Wednesday, December 5, 2007

News - November 2007

Another quarter, another correction for the stock market – or at least the first official correction by traditional definitions – although we have seen correction-like action in the stock market two other times this year. The monotonous, troubling news concerning falling home prices and falling valuations of securities backed by mortgages sometimes feels very unnerving. We are all undoubtedly growing more familiar with terms such as “CDO,” “CMO,” “sub-prime,” and “credit crunch.” In financial publications and our local business pages, there are several articles devoted to the subject each day. The one reaction that continues to strike us is how so many lenders, borrowers, mortgage brokers, and self-proclaimed Wall Street geniuses could be so completely foolish.

For years, specifically from 1992 through 2006, Americans had seen their home values steadily rising. In stark contrast, the S&P Case-Shiller U.S. National Home Price Index measured the national average of home prices falling 4.5% from the 3rd quarter of 2006 to the 3rd quarter of 2007. This marks the largest annual national decline reported in the survey’s 21-year history. Florida and California are the two notable regions where housing prices are suffering the worst, showing some locals with home prices over 10% lower than a year ago. This is not totally surprising since those locations also showed some of the largest gains before the real estate markets turned soft. It’s not unthinkable that poor real estate markets in these very populous states could have an affect on the economy as a whole.

There are some exceptions to the housing price declines, notably in parts of the Pacific Northwest and the Southeast, including Atlanta. Home prices in Atlanta, as reported by the S&P Case-Shiller report, continue to buck the national trend. Not only are prices not showing a year-over-year price decline, but they are actually still showing slight gains year-over-year. The survey shows prices gaining 0.4% over the past year compared to prices reported in the 3rd quarter of 2006. The rate of increase in home prices in Atlanta is slowing, however.

Stock market volatility continues to flow more than ebb this year largely in response to the saga surrounding real estate prices and those securities associated with mortgage debt. The ebbs and flows of the market and volatility are becoming more regular and are in stark contrast to the tranquility experienced in the early part of the recent bull market from 2003 through 2006. The VIX, an index which measures market volatility, had been very tame in recent years following the tech bubble and burst culminating in 2002. We are seeing regularly occurring spikes in this measure this year as the bull market shows its age a bit.

During the late 1990’s and into the early 2000’s, the stock market was experiencing much greater volatility than we have experienced recently. The levels of volatility this year are still relatively low compared to what we had experienced in the late nineties and early in the 21st century. Only recently, as the market has dipped three times this year while rebounding in the spring and earlier this fall, have we been getting the volatility levels that were commonplace from 1997-2002. The troughs in volatility during that period are coinciding with peaks in volatility of this year. How did we manage sanity during those volatile boom and bust periods? The numbers are larger now, because the indexes have grown to such high levels, which may make us feel as though volatility is even greater than it really is. The Dow Industrial Average needs to move about 130 points today to make a 1% gain or loss, while 10 years ago the 1% threshold was only 70 to 80 points.

For the month of November, the Dow Jones Industrial Average lost 3.8%, the S&P 500 lost 4.2%, and the NADAQ lost 6.9%. Again, financials and real estate related stocks have fared worse than the broader market. A popular Financial ETF lost roughly 8% of its value during the month of November and has lost 15% for the year. Large, and historically highly regarded, financial institutions like Citigroup, Merrill Lynch, Bear Stearns and Morgan Stanley have all lost between 30% and 40% of their market values since the first of the year.

The trend favoring international investments has remained intact, partly aided by the continued weakness in the U.S. dollar. The dollar has lost about 10% against the Euro this year, including a 1% drop in November. The dollar, like the stock market, did rebound some at the end of the month minimizing the losses for November. Emerging markets performed roughly in-line with the U.S. markets, while the developed international markets lost a relatively impressive 3.7% for the month of November.

The performance of the emerging markets is interesting in that during the previous market sell-offs, the emerging markets index had an exaggerated move down. Some analysts have questioned whether emerging economies can prosper even as the U.S. economy shows some signs of an impending slowdown. And if so, then investments in those markets may provide diversification benefits beyond additional risk and return potential.

The market would have been significantly deeper in the red had the market not rallied over a couple days near the end of the month. The Dow 30 Industrials tacked on gains of roughly 550 points, or roughly 4.3%, in two days of trading during the last week of the month. Despite the financials suffering losses, the broader indices are still safely in positive territory for 2007.

Technology, Materials and Energy stocks have exceeded the gains of the broader market, helping to boost the indices. Some have opined that these high-flying sectors could be vulnerable if the problems in the financials and real estate do, in fact, spill over to the economy and cause a recession or major slowdown. The fact that these sectors are holding impressive gains for the year could in itself be signaling that the economy will withstand the aforementioned headwinds.

The catalysts for the rebound over the last few trading days of the month were clear and numerous. It appears that the government is about to take a more active role in trying to mollify the financial markets. It has been reported that the Bush administration will try to broker a deal freezing some of the adjustable rate mortgages, allowing borrowers to keep their lower introductory rates on adjustable mortgages for up to seven more years. The Federal Reserve, including chairman Ben Bernanke, appear to be developing a more accommodative stance, signaling that further interest rate cuts are a good possibility. These developments late in the month of November helped diminish some of the losses in the stock market since the end of October.

