Summer 2004

A Brave New World        

The Federal Reserve lifted the overnight funds rate by one quarter of one percent on the last day of
June, signaling the end of the hyper-accommodative monetary policy that has provided a prop for the
wobbly economy that existed after the tech wreck of 1999.  A new era seems to have dawned with
the economy now able to grow without assistance.

However, even after the rate hike, rates are still extraordinarily low and so further rate increases are
on the horizon. The Fed has left rates so low for so long that we believe it has set the stage for a significant increase in the rate of inflation in the future. Indeed, cost pressure has been rising in the supply chain for some time now. This is a mixed bag for investors. The up-tick in inflation should allow some companies to charge more for goods and services and increase their profits. On the other hand, the accompanying increase in long-term interest rates will make bonds more attractive to investors and stocks less attractive.

Stocks, Bonds and Cash                 

Offsetting some of the effect of higher rates on the stock market will be several quarters of what we believe will be strong profit growth. The offsetting seesaw effects of higher rates and higher profits is complicated somewhat by the uncertainty created by the situation in Iraq and the middle east. As the investing public despises uncertainty, the U.S. stock market is likely to be range bound, as it has been for the past several months.  Because the market runs in place and with profits on the increase, value is more easily found within the universe of U.S. stocks, making it more attractive for patient investors to establish positions in quality stocks. So if there is a breakout in stock prices it is likely to be on the positive side of the ledger.

As short rates rise over the next few quarters, the difference between short-term rates and long-term rates should narrow. We believe long-term rates will rise modestly with the 10-year Treasury finding equilibrium between 5.5% and 6%. We still believe, as we have for over a year, that a fixed income portfolio should have a significantly lower than average duration and be underweight, high quality gilt edged securities such as U.S. Treasuries.

The cash reserves that have been earning returns of less than 1% will rise smartly over the next few months, taking some of the pain out of holding these more liquid assets.

Real Estate, Foreign Markets and Alternative Investments                  

The price of real estate investment trusts has rebounded since their sell off in May. The prospect of rising inflation makes rising rents more likely and should support these investments. The Euro-zone and developed Asian stock markets are still attractive relative to U.S. stocks and we recommend exposure to them, particularly with a rapidly improving Japanese economy.  Commodity prices have corrected significantly over the past several months. We expect the price of industrial commodities to rise again along with a rebounding global economy.      

The Altavista Investment Team - Summer 2004