Enclosed please find your reports for the second quarter of 2006. The first half of the quarter was filled with optimism and impressive returns. However, in the second half, the market quickly changed and was dominated by pessimism and anxiety. Therefore, some of the first quarter gains were given back but your portfolios still remain in positive territory.
Economic and Market Overview
The economy reflected a split personality for the quarter. The optimists pointed to very robust corporate profits, reasonable valuations, higher than expected GDP, and the lowest unemployment levels since June 2001. The pessimists countered with rising global interest rates, higher than expected inflation, and a housing market that is showing early signs of cooling.
The Fed policy did indeed loom large this quarter. Core CPI rose more than expected due to rising rental expenses. New Fed chairman Ben Bernanke found himself in the unfortunate situation where the market simultaneously feared he was not vigilant enough on fighting inflation yet would go too far in raising interest rates. The final Fed statement on June 29th, combined with stabilized inflation data, went a long way towards soothing market participants.
Housing continued to show signs of slowing but non-residential construction has continued to surge. Corporations have historically high levels of cash and have been increasing their spending on capital equipment. We expect this increased capital spending to offset the moderating consumer. This data leaves us cautiously optimistic about the continued economic expansion. Year-to-date, the markets are still up with strong corporate earnings. We do expect high levels of volatility to continue in the near term.
Portfolio Update
We have made several defensive moves in our holdings to reduce your risk. As discussed in our May letter, we reduced exposure to some of the more volatile funds such as Artisan International Small Cap, Laudus Rosenberg International Small Cap Fund, and Buffalo Mid Cap Fund. The two international funds have averaged over 25% returns for the past three years. Cashing in on these accumulated profits allowed us to reduce your overall risk and to be better diversified. Proceeds from those sales were invested short term into the Schwab Yield Plus Fund. Once we feel the market has more clarity, we anticipate re-investing these proceeds later in the year.
Second, we analyzed and re-balanced all accounts to remove unacceptable risk. Most positions that were reduced had become very profitable over the past two years. The cashing in of these profits tended to reduce the overall risk of portfolios. Similar actions were taken for our clients holding variable annuities.
The PIMCO Commodity Real Return Fund recovered as expected from its poor first quarter results by rising 5.3% during the second quarter. The case remains for holding commodities due to the large increase in demand of those goods from developing countries. Inflation fears also aided this fund since commodities are generally a good hedge against inflation.
Finally, on the fixed income side, we continue to utilize ING Senior Income Fund and Eaton Vance Floating Rate Fund. This tactical move began in late of 2003. These funds are protected against rising interest rates since the bonds are very short-term, and their yield increases as rates rise. This move has been a positive for all portfolios holding fixed income positions.
Year End Outlook
We had projected that the 2nd and 3rd quarters would involve significant volatility. Our research shows that the 4th quarter should offer significant opportunity for gains. For the first time in six years, Large Cap Growth is priced reasonably. This creates a buying opportunity, but we will proceed with caution over the next few months.
Our intention is to redeploy short-term assets into more rewarding sectors once the current cycle has subsided. Periods of volatility are not unprecedented but strong fundamentals like corporate profits provide us with optimism about future opportunity in the market.
News at Singer Xenos
Our partner Marc Singer recently attended the Schwab Explore conference in California. Schwab invites the nations top 150 wealth management firms to attend. Marc had the opportunity to speak personally with CEO Chuck Schwab and Schwab Institutional President Deborah McWhinney. They both discussed at length Schwab’s commitment to providing ethical low cost service to their clients. Marc was also interviewed for a Wall Street Journal article on asset protection, which should be published in the next few weeks.
We remain optimistic for 2006 and wish you a pleasant summer.
Singer Xenos Wealth Management
