2nd Quarter 2006 Review

From the Desk of Ron Rowland

"The perfect is the enemy of the good." -- Voltaire, 1772

One of the prime obstacles to investment success is emotion. Two emotions in particular cost investors a lot of money: fear and greed. We would all be much wealthier if we could remove these feelings from our decision-making. Because we're human, our only choice is to deal with them.

Nothing brings this into focus like a falling market. For example, suppose you made a brilliant forecast and bought a particularly hot stock just as it was taking off. You quickly accrue a substantial profit. Until you sell, of course, the profit exists only on paper. All good things come to an end, and in time your stock begins to fall. The profits you had been celebrating are disappearing quickly. If you sell, you might get out just as the bottom is reached and miss out on more gains. If you hold, your profit could shrink even more and eventually turn into a loss. What do you do?

In such circumstances, most people will freeze and do nothing - and sometimes "nothing" is exactly the right thing to do. More often, however, investors end up doing "something" after it is too late. The result is lost money or lost opportunities. Then they kick themselves and start the cycle all over again.

At CCAM we are human, too. The advantage we have is that we can focus our full attention on making investment decisions in a systematic, disciplined way. That allows you to focus your attention elsewhere - on your career, your business, your family, or whatever else is important you. You can do so knowing that your portfolio is in good hands.

The Quarter in Review

The 2nd quarter of 2006 will be remembered as a painful one by most investors. For the quarter, the Nasdaq Composite Index fell -7.2% and the S&P 500, including dividends, was off -1.4%. These numbers mask the true extent of the losses buy-and-hold investors had to sit through. From their peak values earlier in the quarter to the bottom in mid-June, the Nasdaq Composite dropped -13.1% and the S&P 500 was down -8.1%. The hot Emerging Markets iShares (EEM) plunged -26.2%.

All investors are aware that markets go down as well as up. This caveat is easily forgotten when the bulls are in charge, as was the case this year from January through early May. Wall Street's new nemesis is Benjamin Bernanke, who took over as Fed Chairman from Alan Greenspan on February 1st.

Before we are too hard on Bernanke, we must concede that Greenspan is a tough act to follow. He managed the economy like a maestro since taking office in 1987, and a generation of investors has never seen anyone else in charge of the Fed. So it's not surprising if everyone needs a little time to get acquainted and build confidence.

The Bernanke era started pleasantly enough. The new chairman gave every indication that he would continue Greenspan's benevolent policies. Before long, however, Wall Street began to wonder whether this new fellow really knew what he was saying and doing. Fed statements became increasingly hawkish, and it began to appear that interest rates might go up much more than anyone had expected. That did it. A May 10th release of Federal Open Market Committee meeting minutes marked the year's top for most benchmarks.

The 2nd quarter declines brought the high-flying natural resource sectors back to earth along with the broad market. Gold funds fell more than -20% from their peak, as did energy funds. Small-cap stocks were very strong going into May but then led the way down. Technology funds were extremely weak. The traditional defensive sectors, such as utilities, consumer staples, and bonds, attracted capital as everything else fell, but were by no means bullish.

We began moving most of our programs to cash in mid-May, and by the end of the quarter we had only minimal exposure to stocks. The June lows have held for almost a month now, so it may be that the bottom has been marked. Time will tell. For now, few sectors are showing any kind of consistent momentum, so we are generally remaining on the sidelines.

Going forward, we expect 3rd quarter markets will continue to be dominated by economic data, especially indications of Fed action, along with geopolitical events. Another active hurricane season could focus some attention back on energy, which as of this writing appears to be regaining some momentum. As new sector leadership emerges we will re-position our assets accordingly.