Oil has dropped about 10% from the highs earlier this month and is hovering around $90/barrel as opposed to closer to $100/barrel. It seems difficult to comprehend the extreme volatility in oil lately without the explanation that speculation is taking control of that commodity price. Regardless of the explanation, it probably supplies the Federal Reserve with confidence that inflation will not explode if and when they reduce interest rates further.

GDP has continued to stay surprisingly strong as well as employment. The revised estimate for 3rd Quarter GDP came in at 4.9%, which would be the highest quarterly growth rate in four years. One component cited in the government report is the impact of an improved environment for exporters, which is one of the benefits of a weaker dollar.

We would think that some effect of the housing and sub-prime issues would have shown up in the 3rd quarter, although, according to the government statistics, that seems to not be the case. Such a good estimate for 3rd quarter growth is encouraging in that it points to the possibility that recession can be avoided, while a slowdown in growth still seems to be the most likely scenario.

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Monday, November 5, 2007

News - October 2007

Commodity prices, especially those related to energy, are spiking yet again this year. Oil, which averaged trading at about $23/barrel as late as the year 2002, is now hovering around the $95/barrel mark. High oil and gas prices paired with a national downturn in housing prices (although figures vary significantly from one region to the next) and the fact that many of the largest financial institutions are struggling to value their financial assets might typically provide a backdrop for a sinking stock market, not a resilient environment for investors that we have seen this year through October 31st 2007.

The conditions working in favor of a rising, healthy stock market have been the Federal Reserve aggressively lowering interest rates and the continuing growth in foreign economies. The Federal Reserve is trying to alleviate some of the pressure on financial institutions and individuals who are now sensitive to defaulting mortgage loans and a less liquid mortgage-backed securities market. The broader stock market has reacted positively to the lower interest rates. Interestingly, financial stocks, the focus of the rate cuts, continue to falter. As a result, many economic observers are expecting additional rate cuts necessary to stabilize the financial institutions.

Another situation that is increasingly covered by the financial media is the weakness of the US dollar compared to the other major currencies. The weak dollar is actually a beneficial component in the outperformance of our international investments. A weaker dollar is a predictable response any time the Federal Reserve reduces interest rates while other nations are raising or keeping rates constant. As we have discussed, a lower US dollar benefits those US companies exporting goods and doing business abroad. Positive currency effects, from a weak dollar and strong foreign currencies, generate additional value for US investors of foreign entities and corporations.

Another cursory effect of a weaker dollar is its affect on dollar denominated commodities. Some have voiced the opinion that commodities priced in dollars (like oil and gold) are rising simply as a natural offset to the weakening of the US dollar compared to other currencies (as the dollar goes down, commodities tend to go up). Higher commodity prices are benefiting many companies trafficking in such businesses and their alternatives. Some argue that commodity prices are artificially high and have risen in part from speculation.

In addition to the currency effects, old fashioned supply and demand theoretically should have the most significant affect on commodity prices. Some are astonished that energy and commodity prices can rise while many of the developing countries economies show some signs of slowing. That observation may actually point to higher future commodities prices, as we try to gauge the impact on prices when (and if) the US, developed Europe and Japan experience higher economic growth in the future.

One question that may be on investors’ minds is why inflation has not been more pronounced in the wake of higher materials, agricultural and energy costs, and how is it that the economy can sustain fairly healthy growth when food and energy prices are rising. Productivity and technological progress are two major influences that enable the economy to gracefully absorb these potential pitfalls. As society makes technological progress, we become more efficient users of natural resources. While many individuals choose to drive vehicles that are not much more fuel efficient than cars and trucks of the past, we certainly do have more options and can transition to fuel efficient vehicles if higher fuel costs become a burden.

October saw the Dow Jones Industrials achieve all-time highs before settling October 31st at just 70 points below the 14,000 milestone. The quick action in the markets signifies precisely the concept cited by market theorists who say that timing the market is nearly impossible and that staying consistently invested is typically the most prosperous strategy. Of course it’s essential to stay broadly diversified across many sectors and assets classes because the different groups within the market fall in an out of favor as economic conditions and sentiment evolve.

Since the Fed unexpectedly cut the discount rate in August, the Dow Jones Industrials and the S&P 500 have advanced 8% while the NASDAQ has advanced a stellar 16% in only 2½ months. For the month of October, the S&P 500 gained 1.6%, the Dow Jones Industrials advanced 0.4%, the NASDAQ added 5.9% and the Russell 2000 (small cap stocks) gained 2.9%. All of the major large cap indexes are in the black by at least 10% with the NASDAQ advancing a very strong 19.1% for the year. Growth significantly has outperformed value during the year and that trend held during the month of October.

