3.31.20052005-First Quarter Client Letter

Economic Update: Accelerating Growth

US economic growth as measured by Gross Domestic Product in 4Q2004 increased at an annual rate of 3.8%, down from 4.0% in the prior quarter. Although economic growth decreased quarter over quarter, economic growth may be accelerating going forward.

One indication for economic growth is individual income taxes paid to the Federal Government. During the first quarter of 2005, payroll taxes paid to the government were 8% greater than payroll taxes paid during the same time period in 2004. This can be explained by more US workers and higher wages for all employees.

Could the source of the growth be several hundred billion dollars in repatriated cash by corporate America? On Oct. 22, 2004, Congress passed the American Jobs Creation Act. This legislation allows US-based corporations with overseas operations to repatriate as much as $500 million per year in overseas income at a 5.25 percent tax rate rather than the usual 35 percent tax rate -- provided that the companies use the repatriated money for certain purposes, such as job creation and capital expenditures. Repatriation is the return of corporate profits earned overseas in the form of cash back to the United States. Without the lower tax rate from this legislation, corporations were discouraged to return the overseas earnings because of the high 35% corporate tax rate.

Market Update Individual investors are bearishly selling stocks and corporations are bullishly buying. Who has it right?

Individual investors are as bearish now as they were right before the outbreak of the Iraq War in March 2003. Since that time, the overall stock market has risen 40%. Once again, the individual investor gives clues as to the future market direction. Keeping with our contrarian beliefs, this should bode well for the stock market in the coming months.

American publicly-traded corporations are purchasing their own stock in quantities twice as great as the record pace set in 2004. In the past six months alone, announced stock buy-backs total $500 billion. Why is this important? This indicates corporations have excess cash and believe their stock is cheap. Secondly, this cash is going to investors who generally will re-purchase shares of other corporations. This should increase the price of stocks.

There are two possible reasons for the April stock market decline: income taxes payments and a bill passed by the Senate. Investor’s sell equities to make their April 15th tax payment. This temporary event is typically followed by a rally. Secondly, the US Senate passed a bill for across-the-board tariffs on imports of Chinese goods unless China agrees to revalue its currency. This legislation would be a huge tax on the American consumer and would have an almost immediate affect of raising interest rates, causing a drop in housing values and a recession. It is reported that President Bush will veto such economically detrimental legislation.

Portfolio Updates

Even as things change, they remain the same. I am referring to euphoric investors continuing to purchase yesterday’s winners. The mirror-image of the late 1990s is occurring in small company value stocks. From 1995-2000, large company growth stocks outpaced small company value stocks by 200%; large growth was up 303% and small value was up 103%. The last five years, small company value stocks have out-performed large growth stocks by 138%: 101% return for small value, while large growth stocks are down 30.7%. Across all 10 years, small value is up 444%, while large growth is up 295%, investors continue to buy small value funds and sell large growth funds

Over the past 51 weeks, investors have withdrawn money out of large company mutual funds on all but 17 days. Alternatively, small company mutual funds have received more money than was taken out on 80% of all days during the same time period. Accordingly, we believe this is a time to tip toe back into large companies and reduce positions sizes in small companies. As soon as large company growth begins to outperform small company value, these same investors will migrate from one to the other. We would like to get there ahead of the herd.

Thank you for your continued trust and support.

Trevor K. Holsinger, CFP