Third Quarter 2004 Review

The third quarter of the year was stuck in neutral. The Dow Jones Industrial Average drifted lower from 10334 on July 1st to 10080 on September 30th. The index that reflects about 95% of the capitalization of all listed U.S. stocks, the iShares Dow Jones Total Market Index, a popular exchange traded fund, moved very little during the third quarter. It closed at $53.78 a share on July 1, 2004 and closed at $53.04 a share on the last day of September. Our domestic market is stuck in the doldrums, neither encouraged by improving corporate earnings nor discouraged by the barrage of daily slings and arrows that fill the news. Similar stodgy results were seen abroad. The Morgan Stanley Capital Index of European, Australia and Far East stocks (MSCI-EAFE) began and ended the quarter at around $141.00 per share. Why are the markets stalled? The apparent answer is that the forces of up-market and down-market are in balance, a rare phenomenon.

Accelerators as well as depressors are always at work in the economy and the markets. One depressant that affects all of us has been the increasing price of crude oil. Oil has not only been crude, it's been downright mean and nasty. The causes of higher oil prices include higher demand, especially in developing countries like China; turmoil in several of the producing countries, such as the disruptions in Iraq and Nigeria; hurricanes in the Gulf of Mexico which disrupted both production and refining; and speculation by traders seeking profits from the runup in price and demand. Although there are traders who might hope for $70 oil, the consensus seems to indicate that $50 oil is unsustainable, because the market will eventually lower both demand and consumption rates. The world runs on oil, at least for now. Alternative energy sources will take years to develop and market. Hybrid engines are starting to show up in Japanese and German cars. Detroit is gearing up to compete. Wind and solar power have begun to replace the burning of coal, gas and oil for electric generation. Again, years will be needed to install enough of these non-polluting devices. The eventual goal of a hydrogen burning internal combustion engine, which produces water vapor as its only exhaust, is a dream that may become reality within ten to twenty years. Being realistic, it's oil and gas for the present and the foreseeable future.

The current political climate is hot and sticky. I can't remember a more emotional election cycle. It seems to me that many of us only read or listen to those opinions with which we already agree. This makes political discourse very contentious. There is an almost religious fervor surrounding this season of candidate sorting and selection. Uncertainty about the November elections is another factor that's keeping the market from moving up. We should know who will occupy the Oval Office sometime in December if the vote is very close. The lawyers are ready for another fight.

The global spread of Wahabbism, a sect of Islam that is embraced by Al Qaeda and other terror groups, is a truly vile market depressor. One of the stated goals of the Wahabbists is the destruction of the West, its economy and its values. Their beliefs stand in stark contrast with the rest of the civilized world and the great religions, including Islam. There's probably no self-help program for this group of thugs.

The accelerators are still in place, still idling and still waiting for a green light to move the stock market up to higher levels. Low inflation and low interest rates, a healthy consumer demand, unemployment in the U.S. at 5.4% and growing corporate earnings are all in the good column. America's unemployment rate compares favorably with Germany's 10.7% out-of-work. France has 9.5% unemployed. According to the OECD (Organisation for Economic Co-Operation and Development), in the Euro zone, (twelve European countries minus the UK) the standardized unemployment rate in July was unchanged at 9%. The unemployed in all of the United Kingdom accounted for less than 5% of the work force.

The U.S. trade deficit is running at a record annual rate of $590 billion, according to a recent report from the Associated Press. During the third quarter, the U.S. dollar continued weak against the Japanese Yen and the Euro. A lower dollar benefits our manufacturers who export product and hurts foreign importers who must convert their currencies into dollars. Should our trade deficit and budget deficit continue to expand, higher U.S. interest rates and inflation are almost inevitable because foreign investors (banks and governments) who hold our U.S. Treasury debt will demand higher yields to compensate for the higher risk of an inflationary U.S. economy. The entire world is now interconnected by trade, communications and travel. A lower dollar makes foreign travel more costly for us, but attracts foreigners to our shores. A higher dollar does the opposite. At present, our lower dollar makes for more profitable international trade for American companies.

A large piece of the economic puzzle is the overall health of a national economy. Think of a healthy economy as one in which the circulation of transactions and money is rapid. An unhealthy economy is characterized by a sluggish circulation of transactions and money. In a fearful, depressed economy, people hoard their money and only buy what is absolutely necessary. Dining out at restaurants is curtailed or dropped. Wait staff is let go. The old clunker is kept on the road. Car dealerships go broke. Magazine subscriptions are dropped, etc. In a depressed economy, one loss leads to another.

In a growing consumer economy, the kind that we often criticize as wasteful, goods and services are traded for money at a rapid pace. Each time a transaction occurs, there is usually a tax consequence. If a business sells its inventory quickly, it collects more sales tax in a shorter time than in a recession or a depression. The government gets more tax money. If a professional is hired by more people needing his or her services, the income of the professional increases and with the increase there is an increase in that person's income tax. The government gets more tax money. The theory behind cutting taxes is that it stimulates more economic activity per unit of time because people are able to keep more of the money they earn. Consequently, this increases the total amount of tax collected for the government from the "faster" economy. It worked for Presidents Kennedy and Reagan. President Bush promoted and the Congress passed the most recent set of tax reductions. These cuts benefitted investors, savers and small and large business.