Emerging Markets continue to significantly outperform the domestic stock indices. A popular Emerging Markets ETF returned 11.87% for the month of October and has advanced 46.17% for the year. A notable catalyst to the Emerging Markets gains is the well publicized performance of Chinese stocks this year. An ETF tracking 25 Chinese stocks has nearly doubled since the beginning of the year, increasing by an incredible 96% and an equally astonishing 21.39% just for the month of October. Many analysts and prognosticators have expressed the opinion that Chinese stocks are entering bubble territory. Valuations in China are much higher than is typically sustainable, however the Chinese economy continues to grow at staggering rates. The developed international markets have also done well making 17.59% for investors year-to-date, and 4.25% for the month of October.

As would be expected with commodity prices rising, the energy and commodity stocks are doing very well this year, outperforming the broader market. A popular ETF consisting of energy related stocks has gained 32% for the year, rising 2.5% in the month of October. An ETF tracking actual Oil prices has increased 42.59% this year while an ETF tracking a basket of commodities has moved ahead 13.69% for the year and advanced 3.46% for the month of October. Materials stocks, which tend to benefit from a strong global economy, and demand for raw materials have also bested the broader market, gaining 27.3% for the year and returning 4.16% for the month. Technology stocks are once again starting to garner some attention as the NASDAQ 100 tracking ETF has moved higher by 27.8% for the year and 7% for the month of October.

Financials and Real Estate, as we have previously mentioned, along with retail stocks have been laggards all year long. The retailers have both high energy prices and weakness in home prices working against them, but retail stocks do may perk up if energy and commodity costs trend lower. Real Estate is showing some signs of an improved environment as the Federal Reserve has shifted towards a lower interest rate policy. Even though REITs are still in negative territory for the year, they have done much better over the past three months gaining 13.05%.

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Wednesday, September 5, 2007

News - August 2007

When is the market merely correcting versus predicting upcoming economic difficulty or even a recession? Corrections can be great buying opportunities where additional equity investments are rewarded. To the contrary, it could be that the cause of the correction is a foreboding sign of systematic economic issues that validate the correction. Amid the uncertainties, one thing we know for certain is that when the market corrects 10% within a few weeks (as they did in July), it is signaling that risk levels have been elevated. Additional investments can be rewarded handsomely. Of course, accompanying those possible rewards is increased risk, which is either real or perceived.

Navigating these questions and making investment decisions based on the data and risk assessments is at the crux of what an investment advisor is about. Even the most accomplished investment analyst or commentator cannot with any certainty time these events, correctly predict the degree of a correction or with complete accuracy provide an analysis of how the events will unfold for the broader economy over a longer period of time. It’s more appropriate to provide probabilities on how these events will play out, realizing that any scenario is not absolutely certain.

The current correction is reminiscent of the corrections in the late 1990’s. In 1997 it was the “Asian Contagion” and in 1998 there was the Long Term Capital Management hedge fund that collapsed because of issues with Russian debt. The US stock market reacted sharply to both of these events, but the corrections did not last, as they did not have a great effect on the US economy. Looking back, those who invested in those uncertain times were rewarded handsomely (and relatively quickly). Remember how the markets sold off in February, 2007 due to the Chinese sell off, but recovered rather quickly to reach all-time highs?

There is a possibility that the current correction could be more significant due to its relation to home real estate prices. Homes and real estate are significant assets for most consumers and investors. But again, there are a number of opinions and variables to be considered when evaluating the current situation. What will be the effect of a prolonged period of falling home prices, if that materializes? Will falling or stagnating prices, if any, have an effect on the broader economy if they are felt regionally, not nationally?

Unlike the potential reduction in home prices, the “sub-prime” and credit issues hampering the banking and lending institutions are not expected to have a great impact on the broader economy. The financial firms who make loans, securitize mortgage loans, sell derivatives of these products, or make any investments in these products are likely to suffer some negative effects. The amount of “sub-prime” loans and lack of liquidity are relatively insignificant issues that should be resolved quickly without a major lasting effect. However, there are many other sectors of the economy that will feel a greater effect based on the level of housing prices.

The homebuilders are the most obvious group of companies that will be impacted by tougher lending standards and sluggish or falling home prices. They have already seen their profits evaporate and are now reporting losses on a quarterly basis. Other retailers may not see their profits disappear, but the expected growth in profits may not materialize.

Over the last month, market volatility was even higher, evidenced by 14 days of 100 point moves for the Dow Industrials. Despite all of the concerns over the past few months, the market was actually slightly positive for the month of August. The Dow gained 1.3% for the month while the S&P was up 1.5%; the NASDAQ achieved a gain of more than 2.1%; and the small cap stocks showed some strength gaining 2.3%. Thus far for 2007, the Dow remains a leading index at a positive 8.7%; the S&P 500 is at 5.2%; the NASDAQ is at 8%; and the small cap stocks are up only 1.4% for the year.

We have continued to see a shift from “value” investing towards “growth”. Within sub-sectors of large-, mid- and small-cap stocks, the growth subsets are well outperforming the value stocks for the month and for the year. This trend, which we have discussed before, is typical in the economic cycle. As the overall growth rate of the economy begins to slow, it becomes more difficult for slower growing companies (“value” companies) to achieve earnings expansion. Hence, investors tend to prefer those companies that are innovating and have the potential to organically grow their profits.

