First Quarter 2005 Review

Volatility characterized the first three months of 2005. The Dow Jones Industrial Average began the year at 10729, dipped to 10378 in late January, and finished the quarter at 10503. One hundred-point fluctuations in the market were not uncommon as a number of financial potholes contributed to the sharp ups and downs of our domestic stock market. The twin deficits of trade and budget, the relative weakness of the Dollar, and continued high energy prices were some of the negative factors influencing the market last quarter.

Healthy labor statistics, positive corporate growth and earnings reports, along with the steady improvement in the U.S. economy and financial markets buoyed many investors. In summary, although our financial markets worried their way through the first quarter of 2005, the broad economic picture continued to brighten in America and in most of the world.

Trade Issues

Our exports increased by 7 % in the first quarter. The U.S. Commerce Dept. reported that our trade deficit fell sharply in March 2005 to the lowest level in six months. U.S. exports increased to an all-time high and the large inflow of Chinese textiles slowed. However, we Americans continued to import more then we exported. U.S. imports increased by 14.7 %. The trade deficit concerns economists and politicians for several reasons. Perhaps the most significant risk in continuing a large trade imbalance is the effect that aggressive selling of our foreign-held Dollars might have on our interest rates.

Because we don't sell an equal amount of "stuff" to our trading partners, they end up holding an increasing horde of our cash, much of which is converted to U.S. Treasury Bonds. Should the international currency market begin to suspect that a large holder of Dollars might begin selling (dumping) our currency, there could be panic selling of the Dollar. Should this happen, the resulting effect would be lower U.S. Treasury Bond prices and consequently, higher interest rates.

Higher interest rates would occur as a natural consequence of high volume selling. As the price of any bond goes down, its interest yield goes up. Think of two children on a see-saw. When one goes up, the other goes down. So it is with bonds. At this time there is no indication that heavy selling of dollars is imminent, but it is a risk worth our attention. In fact, over the last few weeks the Dollar has been strengthening due to the health of the economy.

International Currency Issues

The currencies of many nations trade in the international currency markets. The "price" of a given currency is defined by the relative value of one currency to another. For example, a certain number of Japanese Yen equals one Dollar on any given day. Prices change minute by minute. Currency trading can be quite dicey. Most of the world's currencies are not pre-set. In one year the Dollar may buy more Euros, or Yen or Pesos than in the next. There is one important exception to this flexible valuation system. It is the Chinese currency, the Yuan, which has been "pegged" to the Dollar for a number of years. Many feel that this fixed price relationship has given the Chinese a trading advantage. This may soon change. A recent report from The China Securities Journal, an official Chinese publication, hinted that the Yuan could be allowed to "float"in the near future. Since 1995, the Yuan has been set at a fixed rate of 8.3 Yuan to the U.S. Dollar. A floating Yuan, no longer tied to the Dollar, could rise against our currency (because of the strength of the Chinese economy), resulting in higher prices for Chinese goods imported into America.

The beneficiaries of such a change in currency relationships would likely be Japan and several other Pacific Rim countries, whose weakened currencies may make their goods more attractively priced in China and elsewhere. If this uncoupling of the Yuan from the Dollar should occur, our trade imbalance with China may improve. We would then likely import less from them and they might be enticed to import more from us.

Budget Issues

Our continued budget deficit further discouraged heavy buying in the stock market in the first quarter. Simply put, we're spending more than we take in. Or, more specifically, the Congress and all the Presidents before and after Andrew Jackson have passed and signed into law spending bills that have more often than not exceeded the taxes, tariffs and fees collected to pay for all the expenses the government authorized. We have good data from 1930 to the present concerning the federal budget. In 62 of the last 75 years the United States ran a budget deficit. The Office of Management and Budget offers details about the spending and tax revenue if you'd like to see where the money goes. Their website is www.whitehouse.gov/omb/.

The debt of the U.S. Federal Government was paid in full during only one brief period of the second administration of President Andrew Jackson. The date the country became debt-free was celebrated at a gala banquet for 250 in Washington, D.C. on January 8, 1835. The national debt in 1835 was about $24 million. The census of 1830 reported a population in the country of about 13 million. Each person's share of the national debt then was somewhere around $1.85.

Not so now. Our total national debt as reported on the U.S. National Debt Clock website is now over $7.752 trillion. That's $7,752,000,000,000. Each American's share of this debt, which has not been paid off, is over $26,185. Historically, the growth of the national debt has been a contributor to the rising cost of living. Over the last 75 years this cost of living, the inflation rate, has averaged about 3 % per year, which is where it is now. At 3%, the cost of living doubles approximately every twenty-three years.

