Lakeview Investment Advisors, LLC
Commentary Date: Summer 2005
by Bill Westhoff, CFA
Lakeview Update: Personal Update
Most of the summer has been spent at the lake with many sightings of loons and other wildlife. We enjoyed a good summer with lots of family and friends. On a personal note, the good news is the collar bone has healed and biking has resumed with an eye to completing the cross country ride in 2006. The sad news to report is that Sadie, our family pet for fifteen years and my office companion, left us in August. We are convinced that she is chasing chipmunks and squirrels again.
Lakeview's business continues to grow at a moderate, manageable pace, and I look forward to helping recent client additions structure portfolios that perform well in a volatile environment.
Market Performance—2005 YTD (September 7)
A review of the major indexes shows a market with little direction in 2005; with the Dow, NASDAQ, and S&P performing in a range from -1.39% to +2.02%. However, in view of the significant increase in energy prices and the devastation from Hurricane Katrina, the broad market performance is respectable. Behind the numbers, in various sectors of the market, there have been areas with very strong performance. As one might expect, energy companies have done well with a gain of almost 32%, but utilities have also shown a gain of over 25%, European stocks have provided a return of almost 15% and small stocks are up over 7%, after very strong returns in 2003 and 2004. Bonds have been a real surprise this year, showing positive returns in spite of the Federal Reserve raising short term rates at every meeting of the FOMC in 2005. Yields on ten year treasury notes are currently lower than in February, indicating either an excess of global savings, or a continuing concern with the state of the world, or both. Federal Reserve Chairman, Alan Greenspan has called the fall of ten year yields in the face of rising short term rates a “conundrum.”
As shown in the table below, the yield on the ten-year note is 4.14%, while the yield on the two-year note is 3.85%, or a spread of only 0.29% (or 29 basis points). This is a narrow spread.
Source: Wall Street Journal 8/1/05
Source: Investors Business Daily 8/1/05
Valuation statistics indicate a market that is not highly valued by recent standards and perhaps fair to cheap in view of the strong growth in the economy and still low level of interest rates. Market technical statistics show a market that is relatively calm, while the number of new highs comfortably continues to exceed the new lows; a market that is "climbing a wall of worry" (i.e., stocks rising in price in spite of the negative headlines).
Lakeview's Advisory Board met in July before Hurricane Katrina, so the comments on economic growth may be too optimistic. At the time of our meeting, GDP (gross domestic product) was expected to grow 3.5% to 4% at an annual rate each quarter until the end of 2006, with productivity growth expected to come in at 2.5–3%; which will continue the trend of moderate job growth.
In spite of moderate job growth, the unemployment rate declined to 4.9% in July. The Establishment Survey that reports on employment growth again reported a softer employment picture than the Household Survey, which provides the unemployment rate. This difference has continued for many months and is perhaps reflective of a situation where larger employers are undergoing significant restructuring/outsourcing of their employment; while more individuals are finding employment in smaller, start-up firms or increasingly working in self-employment.
The Advisory Board discussed two other topics, Revaluation of the Chinese currency the Yuan and the retirement of Fed Chairman, Alan Greenspan. The upward valuation of the Yuan was slight and is expected to have miniscule impact on global economy in the near term. The economic impact from currency changes usually take up to eighteen months due to the long term nature of international trading contracts. We noted that will be a significant event over time and shows China 's increasing confidence in its economy and banking system. Of equal or more importance was the fact that two Chinese companies made bids to purchase entire U.S. corporations (Unocal and Maytag). These bids were unsuccessful, but showed that China has an increasing interest in real assets over U.S. Treasury bonds. At the margin, these moves are more supportive of stocks and less supportive of bonds.
Chairman Greenspan is almost 80, and it is very likely that he will retire in early 2006. Greenspan has been a very capable Fed Chair, and his retirement may make the market nervous. One of the current favorites to take this position is the current head of the Council of Economic Advisors, Ben Bernanke. Bill Melton views Mr. Bernanke as a well respected economist whose previous votes on the FOMC were solid and whose public speaking comments are not controversial.
In the meantime, Chairman Greenspan has indicated that Federal Funds interest rates at 3.5% are not neutral and need to go higher. The after-effects of the hurricane may cause the fed to pause in its tightening moves, but we would not bet on it.
Market Outlook (Current stock view: +, moderately positive exposure to stocks and bonds versus the benchmark)
My current view is unchanged from the last commentary, and I believe that stocks will out-perform bonds over the next 12 months. Historically, markets have not shown lasting effects from natural disasters, because (as noted by USA Today, 9/1/05 ): "The impact is local, not national; investors are forward looking; and damaged stuff has to be replaced or fixed."