Mid-cap stocks, which have been in the “sweet spot” for much of the recent buyout activity, have underperformed for the month. As some of the recent takeovers have come into question due to the tightening credit environment, we have seen the mid-cap stocks struggle.

International stocks did not make it into positive territory during the month, as both the developed foreign market index and the emerging markets were down 1.6% and 0.6% respectively. Foreign investments may have been weak partly due to the fact that there was such a great “flight to quality” over the past month. Short-term US treasuries were in demand as yields fell to under 3.5% during the middle of the month, ending at just over 4.0% on August 31st. This “flight to quality” may have helped the dollar gain some strength, which is a detriment to the foreign currencies and, therefore, investments in foreign equities.

These low treasury yields are implying some significant Federal Reserve actions to lower interest rates over the next few months. Potentially aided by the prospect of lower rates, Financials and Real Estate have reversed their downward trend for now, with gains of 1.5% and 6.4% respectively for the month of August.

While September is historically a difficult month for the stock market, there are some reasons to be optimistic. First, we expect Ben Bernanke and his FOMC mates to follow through and lower the Fed funds rate, which will hopefully slow the rising rate of home foreclosures. It only seems fair that if the Fed is willing to help the big banks who are struggling with credit issues by lowering the discount rate, then they have an imperative obligation to also assist those single family homeowners and consumers who are also struggling. We are not condoning irresponsible lending or borrowing, but we do support the Fed taking action to take some of the sting out of the current situation.

Insiders purchasing shares of stock is another reason for us to be optimistic this fall. The level of insider buying has some analysts citing that these are the most bullish insider purchases since the fall of 2002. Obviously, the executives and CEO’s would not be aggressively buying their company stock unless they believed their prospects were good. Some of the buying has been concentrated in the financial sector, which has suffered the most because of the sub-prime fallout.

We do see some increased risks to the economy and our investments as we navigate though this uncertain period, and as such, we are a bit more cautious in the near term. Over the long term, we expect the lower interest rates to stabilize the credit markets and housing prices. We may see some disruptions in certain sectors most closely related to these issues, but the long-term effects should be minimal. A slightly more conservative portfolio with an increased emphasis on fixed income investments and consumer staples investments may be appropriate for a relatively risk averse investor.

We are also excited to be approaching the best time of year for equity investments – November through May of each year. Fortunately, that seasonally strong time of year is just around the corner.

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Sunday, August 5, 2007

News - July 2007

The credit markets have been spreading a wave of worry through the financial markets over the past month. Well documented issues with mortgage lenders and the housing market have been rippling through the financial services sector. There have been a few cases where a hedge fund or mortgage lender have been exposed to having taken on too much risk and have collapsed. But by and large the overall extent to which many of the most recognizable financial institutions are exposed to these issues remains unknown.

That uncertainty has spread through the debt and equity markets as investors require higher returns from bonds and have sold off many stocks in the near term. Two hedge funds run by the Wall Street firm, Bear Stearns, have been exposed as being nearly worthless. The funds were invested in mortgage products, but it appears that the funds were highly leveraged. The high degree of leverage more precisely lead to the downfall for their investors. That revelation along with general sentiment has put into question which other Wall Street firms and financial institutions could suffer losses related to mortgage loans, hedge funds and structured products that invest in these mortgage products.

The majority of the loss, however, is not necessarily attributable to Bear Stearns, but those who invested in these hedge funds. The financial institutions may face future litigation and will certainly lose some future management fees associated with these products. The fees are generally minimal in the context of the revenues and earnings these companies generate. The other negative consequence could be a lack of reputation which could linger on for some time.

As current investors have required higher returns for their corporate bond investments, current holders of corporate debt have seen their principle diminish. Many high yield bond funds lost over 3% for the month. As stocks slid during the month also these high yield investments didn’t provide as much protection or diversification as investments in risk free US treasuries.

Government bonds performed well for the month as investors chose to swap out of higher risk bonds and into safe secure US treasury bonds and notes. The yield on the 10-year treasury quickly retreated from the recent high of 5.3% to well under 5% again towards 4.8%. Rates coming back down seem to indicate that the Fed may need to lower rates in the near future instead of raising or standing pat.

The recent stock market events have definitely been taking their cues from the bond market. The government said that the annualized GDP growth in the second quarter was 3.4%, which was higher than expected, and marked the fastest economic growth since the first quarter of 2006. Consumer spending was lagging though as record setting oil prices and a reduction in home equity withdrawals seems to finally be taking its toll on the American consumer.

Many economists and analysts have remarked that the global economy is in the best shape as they have ever seen. The strength in the global economy continues to bring along the US economy from our perspective. While the declining dollar has some negative implications it also helps US exporters sell US manufactured goods at cheaper prices abroad. This should help reduce the trade deficit to the benefit of many manufacturers and workers here in the US.

