Newsletter

March 28, 2005

To Our Valued Clients and Friends:

I. Expected disappointment
II. Foreign money
III. The cards are stacked against you—Be careful

I. As the first quarter of 2005 comes to a close the markets have delivered an expected disappointment. I have suggested that an increase in interest rates would hurt the markets because of the historic relationship between the prime rate and what investors perceive is a fair price to pay for a dollar’’s worth of corporate earnings.

NOTE:
• The price earnings ratio is the price of the stock divided by earnings per share. (E.g., $10 stock with $1 of earnings = a P/E ratio of 10).
• Please recall that when the prime rate is divided into one, a “fair value” P/E ratio is established. Today’s prime rate is 5.5%, so 5.5 divided into 1 provides you with a “fair price earnings ratio” of about 18.

Over the last year the Fed has continued its march to higher rates. The current prime of 5.5%, compared to the 4% prime rate of last year, has caused the fair value of the P/E ratio to fall from 25 to 18. As a result, corporate earnings would have to jump by a full 28% to justify current market levels.

Earnings have improved, but the market will have to work its way through its concern for higher interest rates before the DOW can return to the 11,000 level. The 11,000 level was almost achieved before the current downturn. The market has dropped from 10,940 on March 5th to 10,442 at this writing. This is a 4% decline in the Dow Jones Industrial Average over the last three weeks. The NASDAQ, for comparison, is down 8% year-to-date. With the increase in interest rates bonds have taken a hit as well. You will recall that when interest rates go up bond values go down. This helps older bonds compete with newer bonds being issued at higher coupon rates. The 10 year Treasury yield has risen to 4.6%. This is 86 basis points above the rate of last year or a 22% increase in the yield for a 10 year Treasury bond.

To complicate things, the recent jump in the strength of the U.S. dollar, (believe it or not the dollar actually strengthened over the last week) has driven down the price of gold from $455 a troy ounce to $425, a 4% decline in recent weeks. It seems that gold has become more of a barometer of the dollar’s strength than a proxy for real inflation concerns. If it were still a barometer for inflation the recent up tick in interest rates would have given gold prices a bump.

Real estate investment trusts have also declined because of interest rate concerns. I have been surprised by the severity of the drop which reflects a 9.7% decline in the real estate investment trust (REITS) index year-to-date. I have decreased our REIT holdings. I feel that the substantial gains we have enjoyed over the last three years from these positions, along with the substantial current dividend yield, continue to justify holding the remaining positions. (Both Inland and Kensington have fallen by more than 5% year-to-date, but this excludes their dividend distribution during the first quarter).

As you know I have been quite defensive over the last year. The balanced funds, which are the core of all of our portfolios, continue to outperform the market. As we approach the end of the first quarter our balanced funds are down approximately 1% while the overall market indexes are reflected below.

	12/31	3/28	% change for 12/31
DOW	10,783	10,485	(2.7%)
NASDAQ	2,175	1,992	(8.4%)
S&P	1,211	1,174	(3%)
Russell Value	656	647	(1.4%)
Russell Growth	493	471	(4.4%)
Treasury Index	88.5	87.7	(.9%)
Real Estate Index	1,234	1,113	(9.7%)

Conclusion: I believe that the market is over reacting to the concerns regarding interest rates and I believe that this may provide a buying opportunity if the market nears the 10,000 level. I do not believe the market will decline quite that far, but if we do get to the 10,000 level we will certainly consider increasing equity positions.

The market could decline further if oil prices remain high and exceptionally high gasoline prices begin to impact consumer spending. I continue to be amazed at the consumer’s ability to drive their large SUV’s to Wal-Mart and continue to support retail sales at current levels. The sale of SUV’s has however dropped considerably this year. Sales of Chevrolet’s popular Tahoe model dropped a full 30% year-to-date. I do not know whether the consumer is pulling back, or if everyone in the world who wanted a Tahoe has already bought one over the last three years.

I believe that bond prices are approaching attractive yield levels. If interest rates drive the 10 year Treasury to a 5% yield, and the economy begins to slow down, we may consider loading up on 10 to 15 year maturities of both corporate and government debt.

