 Wealthiest Americans. People make the list in a variety of ways, of course, but what stood out to me was that none of them seemed to get rich strictly through investing in the market. For the most part, their wealth came from having a vision and starting a successful business based on that vision. Though many are now active investors, their initial capital came from their own businesses.

This brings to mind an important point about investing with CCAM, or any other money manager. Our job is to manage your wealth and help make it grow. In order for us to do this, you first have to be headed down the path of wealth accumulation. The more you accumulate, the more we can do for you.

Some important lessons flow from this. The most important is to pay yourself first. However modest your income may be, set aside some part of it for your retirement or other financial goals. Even if you have a substantial income, it's important to add to your savings regularly. The time will come when you'll be glad you did. One of the best resources on this subject is a great little book entitled The Richest Man in Babylon, by George S. Clason. It is widely available in paperback for less than $10. Although this book was written in 1926 and is based on parables that are thousands of years old, its lessons are still relevant today.

Next, do what you can to increase your income. I'm surprised how much time people spend trying to squeeze an extra percent or two out of their investment portfolio. This does not seem to be what members of the Forbes 400 do with their time. Instead, they focus on building their earning power by starting or expanding their businesses, while leaving the investment decisions to others.

That is essentially what you have done by hiring CCAM to manage your money. Nothing would thrill us more than to see one of our clients make the Forbes list someday. Will it be you?

The Quarter in Review

The third quarter of 2005 was dominated by one sector: energy. As the quarter began, crude oil jumped past $61 and energy stocks leaped. Energy funds rose steadily throughout the quarter, with only a mild correction in mid-August. Then came Hurricane Katrina, which in the blink of an eye cut off a big part of U.S. energy production and refining capacity, followed by Rita with yet more damage.

Throughout the energy bull market of the last two years, American consumers seemed largely unperturbed. SUV and truck sales remained strong, utility bills were manageable, and no one seemed too concerned. Even heavy energy users such as the airlines seemed to find ways to deal with the high prices. A commodity trader friend once told us "The solution to high prices is high prices." The law of supply and demand really does work. If prices get too high for energy (or anything else), demand will eventually fall and prices will come back down.

The sudden jump following the twin storms finally grabbed people's attention. As the quarter ended, reports began to suggest consumers were cutting back on fuel usage. Even though consumer appetite for gasoline did not appear to diminish during the quarter, there were signs that consumers were making adjustments in their spending. Consumer discretionary, as measured by the S&P Select Consumer Discretionary SPDRs (XLY), dropped more than 6% in August and September, making it the worst performing sector so far in 2005.

Interest rates were another focus of attention in the third quarter. The Federal Reserve continued its anti-inflationary campaign by raising rates two more times. Following Katrina, some traders as well as politicians believed the Fed should slow down or stop raising rates as a way of dealing with economic disruptions caused by the storm. The Fed did not agree and charged ahead.

Coincident with rising rates, the high-flying real estate sector lost its momentum with a breakdown in early August. Real estate funds plunged 10% in a matter of days, then wandered sideways without making new highs for the rest of the quarter. As of this writing the sector appeared to be on the verge of taking another leg down.

International markets also rose strongly in the third quarter even though the $US dollar ended the quarter at about the same level as where it began. European and Asian markets also rose in terms of their local currencies, suggesting a more sustained uptrend could be in store. Japanese stocks surged in August when Prime Minister Junichiro Koizumi, facing parliamentary resistance to his package of economic reforms, boldly called for snap elections in September. Koizumi's party won handily and the Nikkei 225 Index rose to a four-year high.

Wall Street mavens, faced with a more or less flat stock market and only three months to go in 2005, are desperately hoping for a fourth quarter rally to bail out the year. They may get their wish, but as of early October the major benchmarks remained quite weak. Falling energy prices did not seem to bring buyers back to the table, while higher interest rates began to take a bigger bite from consumer spending. With no other sector rising to take the lead from energy, it isn't clear what will drive the market higher. As always, we will let the market be our guide.