Newsletter
December 29, 2004
To Our Valued Clients and Friends:
I. Is it already a year?
II. Indexes, interest rates and bull markets
III. The tired consumer
IV. Warren Buffet, Jimmy Rogers and the weak dollar
V. Where do we go from here?
This is usually the time of year that Beth, the kids and I retreat to Perdido Key and enjoy a few days of collecting our thoughts before the New Year. Thanks to Ivan, I find myself in the office wondering what on earth happened to the year 2004 as it comes to a close.
Although the year went quickly, it sure had a full agenda. Washington was not nearly as entertaining, or as civil, as we had hoped during the presidential election. Conditions in Iraq are more uncertain now than they were a year ago and “mother nature” reminded us all of who is really in charge by throwing four hurricanes at Florida and a tsunami that may leave over 100,000 dead in Southeast Asia as the year draws to a close.
The purpose of this letter will be to revisit my 2004 predictions, mention a few concerns that I have in regard to 2005, and outline for you why we will continue to be slanted toward the conservative side for the coming year.
2004 — I had suggested that 2004 might result in a market advance of between 8%–14%. This made the assumption that the market would follow up it’s 2003 rebound and reflect a historically “normal” second year of a “bull market.” While the S&P is up 9.9% I believe that a review of the indexes reveals much more than the fact that we were correct with our 2004 prediction. Here are the numbers.
Investment Indexes:
12/31/03 |
3/30/04* |
6/30/04* |
9/30/04* |
12/28/04* |
|
|---|---|---|---|---|---|
| Dow | 10,321 |
(.9) |
(1.1) |
(2.3) |
5.1 |
| S&P | 1095 |
1.3 |
1.5 |
1.3 |
9.7 |
| NASDAQ | 1973 |
(.05) |
2.1 |
(5.2) |
9.3 |
| Russell Value | 569 |
2.1 |
3.3 |
4.7 |
15.4 |
| Russell Growth | 462 |
.004 |
2.3 |
(2.5) |
6.2 |
| REIT Index | 99.27 |
9.09 |
2.4 |
8 |
23 |
| Ten Year Treasury | 85.85 |
3.8 |
(2.56) |
4.2 |
2.2 |
Observations:
A. While the S&P fell within our predicted range, the Dow, a more concentrated reflection of the market, climbed only 5.1%. This 5.1% return is enjoyed only because the Dow has rallied by 11.3% since August on very little, if any, good economic news.
B. While the NASDAQ was up 9.3% for the year, the broader Russell Growth index was up only 6.2%, or 33% less than the top 100 OTC stocks. I believe that speculation in the NASDAQ 100 is alive and well and is being played by investment in the old QQQ (triple Q is now actually quadruple Q). Watch for disappointment in the top 100 OTC stocks that will not be reflected in the broader growth index.
C. Value outperformed growth by more than a 2:1 margin. This is the fifth year of this trend and while this might suggest that we should begin to shift to growth, I am not ready to do so.
D. The ten-year treasury index moved only 2%, even though the fed increased short-term interest rates five times since midyear. This reflects the fed’s concern more about a weak U.S. dollar than it does about an overheating economy. Bottom line: 2004 was not so much the second year of a “bull market” as it was a return to normalcy after the market digested 9-11 and the bursting of the tech bubble. The Dow’s modest 5% increase in 2004 does not reflect a thriving economy, but does reflect a fairly valued investment market.
Interest rates - Remember my comments regarding the historic relationship between the prime interest rate and what investors are willing to pay for earnings? The prime interest rate divided into 1 equals “a fair PE ratio”.
Today’s prime is 5.25%. Divide that figure into 1 and it equals 19.04. Today’s PE ratio for the Dow Jones Industrial Average is 18.1 and the S&P is 20.95. This might suggest that the Dow is undervalued by 5.7% while the broader S&P index has already reached full value. While markets usually run beyond their value to a point of being overvalued, do not expect 2005 to provide much more than a single digit return.
Bull markets - For those of you who still believe that we are in a resurgence of a bull market, please allow me to point out that the average bull market from 1932 forward has lasted only 2.6 years. Historically the average bull market increases in value by 44% in that 2.6 years.
