April 28, 2006

 

I try to write these letters to you as late in the quarter as I can.  Inevitably, it is usually my delay in writing that holds up the reporting process.  So I am getting started a little earlier this quarter in the hopes of keeping the little elves that produce these reports from having to yell at me at the end of the quarter to get the letter finished!  No guarantees, but it is an effort I am trying to make for the good of the team.

 

Actually, this is one of the fun quarters to report on.  Every index we follow - except the Lehman Brothers Aggregate Bond index - produced positive returns for the first quarter.  Cap stocks, both growth and value, were the top-producing asset classes for Morgan Stanley’s EAFE (Europe, Asia and the Far East, excluding Japan).  See the Scoreboard for returns of the indexes we currently follow.

The Scoreboard

(www.investmentadvisor.com)

 

 

2002

 

2003

 

2004

1stQ

2005

2ndQ

2005

3rdQ

2005

4thQ

2005

 

2005

1stQ

2006

DJIA

-23.7%

+28.3%

+3.15%

-2.59%

-2.17%

2.86%

1.40%

-0.61%

3.66%

S&P 500

-16.7%

+28.7%

+8.99%

-2.59%

0.92%

3.15%

1.59%

3.00%

3.73%

NASDAQ

-31.5%

+50.4%

+8.59%

-8.10%

2.89%

4.61%

2.49%

1.37%

6.10%

LBAB

+10.27%

+4.11%

+4.34%

-0.48%

3.00%

-0.67%

0.60%

2.43%

-0.65%

(Investors cannot invest directly in indexes.)

 

That said, I remain cautious about the stock and bond markets.

 

Short-term bonds, as measured by the Fed (Federal Reserve Bank) rate, have continued to march ahead at a ¼ point per meeting.  Nothing in the most current Fed statement suggested that they were planning to stop at 4.75%.  Correspondingly, the long-term rate, as measured by the 10-year Treasury bills, has barely moved over the last year.  Today as I write this we are seeing long-term rates flirting with 5%.

 

So what’s the big deal?  Well, when short-term rates are consistently higher than long-term bonds you have what we call an “inverted yield curve” and the last five recessions have all been preceeded by an inverted yield curve.  In layman’s terms, it appears that the Fed will continue to raise their rates, which is akin to putting on the brakes of the economy.  The Fed remains concerned about inflation and personal debt.  Both issues that need our attention.  Inflation is currently 3%, the biggest portion of which comes from energy costs, which were up over 20%.  Needless to say, the Fed is hoping to see long-term rates continue to rise so that short-term rates can be used to combat inflation and slow the economy down.  Our new Fed Secretary, Ben Bernanke, will work with all his considerable influence to see that we are out of the worst of it (the hard times of 2000, 2001 and 2002).

 

None-the-less, an inverted yield curve is a bad thing and it is one of two indictors we watch.  The second is a measure of productivity, the ISM Indexes, specifically the PMI (Purchasing Managers Index), which tells us if the Manufacturing sector is still expanding.  Any PMI number over 50 indicates an expanding economy, and this month the PMI was 55.2.  Economic activity in the manufacturing sector grew in March for the 34th consecutive month, while the overall economy grew for the 53rd consecutive month.  This suggests to me that there are still legs under the stock market.

 

Not all companies’ share prices go up.  This is where active management of your investments - which is what we do - can add value to your returns.  Ideally, active managers should be focusing on the companies that have the potential to go up; unlike passive management, which is more commonly known as index funds.   Index funds have to own the whole index, good stocks and bad.  In the 1990’s there was no such thing as a stock that didn’t go up and so conventional wisdom began that all you had to do was buy index funds.  Active management is now back in vogue and in this environment, having good stock pickers on your team is vital.

 

So what are we doing about all of this?  Right now nothing.  We continue to watch the ISM index, and if we see it beginning to indicate a contracting economy, and the yield curve continues to be inverted, we would suggest making changes in your portfolio to reduce your exposure to stocks.  We will be doing this in two ways - buying more bonds, or consider adding REIT’s.  Both investments are designed to provide a counter weight to stocks.

 

We will continue to be watchful over these trends.  I am not recommending making changes today, but as I have told many of you, I see a bright yellow light right now, not a red light, not a green light.  I am very cautious today; optimistic about the future in general and for the long term, but cautious about what is happening today.

 

The SEC’s new Rule 202 has finally given some weight to the words “financial planning”.  The rule says that if someone says they do financial planning, or creates a financial plan for you, they must be a Registered Investment Advisor (RIA) or Investment Advisor Representative (IAR).  I have long argued that to legitimize the financial planning profession we had to have some registration that would separate those of us who have satisfied the educational requirements to be a Certified Financial Planner® or who are RIAs or IARs, from those that use financial planning as a marketing tool.  Many of the wire houses (Merrill Lynch, Smith Barney, etc.) balked at the new rule and insisted that financial planning was “ancillary” to the investments.

 

We don’t agree.  Financial planning is the core of what we do.  I believe that every one of you should have a plan.  Some will be more formal than others, but that is what separates FFM from the rest of the field.  We are a fee-based financial planning organization that offers excellent investment opportunities.  As an IAR, we are periodically required to offer you an updated ADV for our Broker/Dealer, Multi-Financial Securities Corporation (an ADV is Multi-Financial’s registration with the SEC as a RIA).  When you first began your fee-based investments with us, we would have given you one.  If you would like a current Multi-Financial ADV, please call Alexis in our office.  If you have done a financial plan with FFM, then FFM’s ADV is also available upon request.

 

Included with this letter (in some cases) is a Portfolio Consolidation Request form.  Your signature on this form is required when your individual account information is combined on a report with someone else’s.  In this case, the Quarterly Report that we provide you contains accounts for both you and someone else.  (A parent may sign for a minor.)  A form will not be included if you’ve already signed one during our review meeting.  Please sign and return the form to our office, and any questions may be directed to Mari.

 

One other thing I must mention at this time is the letters you have been receiving from Multi-Financial asking for specific information relating to your accounts.  Please ensure that the information they have on file is current and if not, please correct it and either fax or mail back to them at the numbers provided.  You are also welcome to bring or mail the form to our office and we will handle it for you.  Please contact Mari in our office if you have any questions.

 

If you have questions about your investments, or some of the observations I’ve made in this letter, please give me a call or send me an email and I’d be glad to answer them.  If I’m not available, please ask for my associate, Darla Greer.  She’s a wealth of information and can answer some of the questions you may have about your portfolio and help you make any changes that may be necessary.

 

Again, I appreciate the confidence you have placed in me and all of our team here at Falcon Financial Management, Inc.  As always, I wish you the best and look forward to seeing you soon.

 

Sincerely,

 

 

Jeff Davis, CFP®

President

Falcon Financial Management, Inc.

 

All economic and performance information is historical and not indicative of future results.  All views expressed in this letter are those of Jeff Davis,CFP® and should not be construed as investment advice.  All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.  Additional risks are associated with international investing, such as currency fluctuations, political and economic stability, and differences in accounting standards.