6.30.20052005-Second Quarter Client Economic Update: Economy Stronger Than Expected The Commerce Department reported that U.S. GDP rose at an annualized rate of 3.8% in the first quarter, which was significantly higher than its original estimate of 3.1%. This 3.8% growth rate was equal to the growth rate in the fourth quarter. An indication of continued economic strength is that personal and corporate income is up significantly. TrimTabs Investment Research reported that individual take-home pay has increased a staggering 10.8%, or $290 Billion year-over-year so far this year, from $2,683 billion to $2,972 billion. Corporate income tax payments have exploded by 28.6% year-over-year as well. This strength will likely cause the Federal Reserve to continue raising interest rates. Market Update: Housing Market in Bubble Territory At the beginning of the year, there were supposedly two resounding “givens” with respect to the capital markets in 2005: (1) the dollar will continue to go down and (2) bond yields will go up. As I write this, both forgone conclusions have been totally wrong. On March 21, 2005, the Newsweek cover story read “The Incredible Shrinking Dollar”. The headlines today read “Dollar Hits 13 Month High Against Euro”. Regarding interest rates, long term rates have fallen 0.5%. In both cases, exactly the opposite has come true. Why do I bring this up? Contrarian thinking will add value to your investment portfolio. When it is so obvious that everyone believes something will happen, the market anticipates its occurrence and it doesn’t happen. One of the most drastic examples of this was in 1979, when the Business Week cover proclaimed “the Death of Equities”. Soon afterward in the 1980s and 1990s, US equities had the largest bull-run in history. The moral: don’t always believe what you read. Short-term interest rates are rising as the Federal Reserve raises the Fed Funds rate for over night lending to financial institutions. Currently, short-term interest rates are 3.2% and long-term interest rates are only slightly higher at 4.5%. If short-term interest rates exceed long-term interest rates, there is little or no incentive for banks to lend money, or for investors to buy long-term corporate bonds. In other words, the lender does not get paid to invest in the future. As a result, the economy will suffer. I expect the Federal Reserve to keep raising interest rates until the exuberant portion of this economy, speculating in the single family home market, slows down. A significant portion of new single family homes are being purchased as investments. This is where the 10.8% growth in take home pay is going instead of into the stock market. Portfolio Update: Expect a Market Move The stock market has been in a narrow trading range over the past 18 months, as more than 85 percent of the Dow's weekly closes have fallen within a miniscule four-percent range. After an extended period of a narrow trading range, markets tend to move dramatically. The days of the narrow-range environment are growing shorter. We have seen a growing number of new investment products introduced to investors capitalizing on this narrow trading range. Investors’ strong appetite for these products and willingness to accept modest returns indicate their acceptance of more of the same quiet market. Increased volatility is likely to emerge and surprise the growing number of investors pocketing pennies and nickels in such strategies that cap reward and offer very limited downside protection. The mere fact that narrow trading range conditions have become "institutionalized" and accepted by both Wall Street and the individual investor suggests that this environment is likely to end soon. The market will likely move higher or lower quickly. Money continues to flow into the same sectors: Small Cap Stocks and Real Estate. Over the past 63 weeks, investors have withdrawn money from large company mutual funds on all but 20 days. Alternatively, small company mutual funds have received more money than was taken out on 80% of all days during the same time period. Based on the wide acceptance of commodities by individual investors and the two standard deviation event in oil, our next move will most likely be to sell commodity-based investments. As the herd moves in, we want out. Thank you for your continued trust and support. Trevor K. Holsinger, CFP