July 28, 2006

 

Greetings!  Another quarter has run its course and it is my opportunity to share with you some of the thoughts, ideas and impressions of the last 90 days, and my best guess for what the next 90 days hold for us. 

 

First, the last 90 days.  It has been highlighted by volatility, both in current events and the markets.  The quarter started with concerns about inflation and the market pundits’ concern that the Fed (Federal Reserve Bank), led by the new Fed chairman Ben Bernanke, would raise interest rates.  Once the market pundits were certain that the Fed would raise rates, the sharp stock market decline was reversed and the stock market climbed back up. 

 

A month ago the international press was concerned about the shenanigans of Iran and their determined effort to develop a nuclear capability in spite of the international community’s efforts to halt their development of nuclear weapons.  Weeks later the international concerns turned to North Korea’s firing of missiles that may some day carry nuclear weapons.  Today we are transfixed on the problems of Lebanon and Israel. 

 

All of this uncertainty in international affairs has been translated by the world’s stock markets into increased volatility.  Our US stock market can go up or down 200-300 points in a day.  Much of this volatility is based on emotional responses to uncertainty about these world affairs.  The basic fundamentals of the US economy have been ignored. 

 

Productivity and growth are still very healthy.  Expectations of an increase of 9-12% in earnings for corporate America are still on target.  Unemployment is less than 5% and the GDP is expected to remain a healthy 3.5%. 

 

In spite of everything that has happened, the Dow Jones stands today (July 21, 2006) at 10,850.  That is higher than it was January 1.  Admittedly it is lower than the year’s peak that we saw in mid-May, yet it is still up.  Most of our portfolio’s are up for the year.  That said, we saw the 2nd quarter give back many of the gains we accomplished for the year.

 

Last quarter, we saw almost all of the indexes that we follow in the black.  Most of these indexes are up for the year, yet this quarter almost all of them are in the red.   

 

See the Scoreboard for returns of the indexes we currently follow.

 

The Scoreboard

(www.investmentadvisor.com)

 

 

2003

 

2004

1stQ

2005

2ndQ

2005

3rdQ

2005

4thQ

2005

 

2005

1stQ

2006

2ndQ

2006

DJIA

+28.3%

+3.15%

-2.59%

-2.17%

2.86%

1.40%

-0.61%

3.66%

0.37%

S&P 500

+28.7%

+8.99%

-2.59%

0.92%

3.15%

1.59%

3.00%

3.73%

-1.90%

NASDAQ

+50.4%

+8.59%

-8.10%

2.89%

4.61%

2.49%

1.37%

6.10%

-7.17%

LBAB

+4.11%

+4.34%

-0.48%

3.00%

-0.67%

0.60%

2.43%

-0.65%

-0.08%

(Investors cannot invest directly in indexes.)

 

I remain cautious about the stock and bond markets in the short term, and confident in the long-term results.

 

Short-term bonds, as measured by the Fed rate, have continued to march ahead at a 1/4 point per meeting.  It appears that the Fed will continue to raise their rates at least one more time this year.  This is akin to putting on the brakes of the economy.  The Fed remains concerned about inflation and personal debt.  Both issues need our attention.  Inflation is currently 3%, the biggest portion of which comes from energy costs, which were up over 20%.  The current international situation has increased the pressure on oil prices.  If we see the problems in the Mideast deteriorate, and the conflict become a regional conflict, we can expect oil to climb and inflationary pressure grow.  This will give the Fed more of a reason to raise the short-term rates.

 

We continue to monitor the ISM, 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 53.8, down from last quarter but still indicating an expanding economy.  Economic activity in the manufacturing sector grew in June for the 37th consecutive month, while the overall economy grew for the 536th consecutive month. 

 

We have established a discipline that we are using to evaluate the markets and make any asset allocation changes that are needed.  Right now we are not making any changes.  We carefully watch the ISM index and interest rates.  If we see the ISM index beginning to indicate a contracting economy, and the yield curve continuing to be inverted, we will 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 REITs.  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 continued to give weight to the words “financial planning”.  The new 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 Falcon Financial Management, Inc. (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 Kay in our office.  If you have done a financial plan with FFM, then FFM’s ADV is also available upon request.

 

I want to remind you that if you have received letters from Multi-Financial asking for specific information relating to your accounts that this is being done to ensure that the information they have on file is current and if not, to correct it. You are 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 FFM.  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.