October 17, 2007
October 9, 2007 was the fifth anniversary of our current bull market. While we may have come close to a market correction earlier this year – a decline of 10% or more in any given index – we have not had a bear market decline of 20% or more since October 9th, 2002. This is the fifth longest bull market since World War II. You can probably guess the longest: October 11, 1990 – March 24, 2000. Will this bull market continue? As one of my professors during my college years would have answered: it depends.
It depends mainly on corporate earnings. Corporate earnings are the backbone to the stock market. If we start to see a large number of companies warn of lower future earnings, we are probably looking at an upcoming slow-down or possibly a recession. Up to this point, however, we have not seen a large number of corporate warnings or negative earnings adjustments. The global demand for goods and services has had a lot, or maybe everything, to do with the growth of the stock market.
The biggest news over the past few months has to be the ½ point decrease in the federal funds interest rate – the rate at which banks lend balances at the Federal Reserve to other depository institutions overnight. This decrease sparked a rally across all sectors of the stock market. The Federal Reserve believed that this federal funds rate reduction was needed to offset the economy from a further slow-down or possibly a recession due to the sub-prime mess. We have seen several banks tighten their credit policies over the last few months, which scared the Federal Reserve into acting.
Others believe that reducing the Federal funds rate will allow inflation to reignite; up to this point inflation has stayed under control. These same economists believe that as more and more people find jobs and as oil prices continue to climb, inflation will become a bigger factor in the next 12 months. With lower short-term interest rates (due to the decrease in the federal funds rate), many believe that more borrowing will take place; thus, fueling a demand for more goods and services. As we know, the higher the demand for a fixed number of goods and services, the higher the price. Keeping inflation in check is one of the Federal Reserve’s chief functions. It will be interesting to see how they react should signs of inflation emerge.
Where does this leave our investments? Large-cap stocks are outperforming small-cap stocks so far this year due to their foreign operations. There are two main reasons behind this. First, the global growth for goods and services has helped large corporations and their foreign subsidiaries. Second, these global companies are benefiting from having their foreign subsidiaries doing business in foreign currencies. As you might know, the value of the dollar has been sliding when compared to a number of foreign currencies. As the dollar declines, imports into the United States become more expensive, but the exports to other countries become cheaper. All of these things are helping give large corporations a competitive advantage over small companies.
When all is said and done, our over-weighting to large-cap stocks is starting to pay off. I would like to continue with this slight over-weight for at least the next few months. Should the economy start to falter, we will take another look at increasing the small-cap exposure.
Growth stocks, companies growing at a faster clip than your average company, are starting to do a little better. Examples of these types of companies would include Google, Microsoft and Cisco Systems. It is not surprising to see these companies doing well. Overall, growth companies have been lagging their value brethren for most of the past five years. Our large-cap stocks are well balanced between growth and value.
Our foreign exposure (approximately 25-30% of our equity holdings) is doing quite well for reasons mentioned above. I plan on continuing with this allocation for the foreseeable future.
P.S. One of the biggest grumbles I hear from clients is that they receive an endless amount of paper reports from Schwab Institutional. There is now a solution that I thought you should be aware of. Schwab Institutional has implemented the “eDocuments” program through the www.schwaballiance.com website. I have been receiving eDocuments for over one year and I could not be more pleased with the service. Not only are all of your monthly statements available to be printed from the Schwab Alliance website, but you also cut back on mutual fund reports and prospectuses that are required to be mailed out semi-annually.
You can also save cash. One of the investment options that is becoming more prevalent when managing money is exchange traded funds (ETFs). If used properly, exchange traded funds can be less expensive than using mutual funds due to smaller expense ratios. In the next few quarters, I may begin to invest in exchange traded funds within a small portion of your portfolio. One of the tradeoffs to using ETFs as opposed to mutual funds is that there is a commission involved when buying and selling them. If you have not signed up for eDocuments, that commission is $19.95 per trade. If you sign up for eDocuments, that commission level drops to $12.95. Schwab is giving you a nice incentive to have you convert to paperless statements.
For those of you who do not regularly use a computer, I would suggest that you continue to receive statements in paper form. For those who read their e-mail on a frequent basis, I would like you to consider signing up for eDocuments. Once signed up through the Schwab Alliance website, you have access to all of the statements/reports that you would have received via mail. In fact, Schwab has instituted a 10-year archive of all statements and tax forms. American Investment Advisors, Inc. will continue to have access to your statements at any given time. If you are interested in converting, please contact Katie at extension 12. She would be happy to assist you!
Sincerely,
William A. Bullock