For the month the large cap stocks held up much better than the smaller capitalization stocks, while commodities and international stocks held up even better. S&P 500 was down 3.1%, the DOW Jones Industrials was down 1.4% for the month of July. The Russell 2000 index of small-cap stocks retreated 6.8% and the mid-cap stocks were down 4.3%.

Financials and Real Estate related securities continue to be notable underperformers for the month and for the year as rising interest rates and the issues surrounding mortgage lending continue to hamper these two specific sectors. A popular financial services ETF was down about 9% for the month of July and is down about 8% for the year through the end of July. A popular Real Estate ETF was down over 7% for the month and is down a whopping 15% for the year through July 31st.

Although the financials, the largest sector in the market, have struggled the overall market has done reasonably well. There have been many headwinds to the market this year, but the S&P has advanced 3.6% for the year and the DOW Jones Industrials have managed and even better 7.3% gain from January 1st 2007 through July 31st 2007.

Technology, Telecom, Utilities and Natural Resources have all outpaced the gains in the broader indices. Exposure to international markets also continues to be beneficial to investors as the developed markets have gained nearly 8% year to date and the emerging markets have returned 15% through July 31st.

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Thursday, July 5, 2007

News - June 2007

Volatility in the financial markets spiked again this month. Unlike earlier in the year, the June spike in volatility was in response to higher interest rates. For several days this past month, it seemed that the DOW Industrial Average gained or lost 100 points each day. If interest rates remain at the new plateau or rise higher, the increased volatility is likely to continue.

The 10-year bond is important because it serves as a benchmark influencing mortgage rates and other consumer and business borrowing costs. The 10-year treasury reached a five year high during the month of June, eclipsing the 5.25% mark before backing off a bit by the end of the month. While an increase in interest rates can occur because of increasing inflation and inflation expectations, interest rates can also reflect the economic growth expectations.

Current economic strength has all but eliminated the possibility that the Federal Reserve will decrease interest rates later this year. The market increase in rates this month leads to several observations about future economic prospects and inflation. First, the financial markets have adjusted, assuming the Federal Reserve will not lower interest rates later this year. The bond traders, who are generally less optimistic about economic prospects, have now embraced the thought of a stronger economy as they have sold bonds, requiring higher returns. While increased interest rates can indicate higher inflation, the fact that shorter term rates have remained stable probably suggests that inflation is not the cause of recent interest rate changes. Many analysts have commented that the increase in rates is due to an improved economic outlook, with foreign economic strength the likely source of much of the improved outlook for the U.S. economy.

International stocks continue to provide relatively superior returns than the U.S. stock market, as the developed international markets have gained 10.3% and the emerging markets have advanced over 15% for the year. The expanding developed and emerging international economies have been a significant factor in assisting the further growth of American corporations doing business in international markets. Contrary to past years when the U.S. economy sustained international economies, the U.S. economy is benefiting from the faster growing economies in Europe, Latin America and Asia. American corporations are earning an ever-increasing share of their profits from doing business abroad, much to the benefit of the American investor.

The capricious month of June provided a small 1%-2% pullback for most indices, but for the year, stocks have advanced soundly. The S&P 500 has gained 7% for the first six months of the year but retreated 1.7% for the month of June. The technology-laden NASDAQ was the best performer of the major indexes for June with a flat performance, while advancing 8.2% for the year. The DOW was off 1.5% for the month, but has done well for the year, returning 8.8% year-to-date.

Financials, despite relatively inexpensive valuations and high dividend yields, have been notable laggards for 2007. Real Estate stocks have also been laggards as interest rates have moved higher this year. A popular Financial ETF is slightly negative at -0.6% for the year, while a popular Real Estate ETF is off 9.2% year-to-date through June 30th. Real Estate Investment Trusts have outperformed the broader market for the past few years, so the correction in that sector may be warranted with their stretched valuations, regardless of the increase in interest rates.

Economic growth was sluggish during the first quarter as the commerce department reported a 0.7% increase in GDP. Economists expect GDP growth to improve to the 2% level later in the year. We believe the major change was that global growth expectations were recalculated higher while inflation remains a concern (but still in the realm of the target range). Reports in the middle of the month pointed to low inflation with the exception of higher gasoline and energy costs. We believe the economy will be able to absorb these higher energy costs while limiting the effect on other goods and services. Retail sales will likely indicate whether a softer housing market and higher energy costs are affecting the consumer.

Bonds are now trading at levels which make them a more attractive investment than they were just a few months ago. Bond yields have risen 75 basis points since earlier this year, lifting the income an investor will receive from these investments. While rising yields makes bond investments more attractive now, the higher yields push down bond prices, negatively affecting existing bond positions.

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Saturday, May 5, 2007

News - April 2007

Who says the number 13 is unlucky?!? The DOW reached the 13,000 milestone for the first time ever, closing April 30th at 13,063, up some 5.5% for the year and only six months after surpassing the 12,000 mark. For the fist four months of the year, the market rise has been very methodical, save for the blip during the last week of February. Volatility, which started the year at low levels, has become very tame again over the past couple of months after reaching the lows in March.

