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Lakeview Investment Advisors, LLC

Commentary Date: February 2003

by Bill Westhoff, CFA

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Lake Views

Lakeview Update: Desert Views

Greetings from Fountain Hills, Arizona, and Happy Valentines! As many of you know, one of my goals in establishing Lakeview Investment Advisors was to operate from several locations. Ruth and I have been here for two weeks, and my computer and internet connections are working well—if you receive this e-mail, this goal has been realized.

Lakeview Investment Advisors has chosen Charles Schwab as its broker/dealer to handle all client portfolios. This means that if you have a relationship with Lakeview, your brokerage account will be at Charles Schwab. With this arrangement, Schwab will execute most of your trades, provide custody of your securities, and provide a monthly statement. Schwab was selected for several reasons: Attractive commission rates; strong balance sheet; research unbiased by investment banking; and excellent support and service to independent investment advisors (“IAs”).

Currently, Schwab is running an advertising campaign pointing out the number of investors that have moved assets to them in the last year; much of that has been through IAs. Clearly many investors are now realizing they need help navigating this difficult, complex investment climate. As an incentive to transfer assets, for clients who deposit $25,000 or more in cash or securities into a new or existing account, Schwab will waive or rebate commissions on qualifying equity trades. To qualify, the deposit must be made prior to May 30 and the trades must be placed at one time on the same day. On a rebalancing that involves ten trades at the typical commission of $29.95 this is a savings of almost $300. Please let me know if you are interested in taking advantage of this opportunity.

YTD Performance (2/13/03)

Index

YTD change

Dow Jones Industrial Average -7.09%
NASDAQ Composite -4.35%
S&P 500 -7.10%
Russell 2000 (small stocks) -7.39%
DJ World -4.71%
Nikkei 225 (Japan) +0.24%
DJ Euro Stoxx 50 (European) -11.01%
MSCI EAFE (Europe, Australia, Far East) -5.71%
DJ Corporate Bond Index +1.38%
Lehman Bros. MBS (Mtg. Backed Securities) +0.48%
10 year Treasury Note (Yield) 3.91%
3-month Treasury Bill (Yield) 1.15%
Euro (Currency in US dollars) 1.0858
Japanese Yen (Currency in US Dollars) 120.66
British Pound (Currency in US Dollars) 1.6195

Commodities

02/13/03 close/2002 close

DJ-AIG Commodity Futures 119.955/110.276
Oil bbl. $36.31/$31.20
Gold, troy oz. $357.40/$347.60
Wheat, bu. $4.09/$4.14

Source: Wall Street Journal 2-14-03

January started strongly but after two weeks, war worries took over and the market has been down each week since. The trends of 2002 have now continued into 2003, with stocks down and bonds up. Interestingly, commodity prices have also continued their positive trend. It is unlikely that commodity prices and bond prices can both continue to go up. Rising commodity prices ultimately lead to inflation pressures, which are definitely unfriendly to bonds. For the near term, rising commodity prices are more an indication of war fears than excess demand driving up prices.

The Dow has had the weakest performance this year among the major US Indexes, while the NASDAQ has had the best performance. The Euro and Japanese Yen have continued to appreciate versus the dollar. The combination of war worries, a large and rising budget deficit, and falling consumer confidence create a difficult environment for the dollar. This is another negative for the stock market as a weak, declining dollar makes the US market unattractive to foreign investors (at some point this will become a positive factor because the weak dollar will spur exports and provide a source of stimulus to the economy).

I continue to believe that the market bottomed in early October, 2002, but the uncertainty over the Iraq situation and the continual public diplomatic wrangling among our “allies” is pushing the fear in the market to high levels. There are a number of indicators that I watch to gauge market sentiment. One example to site is the yield on the Two-Year Treasury Note, which hit a record low of 1.54% on Thursday (2/13). Positive surprises can lead to big rallies when the market sentiment is so negative.