Although $7 Trillion is dramatic, it's not as bad as it may appear on paper. There is a little economic slight of hand that is played by inflation that has, in the past, made the deficit less onerous than it might otherwise have been. Each year part of the federal debt is rolled over. As the old U.S. Bonds mature, the bond holders are paid with Dollars that are worth less in purchasing power (because of inflation) than the Dollars that purchased the bonds when they were first issued. Eventually, Congress will have to consider ways to reduce the total debt. If it is not reduced, or at least stopped from growing as fast as in recent years, inflationary force will further reduce the value of the bonds. Interest rates will rise without the prodding of the Federal Reserve. Mortgages will cost more per month. Housing could weaken. The financial markets have the final say in such matters. It serves us all to keep the debt from growing.

Employment Data

The Bureau of Labor Statistics released data on our national unemployment rate that was moderately positive. The percentage of American workers who were counted as unemployed in January was 5.2 % of the workforce. In February the rate moved up a bit to 5.4 %. In March the number of our unemployed fell back to 5.2 % of counted workers. The U.S. civilian labor market at the end of March 2001, numbered 143,931,000 employed. Four years later in March 2005, the labor force had increased by 4,226,000 to 148,157,000 at work. This is good news. Zero unemployed, probably unattainable, would be fantastic news.

When compared to the economies of some of our trading partners, our employment statistics appear robust. Consider Germany's current 12.5 % unemployment rate as reported by the German Federal Statistical Office. The Canadian Labour Force Survey lists their current jobless at 6.8 %. Mexico's Index Mundi website reported their "official" unemployment at 3.3 % for 2003, but notes that UNDERemployment might be as high as 25 %.

Global Transformation

The rapid changes in the global economy including labor outsourcing (even the Chinese are sending some of their jobs to other countries), obsolescence and huge improvements in worker productivity have resulted in an economic environment of creative destruction. As an example, consider the many uses of the internet, that global web of interconnected computer terminals. This one new invention has just begun to transform the landscape of the world of information, research, business and money; tearing away some structures and planting others. More consumers are shopping on-line each year. Millions e-mail their friends overseas. News is almost instantaneous. We don't need to wait for tomorrow's newspaper or the 6 PM news.

Corporate Earnings and Growth

Despite the concern we all share about debt and the future, there is plenty of optimism to share. Standard and Poor's Investment Policy Committee recently released their estimates, stating that "forward growth remains steady and will again produce record earnings for 2005." Since October 9, 2002 when the Dow Jones Industrial Average closed at 7286, the Dow has rallied, gaining 3,217 points to close the quarter at 10503. Investors are becoming a bit more optimistic as they watch a slow recovery in equities. The economic news is getting better. The U.S. stock market has been slowly adjusting to the improvements many firms are experiencing. Recent data from the U.S. Bureau of Economic Analysis are also encouraging:

1. The U.S. economy grew at 3.1 % in the first quarter.
2. The U.S. Current Dollar Gross Domestic Product (GDP) increased by 6.4 % in the first quarter to a level of $12.127 trillion. That's $12,127,000,000,000. Our (GDP) growth rate for all of 2004 was up 4.4%, the best showing in five years.
3. Domestic consumer spending went up by 3.5 % during the last quarter of 2004.
4. American business investment increased 12.5% in the first quarter.

Investor Decisions Determine Outcome

Macroeconomic factors by themselves will not determine investment results. Ultimately, the success of any portfolio is a function of time, diversification, security selection and most importantly, investor behavior. Our American stock market is worth about one-half of the total of all stocks globally. It makes sense, in my opinion, to diversify with non-U.S. securities. Also, in this time of underfunded public and private retirement plans, each person is best advised to provide for their own future. I believe that Social Security will be repaired, but remember, it was never intended to be any more than a basic plan to prevent destitution in our retirement years. The best course of action is to take charge of your own finances, get help if needed and follow a financial plan that will help you realize your personal goals. You may want to read about the six-step financial planning process.

BRIMMER FINANCIAL
rbrimmer@nationalsecurities.com
59 Finlay Road - P.O. Box 2806 - Orleans, MA 02653
tel. 508-240-0320 fax 508-240-2309 toll free 800-237-9322
Disclosure · Privacy

Securities offered through National Securities Corporation, Member FINRA/SIPC.
Investment Advisory Services offered through National Asset management, Inc., a Registered Investment Adviser and affiliate of National Securities Corporation.
Accounts are carried by National Financial Services LLC, Member NYSE/SIPC, a Fidelity Investments Company.