4th Quarter 2006

Economic Optimism

As we head into the new year the overall view of the economy is optimistic. The concern that the Federal Reserve was applying the brakes too hard by raising interest rates has diminished. For the second straight month ending in November the sales of existing homes were on the rise. There still is a large inventory of unsold homes, which is currently 7.3 month’s worth, assuming sales continue at the current rate. A year ago there was a 5-month supply. Mortgage rates trending downward and steady job growth will help the housing market and the economy. The median house price is down 3.1% from a year ago. 

Energy costs, which have had a negative impact on the economy, have backed off in the latter part of 2006. However, they remain volatile and we may see them escalate in 2007 because of the numerous supply problems that can occur. The cost of our continued presence in Iraq (estimated at $2 billion a month) and the continued costs of the homeland security program are drains on the economy, which are not productive. We can only speculate what our economy would be today had 9/11 been prevented.

Corporate Board of Directors will most likely be more attentive to the option programs they are agreeing to as they respond to stockholder lawsuits as well as possible civil and/or criminal charges. Many corporations are restating prior year earnings for this problem. Going forward the earnings will be reflective of proper accounting and backdating of options will probably no longer occur. 

Therefore, the bottom line is we see the economy to be good, but probably not great. Corporate profits will probably be somewhat less than in the last few years. Inflation will probably be moderate and the employment numbers will increase, which should result in a prosperous 2007.

The Stock Market

2006 turned in a stronger equity market than we expected. The S & P 500 turned in a total return of 3.0% in 2005. The rate for 2006 was 13.6%. The S & P 500 Index is the gauge by which most stock pickers measure their current results. In 2005, 61% of actively managed mutual funds outperformed the Index. In 2006 less than 20% outperformed the S & P Index. One manager of a large mutual fund had outperformed the S & P for the last 15 years. In 2006 his fund underperformed by approximately 10%. 

We would expect the equity markets to show a 7% to 9% overall rate of return for 2007. 

The Bond Market

Interest rates from an investment standpoint finished the year very close to where they started. The Federal Reserve has not adjusted rates since August 2006. Foreign countries remain large purchasers of Treasury securities. In 2006 foreign investors accounted for 53% of the net acquisition of Treasury securities issued. This is about the same percentage the U.S. owes on outstanding debt to foreign countries overall. As long as the foreign appetite remains at these levels we would anticipate that interest rates probably will decline slightly during the year 2007.

Thought For the Day

In case you’re worried about what’s going to become of the younger generation, it’s going to grow up and start worrying about the younger generation.

Roger Allen