Second Quarter 2005
Mid Third Quarter Disaster Response

Before reviewing the economic results from the second quarter of the year I want to consider the impact of Hurricane Katrina, perhaps the worst single natural disaster to strike our nation. A massive chunk of America equal to the size of England lies in various states of ruin. An estimated 1,500,000 of our fellow Americans have been displaced. As we watch the news coming from the devastated Gulf Coast our prayers and thoughts go out to the victims of this calamity. Generous offers of money and help from Americans and from others around the world are pouring in. Along with the stories of people taking advantage of the victims, there are more stories of people helping those in need. Once the immediate needs of our suffering brothers and sisters are met, the Gulf Coast communities will be rebuilt. New Orleans will once again host Mardi Gras, although it's hard to imagine this now. But it will happen. It's home for a culture and way of life. It will not be abandoned to the sea.

Great cities throughout history have been rebuilt after being sacked, burned and destroyed. Consider ancient Athens and Rome. They suffered wars and invasions. Today they are both large modern cities. London burned in the 17th Century. It stands today. Chicago burned. San Francisco was leveled. They were rebuilt- bigger and better able to absorb the next punch.

In my opinion, the frame buildings of the low-lying coastal areas should be replaced by brick, reinforced steel and/or concrete. Ocean-facing and flood prone buildings should be put up on reinforced stilts. Many displaced souls from the birthplace of America's own music, Jazz, will return, but not for months or years. New Orleans, coastal Louisiana, Alabama and Mississippi have large populations of low income families. Acting as a national community, we all have an opportunity to help raise thousands up from poverty. This temporary diaspora may be the beginning of new hope for many. I believe we will respond to the short-term and long-term needs of our fellows Americans. To neglect this chance for them is to pass on a chance for all of us.

The outlying marshes in the Gulf of Mexico, so recently reduced, must be restored. The city of New Orleans could consider partitioning itself into compartments, each perhaps a half-mile square, designed as a levee grid that could become the foundation for both an elevated highway and a monorail or commuter train system. This egg carton city plan would serve two purposes. It could isolate flooding from the Mississippi or the lakes and deliver a dependable transit system that could move the people away from low areas for evacuation. The engineers could add sequences of connected concrete walls, parallel to the single concrete walls that top the levees. They might be connected together with partitioning supports set at right angles to reinforce the entire system. It was a break in one or more of these single wall levees that caused the flooding. Many good ideas will develop after the mess is cleaned up. Of course there were many mistakes made in the early days right after the storm passed. Lessons will be learned. Everyone hoped that "perfect storm" would bypass them. It didn't.

We fallible humans tend to blame our elected leaders in the aftermath of a catastrophe. It's easy and natural to seek a guilty party after the fact. I'm reminded of the Monty Python spoof on "The Great Train Robbery" when the inspector considers the heist and concludes "we believe this to be the work of thieves." The blame goes to a nasty lady called Hurricane Katrina. There's not enough hot air in all the politicians on earth to generate a hurricane. No one caused the storm. For the rescue there's plenty of blame to go around. In time we may conclude that living in New Orleans, a city that's eight feet below sea level in places, is a bit more risky than we thought. Since the Gulf Coast is where many call home, new solutions will have to be found to protect their homes and businesses.

During a bad storm and high tide that occurred during the night of January 31, 1953, the North Sea broke through the levees and dikes that protected Holland. Over 1,800 Dutch citizens died. Hundreds more in England and the low countries of Europe lost their lives in the unprotected areas fronting the sea. Twenty days later a council was called and the plans for a massive system of flood control projects, the Deltawerken, were begun in Holland. Today Holland is still below sea level. The North Sea still threatens to break through. The Dutch overcame the calamity and rebuilt. However, they know that there is always the possibility that Mother Nature might overcome any of their efforts to keep themselves dry and safe.

There is no guarantee that any place will be free of risk from natural or unnatural disaster. The horrific bombing of Germany and Japan during WW II caused total obliteration in places. Much if not most has been rebuilt. Boston sits on a major geologic fault line. Yes, there are earthquakes in Massachusetts. They're small, but real. Move to Oklahoma to escape the ocean and a tornado hits. So, really, how safe can we be? Safe enough most of the time. And when bad luck puts the hurricane, tornado, flood or earthquake in our neighborhood, we still have each other to lend a hand so we can pick up the pieces of our lives and move on.