2003 Outlook

Last month, I mentioned the formation of a discussion group among former associates and friends in the investment management business. This group met again in late January to review changes in the economy and discuss investment ideas. The economic stimulus package announced by the Administration has been met with a lot of skepticism and this discussion group felt there was good reason for the concerns. (Many of the economic thoughts expressed here are attributed to Bill Melton).

Although consumer confidence numbers continue to decline, consumer spending is holding up better than expectations. Capital spending by business remains disappointing, but there are signs of life in some areas (some tech spending is picking up due to obsolescence). Inflation should not be a concern and will remain around 2%. Excess global manufacturing capacity and excellent productivity growth is keeping the overall price increases to a minimum. The strong productivity growth is a long-term benefit to the economy and rising incomes. However, in the near term, economic growth is equal to productivity growth of about 2 to 2-1/2%; explaining the “jobless recovery” that the US is experiencing.

This brings us to the Administration’s stimulus package which seeks to address a long term imbalance that exists in our economy—a lot of incentives to spend, but few incentives to save. As a result of this imbalance, the savings rate in the US is very low. However, the incentives in the stimulus package do little to stimulate the economy to provide job growth in the immediate future. Even with Republican control of Congress, look for substantial revisions to the President’s stimulus program.

In the meantime, earnings numbers announced by US companies are a mixed bag. Some companies are reporting significant profit increases, while others are still struggling with weak demand and are reducing expectations. The market is largely ignoring the strong reports and choosing to watch the news on Iraq. As long as this uncertainty continues, the market will struggle to sustain any upward move.

Stock Selection

Last month, we focused on Sysco Corporation (SYY) as an example of a stock held in Lakeview Investment Advisors portfolios. This month, we will focus on another type of stock, which is really a bond disguised as a stock. Below is a description of three closed-end bond funds. To buy the bond funds, one must purchase shares or stocks in the funds. The shares of each of these funds trade on the NYSE.

Global High Income Dollar Fund (GHI)

This is a fund that invests in bonds issued by emerging market countries (largest holdings are in Mexico, Poland, Morocco, South Korea, and Brazil).

  • 2/13/03 close: $14.96/share (2/13/02: $14.08/share)
  • Last dividend: $0.135, pays monthly. Current annualized yield: 10.83%
  • Last 12 month yield: 10.59%
  • One year total return (dividend return plus gain or loss per share): +19.04%
  • Hi/Lo last 12 months: $15.88/12.29
  • Fund market capitalization: $290 million
  • Morningstar Rating: 4 Stars
  • Manager Tenure: 10 years.

This fund has performed very well over the last year with a return over 19%. The yield of over 10.5% is very attractive compared to returns on US Treasury Notes (Two Year at 1.54%, and Ten Year at 3.91%). Emerging market bonds do face some risks, but this fund has shown a three year return of 11.75% per year. This fund has performed well enough to earn a Morningstar rating of 4 Stars and the manager is experienced. Historically, low global interest rates have been supportive for emerging economies.

Lincoln National Income Fund (LND)

This fund is considered an intermediate term bond fund, investing primarily in investment grade US corporate bonds, although the manager has used some emerging market bonds. The fund is very well diversified with holdings in 182 different issues.

  • 2/13/03 close:$13.65/share (2/13/02: $12.70/share)
  • Last dividend: $0.265, pays quarterly. Current annualized yield: 7.76%
  • Last 12 month yield: 8.64%
  • One year total return (dividend return plus gain or loss per share): +17.65%
  • Hi/Lo last 12 months: $13.90/12.03
  • Fund market capitalization: $96 million
  • Morningstar Rating: 5 Stars
  • Manager Tenure: 8 years

The return on this fund over the last year was in excess of 17% and the current yield is about 7.75%. Although rising interest rates will hurt the total return potential of this investment and it is doubtful that the fund will earn a total return of 17% for the next year, the current yield is very attractive vs. other fixed income alternatives. The fund enjoys the highest Morningstar rating and again, the manager has a significant tenure to manage in different interest rate environments.