During World War II, the top marginal income tax rate in America was 90%. In the 1970s our top income tax rate was 70%. The top rate is significantly lower today, although the AMT (Alternative Minimum Tax) is affecting more middle and upper income individuals, especially those small business owners who file under Sub-Chapter S Corporate status. Many successful investors own tax-free municipal bonds. Their income tax bills can be reduced by managing the amount they own in tax free or tax deferred accounts. Highly compensated salaried actors, professionals, business owners and executives pay the very highest tax rates because their income tax is based on earned income from employment.

If the current round of tax reductions do not add substantially to the total tax collected, then Congress will likely act to raise the needed money by raising taxes. It generally takes a year or two to see the result from a large change in tax policy. The general rule still stands: "If you tax something, you'll get less of it. If you subsidize something, you'll get more of it." Political policy issues often focus on what to subsidize and what to tax. The billions of dollars collected and spent each year by the many levels of local and federal governments involve thousands of programs and millions of employees. A 30-second sound bite of TV or a 2-minute debate answer can not hope to address the complexity of these multiple issues.

We won't know which development will turn on the green GO light for our stock market. We don't know when it will begin. We never did. We never will. Investors re-balance their portfolios to reflect the realities of the day. There are some who feel that the U.S. stock market will grow at a rate under 10% per year for the next few years. Others feel that the market will keep pace with the average growth rate of the last seven decades, 10% per year. Some have been saying that the market is now at least 20% undervalued. This divergence of opinion is what makes a market.

For those who are not excited about the domestic stock market, high-yielding real estate investment trusts, bonds, and preferred stocks offer current income and potential growth. These are good choices while the market treads water. Foreign markets are on my shopping list as well. Not every country is a good second choice after the U.S., but a number of foreign companies and funds that concentrate on global investing look very enticing now. Call me to discuss these ideas in greater detail.

Retirement Planning

Much has been reported over the last several years about the need for Americans to save for their retirement or semi-retirement years. The best time to start a retirement program is the day you're born. Compound interest can really do a job for you if you give the plan 65 years to work. I don't know too many parents who did this for their children. In fact, my experience is that most people don't have much to invest until they are in the 50s. So when's the best time to start investing and saving? Right now, of course. If you have not done comprehensive financial planning, call me for an appointment. I may be able to help you optimize your budget so that a saving and investing plan can work for you. If you have children or grandchildren who need this type of guidance, perhaps you might give them the benefit of your own planning and investing experience. Encourage them to call me if they need help. A very funny and instructive new book by actor and financial guru Ben Stein, How to Ruin Your Financial Life, published by Hay House, Carlsbad, CA defines in painful detail all the really dumb things to do in order to become a financial basket case, and by clever reverse psychology, those things to do to avoid ruin. This is an ideal gift for anyone seeking advice, wisdom and humor between the covers of a small, very enjoyable book.

I'm enclosing the year-end financial planning checklist. Please review your plans and documents, especially the beneficiary designations on retirement plans, IRAs and annuities.

As always, please call with any questions. I always invite calls from your friends and family.

Annual Financial Check List

As we enter the fourth quarter of the year, I'd like to again remind you to take inventory of the components of your financial plans. Here's a checklist for your review. Please call me if there's anything that needs attention.

_________ Up-to-Date Will
_________ Up-to-Date Trust
_________ Current Durable Powers of Attorney
_________ Health Proxy or Living Will
_________ Update beneficiaries named on insurance policies and retirement plans
_________ Adequate Health Insurance: Hospitalization/ Major Medical
_________ Adequate Long-Term Disability Insurance
_________ Adequate Long-Term Care Insurance
_________ Adequate Property/Casualty Insurance: home, car, umbrella coverage
_________ Adequate Professional Practice/Business Owner Insurance
_________ Adequate Life Insurance
_________ Annual Charitable Contributions Made Before Year-End
_________ Annual Gifts Made to Family Before Year-End
_________ Collect Cost Basis Information on Sold Securities/ Real Estate for Income Tax Filing
_________ Portfolio Review
_________ Portfolio Adjustments to Minimize Taxes
_________ Timely Contributions Made to Retirement Plans
_________ Required Minimum Distributions from IRAs for clients over 70.5 years of age
_________ Distributions should be taken well before December 31st annual deadline
_________ Tax Planning with Your Tax Advisor Before Year-End
_________ All Those "Other" Things You Meant To Do Before Year-End

BRIMMER FINANCIAL
rbrimmer@nationalsecurities.com
P.O. Box 2806 - 19 Brewster Cross Road - Orleans, MA 02653
tel. 508-240-0320 fax 508-240-2309 toll free 800-237-9322
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