That said, these benchmark numbers are just figures and do not represent a justification for the value of the market. It’s important to judge stock prices on a variety of economic and financial assessments. What profits the overall market will earn is obviously the most important figure when valuing the market. The next step is to evaluate those earnings against a number of other metrics, including inflation, the current interest rate environment and the growth potential for the economy. Based on many of these comparisons, stocks still appear very fairly valued – not extraordinarily inexpensive, but also not significantly overvalued either.

The better than expected growth in earnings for the S&P 500 has been the most recent source of optimism, pushing the markets to new highs in the case of the DOW and multi-year highs for the S&P 500 and the NASDAQ. Analysts had been expecting around 3% profit growth over last year, but those expectations proved to be too conservative, in part aided by a weaker dollar which helps those multinationals with operations outside of the U.S. As the 1st quarter earnings reporting season draws toward a close, the earnings have been roughly 7% to 8% higher than last year for the S&P 500 companies. Simple concepts are at work here: the more money a company makes, the more it should be worth, right?

All of the DOW’s gains were achieved during this past month as the average surged 5.7% during the month of April alone. The S&P 500 climbed 4.4% for the month and the NASDAQ rose 4.3%. The small cap stocks as measured by the Russell 2000 Index gained a less stellar 1.8% for the month of April.

As always, certain sectors outperformed the broad market and there were also some underachievers. The Industrial Materials, Utilities, Telecom and Healthcare sectors all bettered the broad market. Real Estate and Financials are the notable underachievers, probably in sympathy with the well publicized sub-prime mortgage problems and real estate valuation apprehension. One thesis for some of the recent stock market strength is that, as investors become more apprehensive about investing in real estate, they look to stocks as an alternative to invest their capital.

The housing sector does continue to be a source of concern about the overall economy, although those concerns have yet to materialize. Consumers continue to spend more, although the pace of that spending growth is expected to be a bit slower for the rest of the year. Countering the troubles with the housing market, which many economists predicted would slow spending more significantly, is the data suggesting that incomes are growing at a faster rate, which should bolster spending. Unemployment remains low at 4.5% for April, although that figure is slightly higher than the 4.4% number released for March.

Overall, there is certainly a mixed bag on the economic front. With GDP growth slowing to a preliminary annualized rate of 1.3% for the 1st quarter, stocks may be hard-pressed to sustain the appreciation we have seen over the past nine months. We believe that as world economies are increasingly cooperative, our investments become less dependent on the rate of growth within the U.S. economy. Many, if not most, of the companies in which we have allocated investments have operations beyond our nation’s borders. The fact that international economies continue to increase their rates of economic expansion, including Europe, gives us confidence investing in the equity markets.

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Monday, March 5, 2007

News - February 2007

The month of February marked the return of volatility to the stock market. After months of monotonous, steadily rising equity prices the market looks to be correcting. While that monotony is certainly enjoyable to investors, there were many who were not surprised by the interruption that eventually occurred. Unfortunately, predicting the timing of such an event is virtually impossible. Many market forecasts had expected the market to slump in the traditionally weak September to October period, but it never developed that way as the market advanced a very methodical 15% from the July period right through most of February.

For the month of February, the DOW, S&P 500 and NASDAQ were all negative at 2.5%, 2% and 1.9% respectively. Year-to-date as of February 28th, the DOW was down 1.2% and the S&P was down by 0.5%. Small cap stocks continue to outperform as evidenced by the Russell 2000 still being positive at 0.9% for the year. According to the Morningstar mutual fund category returns, Real Estate and Utilities continued their outperformance from last year, surging 5.3% and 3.4% for the year through February 28th.

Financials, the largest sector in the market, is the notable underperformer, along with the very largest capitalization companies as indicated by the poor performance in the DOW 30. Utilities and Natural Resources both were positive performing sectors for the month of February, while Financials, Health and Real Estate were notable underperformers, all falling more than 1.5% for the month.

Even though a 416 point drop in one day is significant for the market, on a percentage basis, it’s actually not as earth-shattering as it would have been had it happened in past years. For example, consider that the DOW plunge of 508 points in 1987 accounted for a 23% one-day clip in stock market value. The recent drop on February 27, 2007 was worth about 3.5%. Can you imagine the chaos and media frenzy today if the market erased 23% of its value in a single day? In fact, most corrections of this sort are good buying opportunities taking into consideration the economic and market fundamentals.

There are a myriad of explanations for the drop in the markets. The immediately obvious reason was a reaction to the Chinese market that was sold off by 9% the night before, although the Chinese market is fresh off an incredible increase of 130% for 2006. A market that has advanced at that pace for the past year is much more likely to see wild swings and much more volatility.

Another explanation was that retired Federal Reserve Chairman Dr. Alan Greenspan was forecasting a recession for the U.S. market in 2007. These comments were probably misconstrued, as he was explaining that a recession at the end of this year or next was possible, although not probable. Of course, some of the media and market analysts did not seem to care about what Greenspan was actually trying to convey; rather, they focused more on his use of the word “recession.” To some degree, a future recession is as possible as an expansion, although historically, the U.S. economy is expanding approximately 85% of the time.

