Third Quarter 2005 Review

The recently closed third quarter of the year was generally a good one for the U.S. economy. Our Gross Domestic product, despite hurricanes and the ensuing troubles, gained another 4.3 % according to data provided by the U.S. Department of Commerce's Bureau of Economic Analysis (BEA). This showing was a full percentage point better than the previous three months. The BEA noted that continued strength in residential building, consumer spending, investment in software and equipment by American businesses and non-residential building all added to a positive reading for the economy.

U.S. Corporate earnings continued to improve. Profits were up 16.5% year-over-year from the third quarter of 2004 to the third quarter of 2005. Our domestic unemployment picture brightened a bit, down to an even 5.0 % from 5.1 % in the previous quarter. There are, by government measurements, now 150,000,000 Americans in the work force. However, one nagging negative concerns health insurance coverage: some 40,000,000 American workers continue to be under-insured or uninsured.

Interest rates are unlikely to be pushed up from current levels by the Federal Reserve without risking recession, in the opinion of some on Wall Street. Think of interest as the "price" of money. Higher interest rates cost borrowers more, attract funds from traditional stock investments and have a certain inflationary effect that may be an un-intended consequence of raising rates to "fight inflation." Home owners at the lowest price range, which is the entry point of the "American Dream," can only afford a certain percentage of their income to pay the mortgage. The higher interest rates go, the fewer new buyers there are who can qualify for their first home. This affects all the other owners up the line who want to sell their first home so they can buy their next, better, home. And so it goes, up to the most expensive dream home. The first sign of a slowdown may have already appeared. Regardless of whether rates go higher o r not, it is my opinion that if you continue to hold a high interest mortgage, you should refinance now if doing so will save you enough to make it worth the trouble. My hope is that we will all be able to own a debt-free home. Ask you bank or mortgage company for a chart showing how you can pay down the mortgage faster by adding to your monthly payment.

Americans! Don't we JUST LOVE A BARGAIN?!!

U.S. Personal Income as reported by BEA was up 1.7%, an increase of $ 173 Billion. But our domestic spending spree continued, resulting in a fourth month of negative domestic savings vs spending. We are spending just about everything we earn and saving next to nothing. This savings rate computation is a little skewed however, because it does not count IRAs and 401(k) contributions. But, when compared to Japan, China and many of our other trading partners, our savings rate is pitifully low. We continue to buy from China and other low-cost producers of consumer goods. We get their stuff. They trade it for our paper money. Then they swap the paper money for U.S. Treasury bonds. The more of their stuff we buy, the more of our public debt they own. This is called the trade imbalance. If the rest of the world bought exactly the same amount of stuff from us as we bought from them, there would be trade equilibrium. In the last quarter of the 18th Century Adam Smith, the first modern economist, noted in his Inquiry into the Wealth of Nations how trade created wealth for buyers and sellers. It's still all about supply and demand. There is no other or parallel universe controlling the laws of financial reality. So, if there are too many of our T-Bills floating around the global currency markets, it's only a matter of time before the value of our money drops. This is just what's been happening for the past several years. Book a trip to Europe if you don't believe this.

You and I can not have much impact on the imbalance of trade or any other macroeconomic factor. We can, however and importantly, adjust our own personal balance of payments, savings rate and other microeconomic factors. One of the goals I recommend to clients is to save a certain specific amount every month and give away time and treasure on the same schedule. My favorite all-time champion investor, as most of you know, is Sir John Templeton. I had the pleasure of meeting him twice, once at the top of one of the Trade Tower buildings in New York at a shareholder meeting and another time at an annual Financial Planning Convention. One of my favorite sayings from Sir John is this: "I've never know anyone who saved 10% and gave away 10% of his or her income who wasn't both happy and prosperous." In an economy where many of us are spending 105% of everything we make, this seems like an improbable goal. Of course this is difficult or impossible if your income doesn't allow for even the basics. For those of us who are blessed with income for the basic needs of life and something left over, Templeton's financial advice can be followed. The results are immediate and long term.