II. Foreign investors are actually stabilizing our dollar! I have a few thoughts about foreign markets and foreign money in relationship to the U.S. markets and the dollar. Foreign markets continue to be “cheaper” than ours based on price earnings ratios. Our current price earnings ratio of 21 for the S&P 500 is higher than all other organized markets at this time. Nevertheless, foreign investors are absolutely loading up on treasuries and equities in the United States market. In the month of January foreign financiers bought a net $91.5 billion dollars worth of U.S. bonds, stocks and other financial assets. This was up sharply from $60.7 billion in December and was the second highest level ever for monthly investment by foreign investors in the U.S. I believe that this foreign interest and the Fed’s up tick in interest rates last week contributed strongly to the surge of the U.S. dollar. The dollar strengthened in relationship to the Euro to $1.28 from $1.34 and to the British pound to $1.86 from $1.92. The strengthening of both of these may signal a momentary halt in the slide of the U.S. dollar’s value. This decline in the value of the dollar must be halted before the market can stabilize and return to the 11,000 level. Watch the Euro and dollar relationship—if the dollar strengthens to $1.22 per Euro (which was the level for last year) it may be the signal that we are looking at a stabilized dollar and an improved market.

III. A few hard comments and a warning—The cards are stacked against you. With a down or even a sideway market, many investors begin looking for new answers. The investment industry has responded with an abundance of new hedge funds and funds of hedge funds. This marks the latest effort of the industry to see just how gullible the investment public is. With an undeserving fee structure, modest, if not poor, performance, the industry is betting that investors will be desperate enough for positive results to invest in these “blind pools” which are run by former mutual fund managers that lack the skill, or track record to justify your trust. An article appearing in today’s Financial Times reflect that less than 5% to 10% of managers offering these new hedge funds “have enough skill to add value to their client’s portfolio”. There have been over 9,000 of these hedge funds introduced over the last five years.

Real wealth is achieved by taking ownership positions that are carefully analyzed and held for the long term. Eliminating superficial costs, which are piled on by the investment industry, is also an important factor. I believe that the reason that Warren Buffet may be one of the greatest investors of all time is that by using the wealth of Berkshire Hathaway Buffet is able to take ownership positions while eliminating the fees and extra costs that are sometimes added by the investment industry. By purchasing companies and keeping them private or taking them private, Berkshire Hathaway is able to concentrate on building net worth, not on hitting quarterly numbers for the public markets.

If you review Warren Buffet’s annual letters you will see that he always addresses the increase or decrease, in Berkshire Hathaway’s book value, or real net worth. Any comment about market price of the stock is only in passing, and it will always take a back seat to reports on the stock’s real value or net worth.

As mentioned in earlier letters and conversations, it is our hope to seize several private equity opportunities this year. We are especially interested in two new banks being formed, one in the Birmingham area and a second in Anniston. Both of these banks offer excellent management teams. While we will not be able to tackle the entire offering, we will have the opportunity to acquire between 15%-20% of each bank. It will be an opportunity to take ownership positions in two businesses that show attractive potential as long-term investments. At the same time we can by-pass the commissions and fees that are normally charged by the brokerage firm. Needless to say we will be escaping hedge fund fee structures which normally are an avenue for private equity offerings.

It is my opinion that private equity offerings are an excellent way of accumulating wealth during a stagnant or downward market. These are sound positions that are not affected each day by public trading.

Please help me out with communication: I think we do a pretty good job in keeping you up to date on our thinking, and I appreciate your calls, which reveal both your support and confidence. Nevertheless there isn’t a week that goes by that I don’t worry that we are not providing someone with the attention that they deserve. I have an excellent staff. I am proud of the level of service that Jackie and Amanda can provide for you. Please know that communications are not a one way street. If you have questions or would like to discuss an item of concern, please pick up the phone and let us know what is on your mind. Below you’ll find each of our emails and phone numbers for your convenience. We like hearing from you.

Brooks@Clarkfinancialadvisors.com
Elizabeth@Clarkfinancialadvisors.com
Mario@Clarkfinancianadvisors.com
Jennifer@Clarkfinancialadvisors.com

Birmingham—(205) 298-8480
Anniston—(256) 237-0000
Toll Free—800-791-4087
Brooks’ Cellphone—(205) 218-9886

We look forward to “talking” with you next quarter!

Warmest Regards,

M. Brooks Clark

MBC/alm

PLEASE NOTE: All checks to be added to your accounts should be made payable to: Fidelity

*Clark Financial Advisors is registered with the Securities and Exchange Commission (SEC) as a registered investment advisor and annually files an ADV with the SEC, as required. The ADV II form provides background on the firm and its principals. If you would like to receive a copy of this form please contact Jennifer Gibbs via email at Jennifer@clarkfinancialadvisors.com to receive a copy. You may also return this page of the letter with a note signifying your request for a copy of the ADV II filing for Clark Financial Advisors.