The effects of Hurricane Katrina moved into the economy via disruptions to oil and natural gas delivery. Energy prices spiked shortly after the storm passed by and the extent of the damage became clearer. Within days many of our trading partners and oil suppliers offered help. The Federal Government offered loans of oil from our national Strategic Petroleum Reserve. My guess is that consumption of oil and gasoline will drop for a while and supplies will increase. The result will be lower energy prices. The S & P 500 Index, looking ahead to the rebuilding efforts, actually rose very slightly from Monday Aug. 29, 2005 through Sept.2, 2005. Kuwait offered 500 million barrels of oil. A number of other nations stepped up to the plate. The global economy depends on the steady flow of energy. A disruption in supply or demand affects the entire world. As I'm finishing this letter, oil prices have dropped from $70 to $65 a barrel. Prices are still high, but going in the right direction.

Current estimates for the recovery from this storm run as high as $200 Billion. That money will go into clean-up efforts, construction projects, home building materials and jobs. The short-term effect on the economy in this quarter may be a drop from 0.5 % to 1.0 % in Gross Domestic Product. These are estimates that various media economists are projecting. In sum, this horrific event should have a minor effect on the overall economy short-term. Longer-term, should energy prices stay about where they are now, the effect would be worse. High energy prices are a tax on the growth of the economy. If you tax something, you get less of it. If you subsidize something, you get more of it. That's just the way it is.

Second Quarter Review

It was deja vu all over again in the second quarter. Just as in the second quarter of 2004, investors during this year's April-June quarter were encouraged by an improving economy but discouraged by the sluggish stock market. You will recall that in 2004 the U.S. stock market did little to attract aggressive buying for the first nine months of last year. Finally, patient investors were rewarded in the fourth quarter of 2004. Most of last year's 10.7 % annual gain in the S&P and 12.7% rise in the NASDAQ 100 index occurred in the last three months.

Will 2005 be a repeat of 2004? Many of the same economic conditions that affected the markets last year are still with us. Higher oil prices and interest rates threatened a slowdown in 2004 which never materialized. Remarkably, higher oil prices and interest rates this year haven't yet pushed the economy back into recession as of June. The economy is growing, domestic unemployment is better now than last year, and short-term interest rates have not had the effect on long-term interest rates that was predicted by the "experts".

Housing continues to be a central player in the economic life of the country. We're all waiting for the top to form on residential sales. Demand is strong, in part because mortgage rates have remained low, which allows more buyers into the market. Home sales are largely a function of the ability of buyers to cover the monthly mortgage payment. The National Association of Realtors reported that in June total existing home sales rose 2.7 % to an adjusted annual rate of 7.3 million. From the Federal National Mortgage Association, Fannie Mae, we learned that the national average for a 30-year, conventional fixed-rate mortgage was 5.58 % in June, which is lower than the 6.29 % offered to borrowers in June of 2004. A lot of homes changed hands because a lot of folks could afford the 5.58 % interest rate.

The U.S. Commerce Department's Bureau of Economic Analysis (BEA) reported that the "Real" Gross Domestic Product ("real" means adjusted for inflation) grew by 3.4 % in the April through June quarter, slightly less than the 3.8 % growth in the prior three months. In a few weeks the growth rate will be reported again with any adjustments up or down coming from additional data that the Bureau receives. A growth rate anywhere above 3 % is considered healthy.

The BEA reported that consumer spending increased by 3.3 %. Our exports continued to increase, but as in the last several years, our imports are still higher than our exports. By importing cheaper foreign goods American consumers save money, but at the cost of lost American jobs. The move to cheaper labor is called outsourcing. Opponents of this competitive force in the global economy claim that we are giving away our prosperity long-term for short-term consumer gains in the form of foreign-made bargains. Proponents of outsourcing point to the globalization of capital, labor and materials as a long-term benefit to all nations. The job that went to Mexico, India or China is helping create consumers in those countries with the money to buy their own products. This leads to the development of a middle class. History teaches that a large middle class in a country is a stabilizing force and a powerful creator of national wealth.

Participate in Global Growth

If the American economy continues its steady 3% to 4 % annual growth rate, there should be a number of good domestic choices for investors. I'd like to suggest, however, that much of the economic growth over the next few decades will come from non-U.S. economies. For many years I've recommended the idea of international diversification as a way to spread risk and increase opportunity. I believe this is an important topic. I'm offering three meetings here in our Orleans office on Wednesday, Sept., 14, to discuss global investing. The meeting times are: 9:00 am, 12:00 noon and 5:00 pm. Refreshments will be served.

Call Sue or Debbie to reserve seating at 508-240-0320 or 1-800-237-9322. Bring a friend. I'm looking forward to seeing you on the 14th.

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
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