A Surprisingly Good Quarter

The third quarter of 2005 showed very good overall results for our clients’ portfolios. Almost forgotten now, July was a very strong month across all equity asset classes, and the drop in domestic markets in August was offset by a decent eventual recovery in September. Meanwhile, overseas markets continued to perform exceptionally well throughout the quarter.

Overseas Equities Prevail

We continue to be generally optimistic about overseas investment performance. The recent election in Japan offers at least a glimmer of hope that the Koizumi reform agenda will succeed and, though still inconclusive, the German election demonstrates some willingness to depart, however begrudgingly, from the former pervasive welfare state economy. For the long term, even more significant, the role of China looms large and, we believe, ultimately, for the good. Jason Thomas offers several insights on China’s major impacts in the article that follows.

Still, Threats Abound

For several weeks, it’s been difficult to avoid the press about the collapse of the Bayou hedge fund, once again raising significant concerns about the risks of this broad category of investment vehicle. We continue to monitor each of the fund choices we’ve introduced to our clients and, before Bayou hit the headlines, we were conducting a thorough review of the attractiveness of this entire sector for our clients. For now, we do not fear excessive risk or inadequate gross return but are focusing attention on net returns and the issue of cost. Expect further comments soon.

High commodities prices, most notoriously for oil, could both crimp consumer spending and contribute to a rise in general inflation. The Fed’s determined, meeting by meeting, increase in interest rates is intended to thwart that risk but could slow or even reverse economic growth in the process.

The double calamity for the Gulf Coast of Hurricanes Katrina and Rita, perhaps surprisingly, is expected now to produce relatively little near term damage to the US economy. The recovery and rebuilding could produce positive results for economic growth well into 2006. September’s positive market results probably reflect this relief from the fears spawned by the initial disaster.

The costs of the federal government’s aid in response, coupled with the ongoing costs of the war in Iraq have probably postponed any action on further tax relief for this year. Anticipated legislation to make previously temporary income tax reductions permanent and to drastically reduce the burden of the estate tax is now on hold. And Social Security reform seems completely off the current agenda. Nevertheless, we’ve heard several independent commentators insist that, in time, the White House and the Republican Congressional majority are determined to bring this entire tax agenda back to the fore. Whether that is ultimately good or bad depends to a large extent on one’s political frame of mind. Still, there is little doubt that a failure to eventually make the 15% capital gains and dividend tax rate elements permanent would injure equity market values.

We’ll be watching all of these developments closely as we approach the end of the year.

Tim Kochis,
Editor