Commentary and Articles

2nd Quarter 2004 Quarterly Synopsis

“A Hard Place to Make a Profit”

Investors as a group were skittish about markets in the 2nd Quarter 2004. Many unknown factors added up to a “wait and see” attitude which could be felt throughout the U.S. equity and fixed income markets. The war in Iraq and the impending handoff of power to the new Iraqi government, along with the possibility of rate increases were the major contributors to the climate of wariness.

Last quarter we predicted that the Federal Reserve would hold off on interest rate increases until after the Presidential Election in November, unless increasing signs of rapid economic growth began to force the hand of central bankers as inflationary pressure mounted. The Consumer Price Index and the Producer Price Index in the 2nd Quarter were higher than consensus estimates, showing that the economy was able to command higher prices for goods and services. Thus inflation showed up on the radar screen of Greenspan and Company and the markets began to adjust for the anticipated rate increase.

As the quarter came to a close, it was obvious that it had been a quarter with little activity in the financial markets and many money managers were heard wishing to just close the books and move on to the second half of the year. Trading volumes were down 18% for the quarter, and May mutual fund inflows were at the lowest point since February of 2003. The lack of volatility in markets showed the malaise as well. There were only 10 days on which the stock market moved up more than 1%, and only 14 days on which the stock market moved down by more than 1%, representing only about one-third of the volatility seen in an average quarter.

However, we anticipate the 3rd Quarter, and the second half of the year in general, to be comparatively more exciting. 2nd Quarter corporate earnings are likely to be strong. Although fuel prices have been a major complaint, they are not as high as would be expected on an inflation-adjusted historical basis. Thus, we do not expect that they will dampen the prospects for continued growth. The Iraqi handoff and the trail of Saddam Hussein will make investors more comfortable with the geopolitical climate. The clarity on timing of interest rate increases will cure a major reason for lack of investor confidence.

In spite of the lack of action, we experienced a successful 2nd Quarter in our client portfolios. Our holdings in Qualcomm (QCOM, NASDAQ) and Checkpoint Software (CHKP, NASDAQ) posted higher than average returns. In addition, our energy sector holding in Burlington Resources (BR, NYSE) appreciated considerably. As expected, our industrial holdings in General Dynamics (GD, NYSE) and United Technologies (UTX, NYSE) continued their upward march as the economic recovery advanced. Overall, our composite equity portfolio finished the quarter up 4.61%, significantly better than the benchmark index.

After holding higher levels of cash than we might otherwise maintain, we have begun to reallocate into bonds as opportunities present themselves. We will maintain a conservative duration, allowing us to make the most out of reinvesting at higher yields as prevailing rates move up.