January 17, 2007
Happy New Year! Or, should I say, Happy Old Year! Investors had much to cheer about in 2006 – including a new high for the Dow Jones Industrial Average. In my year-end letter twelve months ago, I wrote about the natural disasters, increasing federal funds rates and increasing energy prices that occurred in 2005. As you know, these issues are not stock market friendly; however, we managed a gain in 2005 despite all that took place. 2006 saw a reversal of these inhospitable stock market issues. It did not end there, however. Corporate profits also had a significant impact on the direction of the stock market this past year.
In 2006, the natural disasters did not hit the scale that many had predicted at the beginning of the year. Weather forecasters had warned that destructive hurricanes were going to become a common occurrence. While 2006 was one of the warmest years on record, the hurricanes did not materialize as expected. This helped many of the insurance and reinsurance companies that profited from their increased insurance premiums due to these expected hurricanes. Many of our value funds hold these types of companies in their portfolios.
The Federal Reserve stopped raising the federal funds rate in June at 5.25%. This move had a significant impact on the fixed income markets. The third quarter saw many investors purchase intermediate bonds, thus lowering the yield the bonds pay out. If you already owned these longer-term bonds in your portfolio, you saw a pretty big increase in the price of these bonds due to the increased demand. Low interest rates means it costs companies less to borrow; thus, more profits filter to the bottom line.
Oil prices started to fall dramatically in the third quarter of 2006. As all of you know, lower oil prices means more money in consumer and corporate pocketbooks. As oil supplies increased in late 2006 due to the warm weather felt across the country, prices fell even quicker. It will be interesting to watch oil prices in 2007. With China, India and other developing countries expanding their markets, I am not convinced that low oil prices are here for the long-term.
There are several items we will be watching in 2007. It is no secret that people around the world are sick of the headlines from Iraq. A change in Congress to a Democrat majority in both houses this past November was one of the results of this nearly four-year Iraq War. Another question for 2007: With the unemployment as low as it is, will this impact the price we pay for goods and services? In other words, is inflation in the cards? Over the past few months, we have seen a drop in the value of the dollar compared to foreign currencies. What kind of an impact will a depreciating dollar have on our trade deficit? Will the housing slump lead our economy into a recession by years end?
I believe an emphasis in large companies in the year 2007 will be the best place for your hard earned assets. If the dollar continues to slide, many of these large multinational corporations will be somewhat insulated with a lot of their revenue coming in the form of overseas currencies. Besides, large corporations tend to do better should we inch closer or fall into a recession by the end of the year. I also believe large companies still hold better value (are cheaper) than small companies at the present time. All of these factors help build the case for a slight overweight to this area.
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 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,
William A. Bullock President
P.S. Please note that the 2006 tax information will be mailed in a separate mailing by mid-February.