January 17, 2005
The stock market returns were excellent in 2004. The Wilshire 5000, or the largest 5000 stocks in the United States, was up an astounding 12.6%. The MSCI EAFE, our foreign stock benchmark, was up 20.2%. At the other end of the spectrum, the bond market, as reflected by the Lehman Brother Aggregate Bond Index, was up 4.3%.
The USA Today recently polled 10 prominent Wall Street strategists asking them to give their predictions of where they believe the market will end on December 31, 2005. While we do not place much faith in predictions, we found it interesting that eight in ten strategists believe the market will continue on the bullish path that we are currently enjoying. The biggest bull analyst that the USA Today interviewed was Brian Belski of Piper Jaffray. He expects the S&P 500 to finish at 1350 – about 150 points (+12.5%) from where it is at the present time. The January 2005 Argus Update indicated a 12 month target for the S&P 500 to be 1300 – an 8.33% increase from where the S&P 500 is right now.
What, if anything, might derail these strategists’ opinions? We see three areas of concern in 2005: consumer debt, real estate and the U.S. trade deficit. As you know, consumer debt has been a problem for years in the United States and the real estate market’s lofty prices have been supported by historically low interest rates. President Bush claims that he supports a strong dollar, but there is very little proof that the Bush administration is doing anything to support that claim. Many investors are wondering how much longer China, Japan and some European countries will continue to purchase and hold United States Treasuries (close to 50% of our national debt is held by foreigners). What would happen if these countries decide to dump their U.S. holdings? Interest rates would begin to climb and in a rising interest rate environment, consumers and corporations would not be able to borrow as much. That could slow down consumer spending, business investment and the real estate market. Obviously, some regions of the country will feel the impact of rising interest rates on their real estate values greater than other areas.
A continued dollar decline will eventually make U.S. exports cheaper for other countries. This might be the catalyst that will reverse the trade deficit we have with foreign countries. At that point, and who knows when it will occur, our trade deficit should begin to shrink. In our 2003 year-end letter, among other questions, we asked the following: “At what point are the budget and trade deficits too large? On the global stage, what impact will a continually declining dollar have on our economy?” These questions remain with us at the dawn of 2005.
The changes we make within your portfolios in the coming year will partly depend on how these issues play out over the next 12 months. Due to the run-up in equities over the past two years, we will probably have to rebalance portfolios during the first quarter of 2005. On the equity side, we will continue to emphasize large capitalization and foreign stocks while we expect to keep your bond allocations heavily weighted to short-term fixed income securities.
As always, we appreciate your past support and wish you continued health, happiness and prosperity in the new year. We would advise that you meet with us to review your portfolio. A review should take place at least once per year. Enclosed you will find your Portfolio Performance Summaries, Portfolio Holdings Statement as of December 31, and a quarterly Account Management Fee Statement. If you desire Morningstar reports or the most recent copy of our Form ADV, Part II, please call us.
Sincerely yours,
President
Portfolio Manager
P.S. Please note that the 2004 tax information will be mailed in a separate mailing by mid-February