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Enclosed please find your reports for the first quarter of 2007. We are delighted that our managed portfolios have outperformed their respective benchmarks in 2007. Our expectations of a maturing economy, favoring larger cap, growth-oriented stocks, has come to fruition this quarter. Your portfolios were well positioned to take advantage of these conditions. Your equity portfolios posted healthy returns for the quarter while the S&P 500 Index struggled to finish positive and the Dow Industrials Index (Dow) finished down for the quarter. Your fixed income portfolios had a strong finish in the quarter and outperformed the Lehman Brothers Aggregate Bond Index.
Economic and Market Overview
Overall growth is still healthy and the economy should continue moderating. Domestically, growth outperformed value stocks during the quarter after an extended period of outperformance by value stocks. Volatility in markets was unusually low the past few years so an increase in overall volatility was not surprising. We continue to feel portfolios are well positioned for this by being in higher quality, typically larger cap securities. After adjusting portfolios last year we continue to be comfortable with your international allocation and feel there are still opportunities overseas. Capital markets and the economy continue their evolution and we diligently continue our research efforts to uncover future opportunities.
The maturing economic cycle will often give off mixed indicators as it continues to age. Gross Domestic Product upticked slightly and remains healthy. The Federal Reserve seemed to confirm market sentiment by keeping short-term rates steady and releasing a more accommodating statement. At the end of the previous expansion (March 2000) we had 3.8% inflation. Currently inflation is about 2.2%, which is above the Fed target of 2.0%, but still benign compared to historical levels. Profits rose by double digits again and as a percent of GDP they are now at a 77-year high. In fact profits are up 91% between the end of 1999 and the end of 2006.
During late February and early March investors were re-introduced to volatility. Typical of mature bull markets; small cap, value, and international stocks have had a prolonged period of outperforming the S&P 500, but economic indicators point to the end of favorable conditions for these segments and a time of relative dominance of mid and large cap, domestic, growth-oriented companies.
As Singer Xenos predicted over a year ago the housing market has begun its decline. This has resulted in a slowdown of both housing and construction related industries. In addition, increases in variable rates have resulted in a large number of sub prime loan defaults (i.e., loans given to individuals with poor credit ratings). Changes made to your portfolios some time ago already considered the future housing decline.
Market Scorecard
| Investment Return: | Domestic and international stocks and bonds all ended the quarter above par, albeit in some cases only slightly, despite turbulent markets in February.
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| Overall Economy: | Economic growth, while still positive, continues a slowing pattern.
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| Employment: | The US runs at full employment, with unemployment at only 4.5%
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| Earnings: | Corporate profits continue to a 19-month run of double-digit year–on-year earnings growth. Profits are at their cyclical peak.
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| Interest Rates: | Interest rates remained unchanged at 5.25%. However, bonds continue to be a tough market as the yield curve remains inverted and yield spreads are tight.
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| Inflation: | Inflation of 2.2%, above the target cap of 2%, raises concerns for the Fed. However, this is still historically extremely low inflation.
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| In the News: | A testing of global equity markets was triggered by a steep drop in the Hang Seng Index (China) in late February. Defaults on poor credit (“sub prime”) housing loans contributed to contracting risk appetites, as did the use of the words “possible recession” by Federal Reserve Chairman emeritus Alan Greenspan. Merger and acquisition (“M&A”) activity continues to be robust. |
Portfolio Update
Our recent research efforts have shown early rewards. The Rainier Mid Cap Fund was added in early February. Rainier outperformed 98% of its peers. In March we sold the Tweedy, Browne Global Fund and replaced it with Julius Baer International II Fund. The PIMCO Foreign Bond Fund was also sold in March due to its drop in performance. Proceeds were invested into the Templeton Global Bond Fund, which outperformed 89% of its peers. In fact, six of our current holdings rank above the 90th percentile in their respective peer groups.
In response to concerns about rising defaults the PIMCO High Yield Bond Fund was sold. Not only are defaults rising but high yield bonds currently are richly valued. Proceeds were reinvested into the Alpha Hedged Strategies Fund. This fund produces a risk return profile that is similar to a high yield bond but the fund’s goal is to remain uncorrelated to the sector.
We will continue our effort to find best of breed managers and superior investment solutions for our clients. We stand by our outlook and feel your portfolios are well positioned for the remainder of 2007.
Singer Xenos Wealth Management
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