Commentary and Articles

2nd Quarter 2005 Quarterly Synopsis

“Shaky Recovery”

The 2nd Quarter of 2005 presented some relief for investors, but there is still plenty of evidence that caution will be the watchword in both equity and fixed income markets.

The Federal Reserve again raised short-term interest rates and suggested that they will continue to do so. One indication the Fed used to support the continued hikes is the GDP growth which grew at a solid 3.8% for 1st Quarter 2005. In addition, national income has grown faster than GDP, which again, give the Fed ammunition to continue the pattern of rate increases. Even as short-term rates have increased, long-term rates have stayed surprisingly low, further fueling economic growth.

This smaller spread between short- and long-term rates would normally suggest an anticipated slowdown in the U.S. economy. We believe that it may in this case be an indication of investor uncertainty over higher oil prices (which rose to $60 per barrel in the 2nd Quarter) and a stronger dollar, which both could have an impact on economic growth. The rising dollar tends to slow purchasing from overseas and the higher energy and labor costs shrink margins for U.S. corporations. Interestingly coincident to the rise in the U.S. Dollar’s value is the shrinking of air-cargo traffic, suggesting that U.S. companies are, in fact shipping fewer goods overseas. As we have mentioned in past commentaries, some of these effects are offset by increasing strength of corporate balance sheets, as corporate debt is retired and cash is accumulated. Most corporations are using the excess cash to increase dividends, stock repurchase programs and business combinations (mergers and acquisitions) all of which should help shareholder value.

The rising oil prices have not had a noticeable impact on consumer confidence. In May, the consumer confidence index reached its highest level in three years. Soaring home prices in many metropolitan areas of the U.S. have provided consumer access to capital as refinancing activities have continued. This refinancing has provided funding for consumer purchasing. We do not expect this to go on forever, however. Corporate managers are also wary of depending on consumer demand driven by easy money. A further sign of a potential slowdown in consumer spending is the indication that the national savings rate increased for the first time since December. World saving rates are already at very high levels and the increases in money supply can dampen economic growth prospects.

In our portfolios, we saw significant gains in core holdings such as Burlington Resources (BR, NYSE), Fiserv, Inc. (FISV, NASDAQ), and Intel (INTC, NASDAQ) offset by significant losses in other core holdings; IBM (IBM, NYSE), and Gannett, Inc. (GCI, NYSE). IBM fell out of favor with investors in the 2nd Quarter, as it lost a chip making contract with Apple Computers to Intel and set about on a plan to restructure the company. We still believe that IBM represents a good long-term core holding and feel that it is value is relatively low at a Price-to-Earnings ratio at 0.92 times that of the S&P 500. In the Telecommunications sector, we added a holding in some portfolios; PT Telekom Indonesia, ADR (TLK, NYSE) which performed very well for the quarter and helped to diversify our portfolios with exposure to foreign companies in emerging markets. We will continue to monitor companies for fundamental strength and lower risk than the overall stock market while seeking a good margin toward upside potential in valuation. We will also seek diversification opportunities which we believe will enhance portfolio returns and mitigate potential risks.

In fixed income, we benefited from a strong overall intermediate-term bond market. We will continue to keep a close watch on duration in our bond portfolios as rates move upward.