There were some other explanations for the market drop that have been mentioned in prior editions of this column. First, sub-prime mortgage brokers seem to be feeling some discomfort. Although we haven’t specifically discussed the sub-prime market, the fact is that these lenders are now finding it more difficult to collect mortgage payments and, because of more stringent lending practices, are having a tough time finding new borrowers. Typically, sub-prime lenders, which account for a small percentage of all mortgages, are those companies lending to the more credit-risky borrowers who are much more likely to default on their loans when home prices fall and interest rates rise.

Another word frequenting the financial airwaves during the last week of February was “correction.” Some have said that the long-steady rise in the stock market could not continue without some relatively volatile re-pricing of equity prices. A correction is, in some ways, a more psychological event rather than a reaction to economic and market fundamentals. Investors have shown an attraction for safe investments by reducing their risk profiles, a trend which may continue in the short-term. Bond prices have risen in response to higher demand for lower risk as the 10-year treasury yield edges downward towards 4.5%.

We believe that corrections are inevitable. This specific correction probably would have happened at some point regardless of the other issues attributed to selling in the stock market. As much as investors might desire, equity prices never rise consistently and continuously unless you consider very long-term horizons. The important thing to remember is that it is foolish to try and predict when these events are going to happen. As such, it’s important to remain diversely invested in order to mitigate some of the volatility.

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Monday, February 5, 2007

News - January 2007

The third year of a Presidential term has been a strong period for the stock market in prior years, as evidenced by not a single decline in the S&P 500 during a third year of a term since 1945. This may be because politicians intent on retaining political control for themselves or their party are inclined to stimulate the economy in order ensure support in the next election. This certainly is no guarantee for higher equity prices, but it is a positive sign. In this news update, we would like to address the performances of the various market indexes and also look at some of the economic and political issues on the horizon and how they might relate to the financial markets as well as individual finances.

The market got off to a somewhat sluggish start at the beginning of January as the growth of the economy was in question and inflation remained a concern. As the first few weeks of the year passed, these nagging concerns were somewhat diminished. Commodity prices, specifically oil, fell abruptly at the beginning of the month to levels not seen since 2005.

Oil fell to $50 a barrel midmonth, a whopping 35% below the all-time high prices reached last summer – so it’s no wonder the inflation concerns have relaxed a bit. At the same time, growth as measured by GDP has rebounded to 3.5% annualized, which is an almost unthinkable combination of events. Most of the experts (along with common sense) seem to indicate that the correlation of economic growth and commodity consumption would certainly be positive.

It was reported that oil consumption actually fell 0.6% in the 30-member countries of the OECD, which include the developed countries in North America, Europe and Asia. This is the first reported drop in oil consumption for this group in 20 years. While fast growing consumers of India and China are not included in the OECD numbers, it is still remarkable that oil consumption was lower while these global economies continued to flourish.

The economy also received good news in the form of the jobs data released during the first week of January. The Labor Department figures showed that 167,000 jobs were created in December and that wages increased to an average of $17.04 in December, which was an increase of 4.2% from December of 2005. This was the largest percentage gain in wages since February 2001. This could be a reversal of recent trends that saw corporate profits expanding while workers’ wages were relatively stagnant.

The fact that wages have begun to climb could have the most significance in the year ahead. In recent months, the populist political rhetoric has sharpened as the Democrats and anti-immigration leaning politicians have gained greater influence. One of their principal arguments is that wages and the benefits of a statistically strong economy have not been shared from top to bottom. They argue that the reasons for the uneven distribution are a combination of an influx of foreign labor, outsourcing, reductions of global trade barriers and the very nature of capitalization.

It’s somewhat ironic that the very circumstances that have allowed our economy to grow are also the same forces that promote some of the inequalities among owners and workers. Most economists believe that our society is generally better off economically despite the fact that assets and wages are not divided evenly. However, some have presented examples where CEO’s are now earning 400 times that of a regular employee as compared to just 20 times a few decades ago, which is a compelling case for how a prosperous society doesn’t necessarily seem to promote equality. A continued acceleration in wages is obviously a positive for most workers, but the effects on a corporation’s income statement, and therefore, our investments, will need to be monitored.

At the very least it is partially because of the improved GDP numbers, job growth and tamer inflation data reported this month that enabled the stock market to show some strength. The major indexes finished January in positive territory as the S&P 500 gained 1.5%, the DOW gained 1.4%, and the NASDAQ rose 2.1% by the end of the month. International stocks lagged slightly as the developed foreign markets gained 0.7% while the emerging markets returned a negative 0.6%.

Real estate stocks continued the recent very strong performance gaining 9.9% for the month of January buoyed by merger and acquisition activity. The healthcare and telecom sectors also outperformed the market while natural resources, energy and utilities were slightly negative for the month. It is interesting to note that growth funds of each category outperformed value stocks, which is counter to the recent multi-year trend.

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Saturday, January 6, 2007

News - December 2006

At Rollins Financial, we are always optimistic about investing in America and the businesses of our country, especially when considering long-term investment time horizons. This month, we would like to offer reasons for you to be confident about the upcoming year in the equity markets while also discussing some issues of concern that could possibly negatively affect the stock market and the economy in 2007.