Charitable giving blesses both the giver and the receiver. Even the state and federal tax collectors agree, allowing ample tax advantages to the giver. The other great benefit of saving and investing is the compounding effect of putting funds away over time. Albert Einstein chimed in on this when he declared "The most powerful force in the Universe is compound interest" and "It's not that I'm so smart, it's that I stay with problems longer." What better combination of thoughts could there be for long-term savings and investing?

Stock Market Report

Our domestic stock market performed much like the rest of the year this past quarter. The economy continued to show growth. The stock market seemed stuck in neutral. As I suggested in the Second Quarter Newsletter, U.S. stock market performance has indeed mirrored the performance thus far this year that of the first three quarters of 2004. Last year nothing of consequence happened until the last three months of the year. As of December this appears to be a reprise of last year. The old saying is " The Bears have Thanksgiving. The Bulls have Christmas."

Our public companies are cash rich. Many are increasing dividend payments. Some are inaugurating a dividend program. The tax treatment of dividends makes dividend-paying stocks more attractive now than just a few years ago when tax rates were considerably higher. The trend then was to buy non-dividend stocks for the capital gains, taxed at lower than dividend rates. The reverse now seems the case. Also, a dividend is proof of profit. Only a profitable company can sustain a dividend program. If the U.S. market is in a period of modest gains, more attention should be paid to dividends. During the period 1966-1982 the Dow Jones Industrials bounced around for sixteen years and never sustained a break about 1,000. Most of the gains for investors during those years came from corporate dividends, especially from those companies which increased they payments over time.

Portfolio Diversification

Investments are divided into risk and return categories. I often refer to many of our industry terms as "secret passwords." Investment terms should be clear so that investors understand their meanings. Unfortunately, this isn't always the case. The stocks and bonds of companies are measured "by weight" in a sense: Large Cap (for Capitalization, the total value of a company), Mid Cap, Small Cap and Micro Cap. Stock portfolio styles are often put in one of three groups: Growth Style, which is the search for fast-growing companies, hoping for fast-growing investment profits, with less focus on the stability of the stock price or how high the price is relative to the company's underlying profits; Value Style, which is the search for securities that are considered bargains relative to their earnings, and/or compared to other companies in similar industries; Blended Style is the mixture of the two other styles. Growth is considered somewhat more volatile, and therefore riskier, than the Value approach. Large Cap is considered the least volatile metric. Micro Cap and Small Cap and the most volatile. Putting the two types of safety measurements together, we estimate that Large Cap Value is the least volatile and Small Cap Growth is the most volatile, for example.

In addition to the measurements of capitalization, investors today are becoming very interested in international diversification. The U.S. is growing at a steady, comfortable rate. Much of the rest of the world is growing at a faster pace. Brazil is one good example of a growing economy. This large country has a population that is developing a middle class. If you know any Brazilians here on Cape Cod, ask if they are sending home any of their American wages to make investments in property and businesses. This is happening all over the developing world. Many workers in the Industrialized nations are earning money and are returning to their native countries to "get ahead." Some are coming to America legally for a better life. Many others are not obeying our immigration laws.

One way to consider fully diversifying your portfolio is to have some representation from each of the major investment categories: large cap, mid cap, small cap, growth, value, U.S. and foreign. A simple way to consider diversification is to divide your portfolio into thirds: Income, Foreign and Domestic. Each third could be subdivided into the styles and capitalization groupings that are suitable for you based on your age, income, personal risk profile and investment time horizon. Portfolio rebalancing is a life-long process. Call me whenever you have a question about your own investment menu.

Annual Financial Check List

As we enter the fourth quarter of the year, I'd like to remind you to take inventory of the components of your financial plan. 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
_________ 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 the December 31st annual deadline.
_________ Tax Planning with Your Tax Advisor Before Year-End
_________ All Those "Other" Things You Meant To Do Before Year-End

I work for people who need and want help with their financial planning. If you know of others who need help, have them call me. I'll be happy to meet with them in person or on the phone to answer questions or make referrals to other professionals as appropriate.

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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