1st Quarter 2007 Review

From the Desk of Ron Rowland

One of the quandaries we face in this business is how to balance consistency with flexibility. Most of our clients invest with us because they expect us to continue delivering results similar to what we have done in the past. This suggests we should just keep doing the same things that worked before.

On the other hand, we have to recognize that the market environment does change over time. New technology and new financial instruments mean that we now have options that simply weren't available when I started CCAM in 1995. If we did nothing more now that we did then, you would be deprived of potentially useful opportunities.

In reality, I am constantly fine-tuning everything we do, trying to preserve the best aspects of our investment methodology while improving wherever possible. Every once in a while I make a major breakthrough, but for the most part our strategies adapt incrementally, a little at a time, after rigorous analysis and real-time evidence. I always test new indicators or techniques with my own money before applying them in our client accounts.

We also try to respond to the particular needs our clients share with us. In the last few years, many clients have asked if we could develop something that is less aggressive than our sector rotation and international programs. They tell us they find these programs useful for long-term assets where they are willing to take on more risk, but they also want to have part of their portfolio in something less volatile without the "watering-down" effect of bonds.

I'm pleased to announce we will soon unveil a new Absolute Return Strategy to help fill this gap in your portfolio. I think you will be impressed with the combination of controlled risk and steady returns our extensive research has produced. Please contact CCAM at 1-800-767-2595 if you would like to learn more about this exciting new opportunity.

The Quarter in Review

A quick look at the benchmark returns for this quarter does not reveal the big swings in both directions. To some degree this is always true, of course. As much as we would like it to, the stock market does not move in a straight line. The unpredictable nature of the market is what creates the opportunities we try to exploit.

The year began with a mild uptrend that lasted through late February. On February 27th, a sharp decline in the Shanghai Stock Exchange sparked a global sell-off that continued into mid-March. What happened in China, however, was probably less important than events in the U.S. housing market. Home sales and new construction are slowing down, and rising interest rates are beginning to drive marginal borrowers into default. Some borrowers who specialize in the so-called "sub-prime" mortgage market are in deep trouble. Now the question is how far the pain will spread, and how much it will hurt the overall economy. If the Housing Bubble is anything like the Technology Bubble of the 1990s, things could get much worse before they get better.

Real estate problems along with signs of economic weakness took a toll on the financial services sector this quarter. For the most part the losses were not too severe, but financials are a huge part of the market's capitalization. Within the major benchmarks like the S&P 500, gains in sectors like utilities, basic materials, and energy could not overcome weakness in the financials, technology, and health care.

The quarter also saw unusually rapid rotation among the various sectors. Leadership changed hands almost weekly, and no one sector was able to consistently stand out from the pack. Having seen these conditions before, we have found the best course is to maintain broad-market exposure during these times. Keeping up with the quick changes in sector momentum is very difficult right now.

It helps to step back and look at the big picture. The major market benchmarks (except the Nasdaq) are very close to their prior bull market highs set in early 2000. This presents major long-term resistance that takes time to overcome. The indexes are consolidating in a broad sideways pattern that will, eventually, resolve itself one way or the other. The fact that a major downturn has not yet taken place is bullish, but this phase could last for some time.

The good news is that by the end of March, a recovery from the recent lows seemed to be well underway and sector rotation was slowing down to a more reasonable pace. If this trend continues, the second quarter should bring much more favorable conditions for us. A new bull market is not out of the question.

News

Roth Conversion Rule Change - A tax law change slated to go into effect in 2010 will remove the modified adjusted gross income (MAGI) limitation that prohibits many taxpayers from being able to convert a traditional IRA to a Roth IRA. The limit is currently $100,000 MAGI. The new law does not change the income limitations on a direct Roth IRA contribution, but it allows one to make regular IRA contributions over the next couple of years and convert them in 2010.

A taxpayer can elect to pay taxes on the conversion in 2010 or split the tax load between 2011 and 2012. Keep in mind, this is a rule slated for 2010, and a lot can change in tax rules in nearly three years. Not only could the new rule be adjusted, it could be eliminated.

Roth IRAs have the opportunity to be quite beneficial for certain taxpayers. They currently provide tax-free growth of your investment, so the earnings are never taxed. They can be a useful estate planning tool. IRA owners are not required to start taking withdrawals at 70 1/2 since Uncle Sam already has his cut.

Now, a Roth IRA is not a great idea for everyone. The entire concept is based on a significant assumption: that tax policy and tax rates decades from now will still make this a desirable transaction. The only thing one can know for sure is how much cash you are giving up to the government immediately. It may, or may not, be less than you would pay by leaving the funds in a traditional IRA.

New Tax Break for IRA Owners - A taxpayer can elect to pay taxes on the conversion in 2010 or split the tax load between 2011 and 2012. Keep in mind, this is a rule slated for 2010, and a lot can change in tax rules in nearly three years. Not only could the new rule be adjusted, it could be eliminated.

There are a few things to remember. The contribution must be sent directly by the IRA trustee to the charity. Those amounts are not taxable to you, but you cannot take a deduction for them either. Some charities are not eligible, such as donor-advised funds and supporting organizations. Distributions made in this manner from an IRA are counted toward meeting the required minimum distribution rules. Be sure to confer with your tax counsel before utilizing this opportunity.