The current market move began in October of 2002 with the Dow under 7,500. Since that date the market has rebounded by over 44%, and it has taken 2.2 years to make that move. Stated another way, we are up 44% and we are already 2.2 years into this measuring period. Unless you feel that we are “in a new paradigm” I suggest that you take some money off the table!
Concerns that I have for the New Year:
The troubled consumer — In 1995 the average consumer had debt equal to about 60% of the net worth of his or her home. Today that same consumer has debt that reflects 111% of the net worth of their house. In light of how much home prices have increased over the last five years it is a staggering statistic to realize that this increase in home equity provided by rising prices has been offset with such a substantial increase in debt. As interest rates have declined, the consumer has refinanced his or her home two or even three times. While this refinancing was often put to good use — to pay off high interest debt — often times there were withdrawals of equity.
Zero interest auto loans after 9-11 made those big SUVs more affordable, but adding $30,000 to $40,000 in debt, while acquiring a depreciating asset, placed havoc with the consumer’s balance sheet. Thirty-eight percent of all refinancing occurred with adjustable rate mortgages. So when interest rates begin to rise monthly payments will begin to increase.
The point I am trying to make here is that the average consumer, who has literally carried the economy since 9-11, is both borrowed and spent out! While the higher end consumer is in good shape with the substantial increases in home and portfolio values over the last two years, the average consumer is worried about slow job growth and is now carrying more debt than ever before.
Do not expect to see an increase in home prices bale out the consumer again. November real estate sales saw an 8.2% decline in the median new home price, the steepest decline since September of 1981. New home sales fell 12% in November reflecting an increase in new home inventory.
The weaker dollar — Normally a slowing economy, or slow growth economy, would reflect fairly stable interest rates. Unfortunately the weakness of the U.S. dollar suggest that the fed will continue to increase rates in hopes of encouraging foreign investors to hold on to their U.S. dollar investments. This is a tough sell. European investors calculate the value of their investment in euros. In the past four years the dollar has fallen from a strong point where it took only 88 cents to buy a euro, to today where it takes a full dollar and 34 cents to purchase a single euro.
A European money manager with a $100,000 U.S. dollar denominated portfolio four years ago might have made the assumption that the portfolio has retained it’s same U.S. dollar value. Instead that manager has watched the portfolio decline by a full 50% as the value of the portfolio is brought back for euro conversion.
Unless you are traveling in Europe or purchasing a new foreign automobile each month, you do not notice the decline in the dollar’s strength. While exporters cheer the weakness of the dollar because it allows their products to appear cheaper overseas, the falling dollar may lead to a movement out of U.S. dominated investments by foreign investors. This will lead to downward pressure on the investment markets and an increase in foreign takeovers of U.S. business. (U.S. companies are now selling at a 50% discount to the price that they were four years ago.)
Warren Buffet and Jimmy Rogers, advisors that I watch closely, suggest that a continued deficit in the balance of trade along with the ongoing U.S. government deficit will continue to contribute to a weaker dollar. Both of these advisors hold major foreign currency positions and state that they will continue to hold these positions “for years.” “Remember, if you own an English company and the stock value remains level in value on the British Exchange, but the dollar drops 10%, or about 19 cents in value in relationship to the pound, you still made 10% on your money on the “currency play” when the value of your investment is brought back into U.S. dollars.”
V. Where do we go from here?
With a concern for a continued weakness in the dollar, higher interest rates and a tired consumer, look for our continued positions in value oriented securities, an increase in international exposure and a holding of our balanced account position. We have been blessed with good returns this year and I would like to take a moment to review the individual positions within our thoroughbred program. That will continue to be held for at least the first part of 2005.
As the year 2005 opens we will continue to hold many of the positions that we have held for the better part of 2004. While many of these positions might be viewed as conservative, these positions continue to give us sound upside performance even in a modest market. If we are wrong, and the year 2005 begins to reflect an explosive uptrend our balanced managers will bring us to greater equity exposure and our pure equity positions will participate.
Thank you all for your many kind comments regarding our investment performance this year. It is our goal to achieve sound performance with modest risk. We ask you to compare your portfolio performance to your goals, objectives and risk tolerance. Do not be distracted by the index of the day.
We hope to deliver to you a good solid 2005.
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.
