The 2006 investment glass will be half empty
I’m an optimist about most things in life, which includes the long-term performance of investment markets. Last year at this time, I was cautiously optimistic about 2005.I decided then that it would be a reasonable bet to see a 6 percent gain for the Standard & Poor’s 500 Index after an 8 percent gain in 2004. For the other broad-market index, the Wilshire 5000, I saw a gain of 7 percent for 2005 compared to 10 percent in 2004.My projections were on the low-side of most forecasters. As often happens, the 2005 markets behaved differently than that forecasted – the S&P 500 came in with a poor showing of +3 percent and the Wilshire 5000 did only slightly better at +4.6 percent for the year. At least we were on the plus side; but if we factor in inflation of 3.6 percent (estimated) for 2005, the S&P 500 was, in real terms, under water and the Wilshire 5000 only slightly above. Not a bad year for the averages, but certainly nothing to cheer about. Hopefully, some of your equity investments beat the averages. For fixed-income investors it was a very painful year. Bond yields hardly moved, and stayed in a very low-rate range throughout the year. None of the intermediate corporate or government bond indexes finished above the 2.77 percent total return mark in 2005.So what’s going to happen in 2006? The consensus forecast of the Wall Street Journal’s annual survey of 56 economists is for a “fifth year of expansion, at a slightly reduced pace.” Inflation is to be “tame,” somewhere in the 2.5 percent range. The benchmark 10-year Treasury note is expected to remain below 5 percent.These relatively benign indicators provide a moderately positive environment for investors. Even though the bull market is into its fourth year, and may be getting a little tired, the majority of equity investment forecasters still see room for some gains in 2006. At worst, they see a meandering, flat year for stocks.Fixed-income returns in the intermediate to long-term markets should improve, however, the behavior of interest rates at the long-end of the market still remains somewhat of a mystery. Long-term rates seem stuck at historical lows. From a comparative risk-return perspective, short-term interest rates look more attractive.Before I get to my “bad news” scenario, please remember that we are only talking about one year. Let’s not forget about the very positive three-year (2003-05) annual average returns we just pocketed. Also, there are some of us (value investors) that look at a down year as a good time to buy some equities at below market value. I’ll mention three events that are likely to have a negative impact this year on financial markets. The situation in Iraq will evolve from its present low-level civil war status into political and economic chaos. For the record, the Iraq issue wasn’t on any forecaster’s radar screen. Apart from the loss of life, the economic consequences for Iraq and the United States (is anyone else going to help us?) will be financially burdensome beyond present expectations.Our problems in Iraq will exacerbate government spending rates and a burgeoning public debt, both of which are out of control. Lastly, the lack of reform of Social Security, Medicare and other entitlement programs means that the budget deficit just keeps growing.The title and content of respected Wall Street executive and former secretary of commerce, Pete Peterson’s book, “Running on Empty,” says it all about our public finances. Is 2006 the year when the tank goes dry? If so, the proverbial glass, in terms of investing, will just be plain empty. The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing and an independent registered investment adviser. Loth can be reached at 328-5591 or email@example.com.Vail, Colorado
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