Perspectives

 

Third Quarter 2005

 

Interesting times.  Gasoline prices made record highs and consumer buying maybe slowing.  Interest rates are rising. Credit card delinquencies have jumped.  Record high natural gas prices promise an expensive heating season this winter.  One of our most charming cities and beautiful coastal regions largely was destroyed by a devastating hurricane.  The Iraq war rages on without a resolution in sight and with no end to its cost.  Some investors have wondered, short of Biblical plagues and locusts, what more can be thrown at the stock market.

 

In spite of it all, during the third quarter markets performed well, the economy held steady and corporate profits continued to mount.  (In fact, corporate profits are expected to rise 16% for the third quarter as compared with the same quarter in 2004.  Profits for the full year probably will increase by 14 % yet stock prices are about the same as the beginning of the year.  Therefore markets now are cheaper.)

 

Most likely, investors will continue to look at the positives.  Aside from excellent current corporate profitability, world economic momentum is healthy.  Germany and Japan finally are improving and China’s economic growth may have accelerated.  (Healthy economies among our trading partners reinforce economic activity here.)  Also the spending of billions of dollars in relief and rebuilding of the storm ravaged areas here will stimulate the U.S. economy.

 

In the meantime the Fed continues to raise short-term interest rates, in response to perceived increasing inflationary pressures, emanating from the higher energy prices as well as higher prices for a wide range of commodities (such as copper, steel, and building materials).  In past business cycles the Fed has pushed rates up to a point where the general economy caved in and then required stimulus to revive.  RCM certainly hopes it does not repeat this mistake.  (See our Forecast.)

 

Forecast

 

Economy

 

The overall domestic economy is slowing.  The combination of higher interest rates and energy prices may be taking its toll on the consumer.  Record high gasoline prices this summer will be followed by very high natural gas prices this winter.  Housing price momentum and activity have probably peaked.  As this economic sector cools, this will further dampen economic activity overall.  In spite of this higher interest rates are on the way. We don’t yet have a sense as to what degree the U.S. economy may slow.  RCM doesn’t expect, however, a precipitous decline.  One reason we believe this is likely, is despite the fact that the Fed has raised rates, those rates remain at historically low levels.  Also keep in mind that currently there is still good growth momentum in the economy. 

 

RCM believes that the GDP growth will fall to about a 2 ½ % rate.    This is much slower than the current 3.3% rate, but it is positive growth nonetheless.  Countering the effect of a lower GDP rate will be the positive aspect for many U.S. companies that trade internationally.  Many of those economies are growing much faster.

 

Equities

 

Leadership among stock categories has been shifting, moving away from companies that depend upon the consumer, to those that are more dependent upon corporate spending (such as industrial equipment and technology), or those which provide necessary goods and services, (like energy).  Companies pursuing global strategies are benefiting from strong growth prospects in many other areas of the world.  International growth will continue.  RCM believes that the slowdown in the economy will amplify these trends.  Companies need to continue to find ways to make their operations more efficient.  Of course essential products like oil and gas will command whatever prices are necessary to balance supply with demand.  Beyond these broad sectors, there are particular companies that are pursuing successful growth strategies.  Right now many of these are in the mid-cap category.  RCM has increased the weighting in this area.

 

International stocks, especially those of Germany and Japan, have attractive investment merit because their respective economies are seeing improved growth with political and economic restructuring.  Their equity markets also are priced attractively for U.S. investors. 

 

Historically, mid-cycle economic slowdowns often lead to very strong equity markets.  Mid-cycle slowdowns occurred in 1985 and 1995; both were followed by very robust stock market increases.  (This was because interest rate tightening peaked for a time and business activity reaccelerated during these periods.)  RCM believes the U.S. market and some international markets soon may enter such a period.  We expect the Fed to pause early next year, if not sooner, and by then spending for reconstruction of the storm ravaged areas will begin to positively impact the economy.