Pimco Commercial Mortgage Fund (PCM)

This fund is also considered an intermediate term bond fund, but it invests primarily in bonds secured by commercial properties (office buildings, apartments, shopping centers, etc.). Because of the secured nature of the bond investments, the bonds are more highly rated and this fund presents the least credit risk of the three funds discussed here (explaining its somewhat lower yield and total return for the last year). This fund is also well diversified with current holdings in 110 issuers.

  • 2/13/03 close: $14.54/share (2/13/02: $14.29/share)
  • Last dividend: $0.094, pays monthly. Current annualized yield: 7.76%
  • Last 12 month yield: 7.75%
  • One year total return (dividend return plus gain or loss per share): +10.22%
  • Hi/Lo last 12 months: $15.21/10.22
  • Fund market capitalization: $161 million
  • Morningstar Rating: 5 Stars
  • Manager tenure: 10 years

The total return of this fund over the last year was over 10% and the current yield is an attractive 7.75%. Again, one must be aware of the impact of rising interest rates on total return. This fund also enjoys the highest Morningstar rating of 5 stars and the manager has managed through different interest rate environments.

The three bond funds have been used in Lakeview’s portfolios in approximately equal weights, adding further diversification. For example, an investment of $25,000 in these bond funds would result in an investment of about $8,300 in each fund. The blended current yield of the three funds would be about 8.75%. While these investments have been the better performers in the portfolio in the last year, I do not expect the same total return for the next year. However, the yields remain very attractive and these funds remain in the portfolios.

As stated last month, equities will ultimately provide more return than bonds or bond funds. In this difficult environment, it is important to focus on companies that are able to grow because of unique business strategies or because they are in areas of the economy that are strong. Below, three companies are highlighted from Lakeview’s portfolios that are doing very well even though the stocks of these companies are flat to down from one year ago (and down from their 52 week highs).

Alliant Techsystems (ATK) 2/14/03 close: $51.04

ATK manufactures weapons and ammunition and provides related services, primarily to the US government. In February 2002 the stock was trading about $60 and the 52 week high was about $75.

The stock was hit recently because ATK makes rocket propellant for the Space Shuttle. For the 3rd quarter ended 12/31/02, the company announced earnings of $0.91 vs. $0.63 in the year earlier period, for an increase in earnings of 44% on a revenue increase of 12%. ATK is benefiting from increased sales of munitions. The “geopolitical” situation of the world is currently unsettled and it is not clear when it will again be settled.

Dell Computer (DELL) 2/14/03 close: $25.77

Dell manufactures computer systems. In February 2002 the stock was trading around $24 and the 52 week high was $31.06. For the 4th quarter ended 1/31/03, the company announced earnings of $0.23 per share vs. $0.17 for the year earlier period, for an increase in earnings of 32% on a revenue increase of 21%. Dell has been aggressively cutting costs and adding products and new markets. Despite the worldwide decline in technology spending, Dell saw its unit shipments increase 25% in Q4, and expects another 25% increase in the next quarter. It should be interesting to see how Dell responds when technology spending resumes to more normal levels.

First Data Corp. (FDC) 2/14/03 close: $32.65

FDC moves money: Some $2 trillion per year. In February 2002 the stock was trading around $33.50 and the 52 week high was $45.07. The company provides processing for credit cards, and its Western Union subsidiary allows consumers to wire funds to over 100,000 locations in 186 countries. For the 4th quarter ended 12/31/02, the company reported per share earnings of $0.48 vs. $0.41 for the year earlier period for an increase of 17% on a revenue increase of 18%. FDC is benefiting from technology advancements in the transfer of money and a global economy that is increasingly interconnected.

I could give more examples, but the point is to buy good companies and be less concerned with where “Mr. Market” is currently setting the price of the stock. Stock investments should have at least a three year, and preferably, a five year horizon. At some point in the next three to five years, Mr. Market will likely place a much higher valuation upon these successful companies. In the meantime, they are demonstrating significant success in a tough environment.

© 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.

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

Ray S. Goodner, CFA, Private Investor, 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

Jim Walline, CFA, President, Walline Capital Advisors, LLC, formerly Vice President and Portfolio Manager, Thrivent Financial Services

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.

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