PERFORMANCE ANNOUNCEMENT

   

As Of: August 22, 2005

GENERAL UNEASE

"There is a general sense of unease.
We miss hearing birdsong on the breeze."

    Humid air hangs heavy on the late summer days. It should be a time of carefree relaxation before the serious business of the fall and winter resumes; but there is an undercurrent of tension that tells us something is not quite right. After the first half of the year produced negative returns for the major stock indexes, July was full of promise as investors replenished the value of their portfolios. August could not continue the rally, and now we are faced with frustration and doubt.

   Analysts tell us the economy is growing, and growing well. If the economy can grow this well in the face of rising oil prices and rising interest rates, then there is little to stand in the way of continued growth. The government tells us that employment is growing and inflation is low. However each individual's personal experience brings doubt to these generalities.

    How can inflation be low when home prices have been soaring? Answer: The government does not include home prices in its calculations. We know that energy and food prices have been rising; but so has the price of healthcare, and tuition, and insurance. And of course taxes go up with house prices. Additionally, compared to a few years ago, families have new recurring monthly costs for cable TV, internet service providers, cell phones, and other data subscription services. Regardless of what the government says, we know life is more expensive now.

    Jobs? Since 9/11, the vast majority of new job creation has been homeland security related. Security and inspection is essentially non-productive employment, and represents a cost to society, not a constructive addition to the economy. Most people's experience is that job opportunities have declined, and the quality of employment has declined. Family wages are not keeping pace with the true cost of living, and certainly not keeping pace with the cost of real estate. Meanwhile, personal debt is soaring. Obviously there is a limit to people's ability to spend beyond their means. There is no meaningful personal savings rate to draw on. Equity refinancing is running its course. The squeeze is on.

    Corporate earnings growth has been stellar. Some say corporations are experiencing "the fastest growth in real profits in the postwar era"; and certainly the growth in corporate profits is substantially exceeding the rate of growth in the economy. This begs the question, "How can it continue?" Much of this growth seems to be a bounce back from the recession of 2001. If this is indeed a one-time event, it is hard to point to any engine that will drive future growth. If the consumer retreats, the economy will follow.

    We sit with a stock market that is priced for a positive outcome. It is an aged bull market that is rich in optimism, but the quality of our position is rather sketchy. Higher oil prices were at first thought to be a temporary event, but no longer. The Federal Reserve keeps raising interest rates with the regularity of a slow water torture. Any good investor weighs risk against return. It is looking more and more like the risk is increasing and the potential return is decreasing. Historically the market "climbs a wall of worry", so skepticism should be natural and does not necessarily forebode anything ill. But there is a general sense of unease that goes deeper this time. The numbers feel artificial. The assurances do not ring true, and birdsong is missing on the breeze.