4.30.20072007 1st Quarter Client Newsletter Economic Update: Let the good times roll The economy continues to defy the odds of a down turn. For two years, the pundits have said higher interest rates and the decrease in equity loans will cause a recession. The next recession claim was the bursting of the housing bubble. Now the story of the day is the sub-prime mortgage market will cause the recession. One of these days, someone is going to get it right. In the meantime, the US economy continues to expand at a brisk pace. US wages increased 7% in 2006 and 7.5% so far in 2007. Low unemployment, rising wages, and strong consumer spending will allow the economy to continue growing. The probability of the economy having problems this year is low, while rising steadily in the following three years. Every year the recession is delayed, the chances of it occurring will increase. Market Update: Buy-out mania causing bull market One of the market metrics I track is net liquidity, or cash available to investors. Excess liquidity enables investors to purchase securities; and vice versa, a lack of liquidity limits demand of securities. Market research firm Trim Tabs estimates each day $4.9 Billion is coming out of stocks in the form of cash to investors. At this pace, over $1 Trillion dollars will temporarily leave the stock market in 2007. This money should return as investors reinvest the cash into new stocks, driving the market higher. Publicly traded companies are being purchased for cash on a daily basis. TXU Corp. has accepted a buyout offer for $45 Billion, Sallie Mae for $25 Billion and Tribune for $8 Billion. These three deals alone will put $78 Billion of cash into investor’s hands. Investors will, on average, re-investment these proceeds back into the market. These proceeds are from the investor’s equity allocation; therefore, the proceeds will typically get re-invested in the same equity asset class. Portfolio Update: Fundamental Indexing Fundamental indexes will dominate investment theory discussions and attract hundreds of billions of dollars over the next decade. Fundamental indexes weight their holdings based on company fundamentals such as revenue, income, book value, cash flow, and employees. Most traditional indexes are market capitalization weighted, meaning they assign the greatest weight to the largest companies. Why the difference? The market capitalization weighted indexes, like the S&P500, allocate more capital to the expensive companies and less to the cheaper companies. Theoretically, wouldn’t an investor want the opposite, more cheap stocks and less expensive stocks? For example, today, Exxon Mobil, the largest publicly traded company in the US, makes up 3.4% of the S&P500. In a fundamental index, Exxon makes up 2.8% of the index. On December 31, 2004, Exxon Mobile was 2.8% of the fundamental index and 2.75% of the market cap-weighted index. Now that Exxon has appreciated the last two years and is more expensive, it makes up more of the capitalization-weighted index. Historically, since 1964, fundamental indices have returned 12.5% versus 10.5% for the S&P500. The performance was robust across time, phases of the business cycle, bear and bull stock markets, and rising- and falling-interest-rate environments. This type of out- performance usually comes with additional risk. Not in this case. Fundamental indexes have less risk than market capitalization indexes, as measured by standard deviation. Higher returns with the same or less risk are just what we are looking for. Since we first purchased the first fundamental index fund (symbol: PRF), it has outperformed the S&P500 by 2%. We hope and expect the out performance to continue. Thank you for your continued trust and support. Trevor K. Holsinger, CFP