First, we would like to address the performance of the various market indices for the year ended December 31, 2006. As the year came to a close, the market reaction was upbeat as the Dow Industrial Average moved to new all-time highs. Recent history has shown that stock market gains have increasingly accumulated towards the last half or even the final quarter of the calendar year.

Over the past few years, the actual earnings have exceeded expectations by the end of the calendar year. Analysts and corporate executives do not want to be held liable for overestimating a company’s expected performance, even though it’s clearly understood by investors to be an estimate. Whether this trend is the result of corporations and Wall Street analysts sandbagging their earnings forecasts early in the year because of increasing litigious liability or genuine conservative expectations, we may never know. This year, just as in the previous several years, the S&P 500 achieved the majority of its yearly gain over the final fourteen weeks of the calendar year.

A summary of the financial markets for the year 2006 is as follows:

The S&P 500 gained 15.8% for 2006 while the DOW gained 19.1%, the NASDAQ gained 10.4%, and the Russell 2000 gained 18.3% for the year. For the month of December, the DOW and S&P 500 gained 2.1% and 1.4%, respectively. International stocks once again outperformed the U.S. market as the MSCI EAFE index rose 26.3% and the Emerging Markets returned 30.7% (as measured by the iShares MSCI Emerging Markets Index ETF).

Real Estate, Telecom stocks, and Utilities were the most noticeable outperformers in 2006, gaining 39%, 34.17% and 20.90%, respectively, as measured by the returns of popular sector ETFs. Healthcare and Technology generally underperformed the broader markets this year.

Interest rates for the 10-year Treasury rose from 4.393% at the beginning of the year to 4.708% on December 29th, although the average mortgage rate declined ever so slightly from 6.22% to 6.18%. The increasingly followed commodity prices were erratic, as oil prices closed the year trading within one penny of the 2005 year end price – $61.05 after climbing close to $80 a barrel during the summer – while gold prices gained $118 to close 2006 at $635.20 an ounce.

The overwhelming sentiment surrounding the financial markets seems to be quite positive considering the rally that has taken place since the last week of September. One of the themes of 2006, and likely to continue into 2007, is the frequent buyout activity. Eight companies in the S&P 500 are scheduled to go private, so it’s obvious that the private equity groups feel that many public companies are trading at cheap valuations. While these groups are not infallible, they control billions of dollars and are generally run by very successful, savvy investors.

Many large mutual fund managers have remarked that these companies, although being sold at a current premium, are still not properly valued and that management, who are often involved in the negotiations, is selling out for a quick immediate gain. Those same members of management and private investors stand to make many times more when the company is brought back to the public, which is generally the ultimate goal. Corporations themselves think their stocks are good investments evidenced by the fact that record amounts of stock buyback are being authorized. Much like the private equity groups, corporations willing to invest so heavily in their own stock must be confident that their businesses are undervalued.

Confidence in the equity markets is also sustained by relatively low interest rates. There is substantial incentive for an investor to buy stocks when a government bond is only paying a return of 4.75%. Corporations will also be able to raise capital for investments in their respective businesses using debt at these low rates. As managers gain confidence in stable interest rates, they will be more willing to invest in their companies. Individuals will behave in much the same manner as a business – borrowing at low rates and investing (spending) in their own lives.

The Federal Reserve and interest rates also strikes to the heart of the obstacles facing the market this year. The housing slump has been worse than many experts predicted. It is no secret that one of the ambitions of the Fed has been to pop the housing bubble. If negative effects of the housing slump eventually materialize and spread into other areas of the economy, this could hurt the consumer and the economy overall.

One thesis is that individuals who entered into variable loans or ARMs are now having to refinance or will begin paying higher interest rates on their loans. Banks have tightened their lending practices and it may be difficult for some of these borrowers to qualify for refinanced loans. Obviously, as consumers are forced into paying more for their homes or selling them at a loss, their spending habits will be adversely affected.

Inflation is another issue to be followed closely. The Federal Reserve continues to insist that their main concern when evaluating whether they should adjust interest rates is inflation. If commodity prices continue their upward trajectory, then interest rates may be pushed higher in order to stifle demand and rising prices. The consequences of such actions could be upsetting to an economy largely dependent on consumers and their confidence.

One last thought is that the stock market rally has been almost too consistent since 2003. Corrections in stock prices are a very healthy and ordinary event, although for investors they can be uncomfortable. Several market technicians have commented that a real correction is on the horizon because that’s what is customary. We can argue about what exactly constitutes a correction, but there are those who think the 7% drop in the S&P during the end of May and into June did not qualify. Looking back, it seems that timeframe was a great buying opportunity, as would be true for most corrections.

Rest assured that there will be ups and downs throughout the year, although we do expect the broader indices to show gains by the end of the year. We will be observing these aforementioned issues closely and adjusting portfolios appropriately. Wherever the market leads us this year, at Rollins Financial we will be investing in great opportunities here in the United States as well as in markets around the globe.

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