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Lakeview Investment Advisors, LLC

Commentary Date: Winter 2005

by Bill Westhoff, CFA

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Lake Views

Lakeview Update: Personal Update

We are back in Arizona to enjoy the warmth and sun; however, the weatherman is playing tricks on us as this is the year to replenish the draught-depleted reservoirs. The Devil in the White City, by Erik Larson was our companion for part of the return trip, and I recommend this fascinating tale about the 1893 World’s Fair in Chicago. We also traveled to Hawaii in January and again enjoyed the sea breezes and flowers in Kona on the big Island. Ruth’s Christmas present to me was a bike tour on the island of Hawaii. This was a great opportunity to see the sites up close and personal, but it was a real wake-up call on the need to train seriously to complete the eastern leg of the bike ride across the United States (see What’s New for photos from the trip).

For this who have wondered: yes, my riding partner, Bill Melton, and I do plan to finish this adventure. We intend to depart Minneapolis in mid May and finish in Bar Harbor, Maine. The ride will again cover approximately 2,000 miles. Thanks to sponsors of last year’s ride to raise funds for the American Lung Association of Minnesota. ALAMN will again provide regular updates; so watch for a separate update on details.

Market Performance—2005 YTD (February 28)

The chart below shows the performance of various indexes through the end of February 2005. Other market statistics are included (it is early in the year to draw many conclusions from market performance).



YTD change

Dow Jones Industrial Average 10,766.23 -0.16%
NASDAQ Composite 2,051.72 -5.69%
S&P 500 1,203.60 -0.69%
Russell 2000 (small stocks) 634.06 -2.69%
MSCI EAFE (Europe, Australia, Far East) 1,548.60 +2.19%
DJ World (ex. US) 177.57 +2.81%
Nikkei 225 (Japan) 11,740.60 +2.19%
DJ Corporate Bond Index 186.32 +0.24%
Lehman Bros. Aggregate 1,108.94 +0.02%
Merrill Lynch High Yield Bond Index    
10-year Treasury Note (Yield) 4.38%  
3-month Treasury Bill (Yield) 2.73%  
Euro (Currency in US dollars) 1.3243  
Japanese Yen (Currency in US Dollars) 104.54  
British Pound (Currency in US Dollars) 1.9223  

Source: Wall Street Journal 3/1/05

Valuation Statistics


5 yr. High/Low

Price to Book Value - DJI 4.18 7.55/3.45
Dividend Yield - DJI 4.36% 4.36%/1.28%
S&P 500 P/E (Argus Research) 18.1x NA
52-Week Highs & Lows (8/2/04) 494 vs. 93  
Public/NYSE Specialist Short Sales 1.69 2.58 (8/13/04) / 0.69 (3/17/00)

Source: Investors Business Daily 3/1/05

While the Federal Reserve continues to increase short term rates, longer term interest rates (10 to 30-year bonds and mortgage rates) have continued to be very well behaved. In fact the gap, or yield differential between 2-year treasury notes and 10-year treasury notes is only 0.75%—a four-year low. This differential was over 2.5% in late 2003. Bond market participants watch this 2- to 10-year yield spread closely and describe this process as a “flattening of the yield curve.” Historically, a “negative yield curve” (where short term interest rates exceed longer term yields) has signaled a recession. Personally, I believe it is too early to be concerned about recession; but this factor is worth watching.

Other measures of market valuation and sentiment show a market that has been consolidating significant gains in late 2004. The month of January turned in negative returns, and many market pundits have sought to remind us that a negative January often portends a negative year. The market P/E of around 18X is somewhat above the long-term average of about 16X. The dividend yield on the Dow Jones Industrial at 4.36% is at a 5-year high, indicating attractive value versus recent history. With continuing low interest rates and higher than average P/E ratios, stocks possessing an attractive dividend yield and the capacity to increase payouts further may be an interesting area for research.

Long-Term Market Returns

A recent report from Jim Walline, a member of Lakeview's Advisory Board, touched on 5- and 10-year price returns (dividends not included) of various popular market indexes. We all tend to remember the recent past most vividly. Although the market has produced good returns in the last 2 years, the three-year bear market from 2000–2002 was so significant that 5-year returns for the Dow Jones Industrials, the S&P 500, and the NASDAQ are negative. Thus, it is not surprising that many commentators describe the concept of private accounts in Social Security as “risky.”

  Dow Jones Industrials S&P 500 Index NASDAQ Composite S&P Mid-Cap Russell 2000
5-year average -1.27% -3.78% -11.78% +8.33% +5.24%
10-year average +10.89% +10.19% +11.21% +14.62% +10.04%

What caught my attention is how the long-term returns (10 years) have stayed in the 10% plus range, even after the worst bear market since the great depression. After reading Jim's Perspectives, I then saw an op-ed piece in the WSJ by Burton G. Malkiel titled, “‘Social Insecurity?’ Hardly.” While the purpose of the piece is to support the concept of “private accounts” in Social Security, the historical perspective on market returns is very interesting.

Mr. Malkiel's research covers an even longer time frame. He points out something we have witnessed over the last 5 years: the stock market is very volatile.