Certainly the devastation from this hurricane exceeds that of previous natural disasters, and the images of the personal tragedies on the television are heart wrenching. The effects will slow growth in the near term and raise prices for some commodities, but the stock market seems to be looking through this and placing a bet on less lasting damage and faster recovery than initially feared.
Mutual Fund Selection
In this commentary two international funds that have been widely used in client accounts are reviewed.
Julius Baer International Fund (BJBIX): This fund is a Foreign Large Blend Fund with a five star rating by Morningstar. I developed a very tough screen to find an all purpose international fund with a strong long term consistent performance record. The screen combed through the Morningstar data base of over 17,000 mutual funds, which was narrowed to 967 Foreign Funds and 555 Foreign Large Blend funds. Next, I looked for funds that performed in the top 25% of the foreign funds over ten years and last three years and in the top 15% over the last 12 months. This narrowed the list of 555 possible foreign large blend funds to only 3 funds meeting these criteria. Two of the funds were the "A" and "I" shares of the Julius Baer International Fund (the I shares typically have a very high minimum initial investment that only institutions or very wealthy individuals can meet; therefore, I focused on the "A" shares).
My research showed a fund with an exceptional performance record and number of attractive characteristics. The fund is managed by a team of two people with tenure of 10.3 years. Morningstar rates the fund as having below average risk, but high returns, relative to its peers over the last three and five years. The overall Morningstar rating is five stars. Over the ten years ended 6/30/05, BJBIX has shown an average annual return of 14.34%, exceeding the average annual return of the S&P 500 by over 4% per year and ranking in the top 1% versus its peers in this time period. Of course, past performance is no guarantee to future results.
The fund manager is the Julius Baer Group which is one of Switzerland's leading banking institutions who manages substantial assets for private and institutional clients from all over the world. This group seems particularly well suited to manage international assets and have demonstrated this through their excellent, long term performance record.
Matthews Pacific Tiger Fund (MAPTX) : This international fund focuses on Asia, but excludes Japan. The fund has a four star overall rating from Morningstar, but a five star rating over the last three years. Additionally, Lipper (another mutual fund research and rating company) gives the fund a "Lipper Leader" rating on the basis of total return, consistent return and expense ratio. Over three-, five- and ten-year periods this fund has ranked in the top quartile versus funds with similar objectives (#5 of 53, #9 of 45, #2 of 23).
Again, this fund's performance record is outstanding. For the twelve months ended June 30, 2005, the total return was 27.9% and a three-year average annual return was 20.9%. The fund is managed by Matthews Asian Funds Group, and the individual managers are Paul Matthews and Mark Headley, who have managed the fund for ten years. I always find comfort when the individual manager's name is on the door of the fund management group.
Morningstar notes in a review of Matthews, "There's a growing excitement about the China story and the potential of several of its neighbors, and we've received a lot of calls about the best way to play the region. Well, the Matthews family is an excellent place to start. It's a pure-Asia shop that has been around for more than a decade..." Morningstar goes on to report that Matthews has beefed up its management team in recent years as assets have grown. This fund management group has six funds focused in the Asian region with five funds having ratings of four or five stars.
Of course, past performance is no guarantee to future performance, and the narrow focus of the fund will mean a more volatile price for the shares of the fund.
Please contact me at Billw@lakeviewadvisors.net if you would like to discuss any of the ideas reviewed in this commentary.
© 2004 Lakeview Investment Advisors, LLC
Any information provided in these materials is believed to be from reliable sources. Lakeview Investment Advisors, LLC makes no representation as to its accuracy or completeness and is not responsible for any damages incurred as a result of your use of these materials. These materials do not constitute a solicitation to sell or offer to sell investment advisory services to residents of any state in which Lakeview Investment Advisors, LLC lacks authority. Part II of Form ADV, which details the business practices, services offered, and management fees charged by Lakeview Investment Advisors, is available upon request.
Lakeview Investment Advisors, LLC participates in a Board of Advisors consisting of professionals in the investment field; however, members of that Board who are not employees of Lakeview Investment Advisors, LLC do not participate in providing investment advisory services offered to clients.
The Economics and Markets Advisory Board consists of the following members:
Theodore H. Busboom, CFA, President, Prospective Value, formerly Senior Vice President and Portfolio Manager, American Express Financial Advisors
William C. (Bill) Melton, PhD., President, Melton Research, Inc., formerly Chief Economist, American Express Financial Advisors
Former Advisory Board member Ray Goodner has moved to Seattle. Jim Walline has returned to the working world, accepting a senior position with Piper Jaffray.