4.21.20042004 First Quarter Client Letter Economic Update The US economy is expanding as evidenced by continued good economic news. The economy, as measured by Gross Domestic Product, grew at an annual rate of 4.1% in the 4th quarter 2003. Again, the major contributors to the increase in real GDP in the fourth quarter were personal consumption expenditures. We have repeatedly mentioned the spending characteristics of Americans and the increased spending by the baby-boomers. We expect this spending trend to continue for the next five years. The economy is not growing as rapidly as it was in the late 1990’s, though it is approaching similar levels. The economy is beginning to produce jobs as the unemployment rate is 5.7%, down from a high of 6.3%. In March, over 300,000 jobs were created. Market Update In the recent quarter, the economic data has been positive, but the stock and bond markets have been lackluster. The price appreciation in 2003 anticipated the economic news and the markets are fairly priced. What should we expect from the stock market in the 4th year of a US presidential term? Historically, during the fourth year of a presidential term, the stock market is up eighty percent (80%) of the time. The average advance of the fourth year is very close to 10%, the historical average for the market. In addition, the market volatility is only 11% instead of 20%. During a Republican President’s 4th year, the volatility has been only 7%. This means the market has a 68% chance of being between +3% and +17% in 2004. This has been true so far in 2004. The market is up, but not much. The market is in a “wait and see” mode until the election. Portfolio Update We continue to favor US small companies, international stocks (particularly small companies), commodities, and Asian equities. During the first quarter, US small companies advanced more than US large companies, international equities outpaced US equities, and commodities have soared. Risk Management: Modern Portfolio Theory (MPT) explains how diversification can allow a portfolio to achieve market returns with less volatility. It suggests owning cash, bonds and equities. These three asset classes do not move in tandem. When stocks are going down, cash and bond investments could be going up. The theory says to re-balance the portfolio by selling the advancing assets and buying the “out of favor” assets that are declining or not advancing as rapidly. As a result, the portfolio continues to purchase the declining asset and sell the advancing asset. Through research and analysis, our asset management approach is a variation of MPT. We have found the markets move in waves: up and down. These waves tend to last for extended periods of time. We agree with the concept of buy low and sell high. However, we disagree with the theory of selling at pre-determined times such as quarterly or selling because the price is higher. If the price goes higher, then we would miss future price appreciation, and if the price goes lower, then we compound the losses. Instead, we believe in owning the securities “in-favor” longer and selling the securities “out-of-favor” sooner. When stocks are advancing, we will participate in more of the advance and vice versa. Risk will be managed by owning higher levels of cash and fixed income when equities are out of favor versus simply defining the level of cash, fixed income, and equities and keeping them constant at all times. We believe this will allow us to capture higher returns in bull markets and minimize losses in bear markets. In addition, we believe in owning alternative investments for additional diversification. Thank you for your continued trust and support! Trevor K. Holsinger, CFP