“From March 2000 to October 2002, S&P's 500 index lost over 40% of its value. In October 1987, the market declined by 20% in a single day (it was the 19th, I remember it well). But long-term holders of common stocks in the U.S., who have accumulated their holdings over time, have always earned generous rates of return.

From 1926 to the present, annual rates of return from the stock market have ranged with a rough band of negative 40% to positive 50%, with the average just over 10% (emphasis added). Clearly, an investor cannot count on a positive stock market return in any single year. But consider an investor who can put retirement money in the stock market for 25 or 30 years. For all 25- and 35-year investment periods from 1926 to 2004, investors have always earned positive rates of return. That was true even of investors who put their money in the market at the 1929 peak, just before the Great Depression. The worst return for a 25-year investor starting in 1929 was about 6%. For a 35-year investor, it was about 8%.”

He goes on to point out those investors who make periodic investments (i.e., dollar cost averaging), the lowest 35-year return over this period was still close to 10%.

Regardless of the political purposes of the article, the statistics clearly show the value of stock market investing over long periods, having patience to ride through the soft spots, and to continue to commit new dollars during these weak periods.

Economic Outlook

The gross domestic product (GDP) will likely grows again in a range of 3.5–4.0% for 2005. Many economists see economic growth slowing moderately from the growth rates of 2003 and 2004. Those who see economic growth staying around 4% point to faster business spending and improved trade numbers providing a boost to growth in 2005. Stimulus from fiscal and monetary policies in 2003 and 2004 worked well to minimize the impact of the recession and encourage economic growth. While new stimulus is not likely, the budget deficit and the level of interest rates are still supportive of economic expansion.

But changes are occurring on this landscape—although interest rates remain attractive, the Federal Reserve has increased short term rates markedly and is committed to further upward moves. Congress will debate making certain previous tax cuts permanent; but additional cuts beyond the current rates seem unlikely in the face of large budget deficits and continuing special appropriations for the war in Iraq. Large budget and trade deficits and low interest rates served to reduce the value of the dollar in 2003 and 2004. This has helped increase farm and some manufactured good exports and will continue to aid these sectors in 2005. At some point later this year or early next, the rising level of short term rates will probably cause the dollar to firm. Unless some new form of stimulus appears on the horizon, the factors that pulled the economy along in recent years will diminish in importance over the next two years.

Market Outlook (Current stock view: +, moderately positive exposure to stocks versus the benchmark)

We did get the anticipated year-end rally, and I still see stocks performing better than bonds again in 2005. However, my level of caution is rising. As we move to the next quarter, I anticipate changing my outlook to a “neutral” weighting vs. the benchmarks. I believe it is appropriate to start reducing stock exposure as the stock market moves higher and implement a more conservative strategy over the balance of the year. The proceeds of stock sales should go to cash reserves, rather than in bonds.

As stated above, sources of economic stimulus will decline this year and while corporate profits are again expected to increase, the rate of growth should be reduced from the prior two years. Long-term bond buyers are either incredibly stupid or perhaps right in anticipating a slow-down in the economy. The return on idle funds (cash) is increasing. While I like being optimistic, I think many signs are encouraging a gradual move to a neutral bet versus the benchmarks.

To avoid sounding too cautious, I include a quote below from another op-ed piece in the WSJ of February 14, 2005 by Arthur B. Laffer (a well known Supply-side economist): “The 10-year T-note yield is near 4%, and inflation is nowhere to be found. Productivity is high, and unemployment at 5.2% is low and falling. Tax rates on capital are at the lowest levels in my lifetime, and markets are more transparent than they have ever been.”

Security Selection

Meridian Growth Fund (MERDX) and Meridian Value Fund (MVALX): These two funds in the Meridian Family have excellent records, and each have a 5-star Morningstar rating.

Both funds have attractive characteristics in common with previously highlighted funds. First, Meridian Growth has been managed by Richard J. Aster for over 20 years. Aster is the founding partner of the management company that manages the fund. Richard F. Aster, Jr. has managed the Meridian Value fund for over 10 years.

The stock-picking style of style of the Asters has worked well over long time periods; for a ten-year period, Morningstar rates Meridian Growth fund as having below average risk, but high returns, relative to its peers. Over the ten years ended 12/31/04, MERDX has shown an average annual return of 14.5%, exceeding the average annual return of the S&P 500 by 2.45% per year, and ranking in the top 9% versus its peers in this time period. Over the last ten years, the Meridian Value fund has an Average risk rating and High returns, relative to its peers. For the 10-year period, the average annual return is 21.0%, exceeding the average return of the S&P 500 by almost 9% per year over this period and ranking in the top 1% versus its peers. Of course, past results are no guarantee of future returns.

In summary, the Meridian Funds have demonstrated a well executed philosophy, which has resulted in an excellent record for both funds. In addition to Meridian’s website, I have selected the websites for Ariel funds, Leuthold funds, and Third Avenue funds. Each of these funds was selected for their unique styles and strong historical performance. The websites offer insight into their unique styles and interesting commentary on the market.

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.

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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