Perspectives

Second Quarter 2004

Tug of War!  The battle in the equity market is between the positives of excellent business fundamentals with terrific corporate earnings and a myriad of geopolitical concerns that includes terrorism, the war in Iraq, a Presidential election, interest rates, etc.  The result is a tight trading range with neither side winning out. 

This type of tight trading creates a chart pattern that is referred to as a “flag pattern” or a “coil.”  Generally, the longer the market stays in this pattern, the bigger the breakout move.  The only question is, to which direction?

Trading volume has suffered.  “Watching paint dry” has been an apt description of market activity.  Many investors have been more comfortable on the sidelines than in the fray.  Periodically, the markets have suddenly lurched, responding to events.  However, in every case, the market soon settled back into its malaise.

Bonds were another story.  Better than expected growth in employment at the beginning of the quarter sent rates much higher.  Now even higher interest rates are widely expected, the only question, “how fast and how high?”  Every new economic statistic is studied to glean hints as to further moves.

Business continues to move from strength to strength.  Most sectors are growing and firms again are hiring.  More and more businesses have the power to put through price increases.  Profits continue to grow.  Unfortunately, inflation is growing too.

Forecast

Economy

The pace of economic expansion continues to surprise many.  Auto sales, consumer spending, and housing starts have stayed strong in spite of rising interest rates.  Industrial production is at a level not seen for many years.  (Even our steel is exported to China.)  Employment finally is increasing.  Over one million jobs have been created since the first of the year.

The second quarter GDP forecast is for an increase of 4-5%, right in line with our expectations.  There is no reason to predict any slackening of the pace for the next few quarters.  If anything, growth is becoming more widespread, that is with most sectors participating.  Other factors that support continued growth are higher employment levels, stronger growth among our trading partners, and recovery in capital investment.

Equities

It is not the risk that everyone foresees that will upset a good market, it is the one that almost no one expects.  Concerns about terrorism, the war in Iraq, and the like, are for the most part, already factored into stock prices.  It is for this reason that RCM expects the “tug of war” in the market to be resolved positively.  What we believe has not been fully appreciated by the market to date are the excellent fundamentals; the surprise to many may be how well corporate profits and the economy are doing.

Again, the breakout from the current trading-range should be to the upside.

Fixed Income

The sustained rise in interest rates has begun, a trend that may last for years.  The economy will have to adjust to this phenomenon.  It has done so in the past and will do so again.  The era of cheap money is passing.

RCM has warned for some time that inflation is on the rise.  It is now becoming obvious.  Unfortunately we believe that Federal Reserve monetary policy stayed too accommodative for too long.  The Fed should have begun raising interest rates some time ago.  A “guns and butter” approach to fiscal policy, resulting in huge budget deficits, also has added to inflationary pressures.

The result is that inflation will be more difficult to tame.  Interest rates will rise higher than otherwise required and the Fed will have to guard against our economy eventually being dragged back into another recession. 

Investment Strategy

Equities

Our portfolios are positioned to benefit from an expanding economy.  RCM believes there still is much more return to be earned from this trend.  To do this we place modest emphasis on the industrial, technology, and healthcare sectors; less emphasis is placed on consumer staples, financial, and utility sectors.  All other sectors are equivalent to the current market weights.  As always stock selection is key.

All portfolio positions have been evaluated and changed (if necessary) with regard to how they might be affected by a terrorist act and a potential shift in the White House come January.

Fixed Income

We continue to invest in Treasury notes in the one-to-three year range.  Interest rates are not yet high enough to entice us to invest for longer duration.  Treasury bonds are preferred for their liquidity, which gives us the option of trading for bonds of longer duration should the opportunity arise sooner than we expect.  This is a very defensive strategy, which RCM deems appropriate.  (Remember that rising interest rates reduce the value of fixed income and other interest sensitive securities.)

Talk With Us

Individual account management or mutual funds; which is right for you?  Both offer professional management.  Each can be an excellent investment option.  There are significant differences, however.

Individual account management has as a distinction the tailoring of an investment approach to the client’s needs and preferences.  A client’s assets are never co-mingled with any others.  Tax efficiency for individuals is one need that can be specifically addressed in the management of individual portfolios.  Another could be periodic income.  Yet another might be stability of value. Specific guidelines particular to each client can be adhered to, as well as specific needs.  As those needs and preferences change, this can be incorporated.

Investment in a mutual fund means pooling ones assets that will be managed to meet some stated goal, style, category, or geographic concentration.  An investor or manager finds the fund that most closely meets his or her needs.  The presumption is, of course, that the stated mandate of the fund will continue to guide their managers’ actions.

More differences between the two investment approaches appear when actions deviate from expectations.  In the cast of individual account management, an investor will notice it almost immediately because he or she is notified of every change when it is made.  On the other hand, in the case of mutual funds, there are considerable lags from the time changes are made and their effects can be noticed.  Individual security transactions are not reported for mutual funds and an accounting of the portfolio is somewhat out of date when received.  Investment managers usually have other tools to monitor such deviations.

Cost is another factor.  Individual accounts of reasonable size are usually managed for around 1to 1½% with all expenses included.  Mutual funds have several charges that must be added together to arrive at a total cost.  Management fees can range from ½% to slightly less to 2%.  In addition, 12(b)1 or distribution fees can add another ¼ to 1%.  Trading expenses normally are not listed in published reports, but can range from under ¼% for funds with a low turnover style to 2% for funds with high turnover and/or expensive security transaction costs.  (For example, security transaction costs are considerably higher in some foreign markets than in the U.S.)  If a commission is paid to acquire the mutual fund, then this cost also must be added to the cost of the service over the holding period of the fund.

In many cases, individual account management can be had for considerably less cost than that incurred in investing in mutual funds. Of course cost is not the only reason for selecting one versus the other.  Results are important, as is the need to control risk through diversification. 

Many investment managers (including RCM) that primarily offer individual account management also use some mutual funds.  The reasons for doing so include being able to provide diversification or opportunity beyond the scope of their expertise.  The manager has the responsibility to select and monitor the appropriate funds.  Riverplace Capital selects mutual funds with the same care that we use when evaluating an individual security.  Cost, consistency of performance and adherence to the stated mandate all are evaluated.  Any change of management style is noted.  When necessary, a fund may be changed for one that better meets the need.  There is no case in which our clients pay a sales charge (or load).  RCM endeavors to provide the most efficient mix of individual account management and mutual fund use possible.  

Both approaches can be used to meet your objective.  We believe individual account management supplemented, where necessary, with investment in mutual funds provides for most any client need.  So if you would like us to analyze your needs and outline an approach for you, Talk with Us.

Major Indices as of 6/30/04

Large Cap Stocks (S&P 500)                         2.60%

Dow Jones Industrial Average                       -0.18%

Mid Cap Stocks (S&P 400)                           5.50%

NASDAQ Composite                                    2.22%

Small Cap Stocks (Russell 2000)                    6.21%

MSCI EAFE                                                  3.04%

Lehman Corp. Bond Index                            -0.12%

Inflation                                                          2.30%   

(Equity indices are six-month returns excluding dividends)