 

Fixed Income

 

As noted earlier, the Fed is raising interest rates.  At RCM, we had expected a pause in rate hikes after the recent natural disasters and resulting high energy costs.  The fact that the Fed did not pause, and made no hint as to when it will, signals that it has its eyes on higher rates yet.  However RCM believes that they are getting close.  We expect the Fed to pause by early next year.

 

That intermediate and long term interest rates have not moved up as much as short-term rates, tells us that investors believe higher rates are likely to slow the economy.  Therefore they believe this slowing will help keep inflation in check and reduce the need for higher long-term rates.  We doubt that will be the case.  A lot of the pressure for higher inflation comes from energy and commodity price increases, which are internationally traded products that are not wholly responsive to our domestic demand.  Therefore RCM expects long and intermediate interest rates to move higher over time.  This may occur even after the Fed finally does pause in its increases of short-term rates.

 

Investment Strategy

 

Equities

 

RCM is shifting sector weightings in large-cap and mid-cap portfolios.  We also are increasing international exposure in all portfolios where appropriate.  Obviously the attempt is to reduce capital applied to areas that are likely to suffer in the current environment to and shift it to those that should benefit.  These shifts will be made incrementally.  All individual holdings are being examined to ensure they meet current criteria. 

 

In wealth management portfolios we are increasing international allocations while reducing domestic equities. 

 

Fixed Income

 

Our fixed income strategy has been to maintain shorter than normal durations for fixed income investment during a rising rate environment.  Because the Fed clearly has signaled still higher interest rates, we will maintain this posture.  We have also used TIPS Treasury Inflation Protected Securities) to give intermediate fixed income exposure while guarding against inflation.

 

Because the spread between corporate and Treasury yields has widened, RCM is buying some short-term corporate bonds and also adding some international exposure in bonds for some fixed income portfolios in order to hedge potential dollar weakness.

 

Talk With Us

 

Over the years we have written about numerous investment topics and about how we have addressed our clients concerns regarding the growth and protection of their assets.  We have implemented strategies with a determined focus and diligent review process. We have added alpha (a term for excess return over a market benchmark) through our research and portfolio management techniques and have adapted to the market through the use of asset allocation approaches that diversify exposure across numerous investment styles, sectors and market capitalizations.  In short, we are truly a wealth management firm with the goal of maintaining and growing wealth for our clients in any and all markets, regardless of media and political hype, economic turmoil, or confusion. 

 

We have beaten all our market benchmarks and have grown our assets in tough times.  Our process has generated outstanding performance so far this year in a market that has generally given nothing.  Where we found weaknesses in our process, we made changes.  We continue to look for ways to further enhance our approach to add even greater performance.

 

RCM manages the firm with the following focus:

                        Performance (absolute and relative)

                        Client Orientation (meeting client goals and concerns)

                        Service 

 

This firm invests in people, software, hardware, tools, and research to drive continuous improvement in these areas.

 

A willingness to learn and explore are among our greatest strengths.  We have an internal library to which we constantly add books and publications on topics that help us improve our performance.  We respect and admire many in our business and hope to learn from all of them.

 

Through the third quarter of this year we are producing results for our clients well beyond the appropriate benchmarks.  We are proud of these results.  RCM has deep respect for our clients, their success and achievement in accumulating their assets.  We are honored by the trust they have shown by retaining us as their investment managers.

 

If working with a firm like this appeals to you, Talk with Us.

 

Major Indices as of 9/30/2005

Large Cap Stocks (S&P 500)                        1.39%   

Dow Jones Industrial Average                       -1.99%

Mid Cap Stocks (S&P 400)                           7.99%

NASDAQ Composite                                   -1.09%

Small Cap Stocks (Russell 2000)                     2.49%

MSCI EAFE                                                   6.82%

Lehman Corp. Bond Index                               1.15%

Inflation                                                            2.8%                                         

(Equity indices are nine-month returns excluding dividends)