The 2006 market – looking backward and forward
Six months ago (January 12) in this column, I took a look forward at the investing environment for the coming year. Here’s a synopsis of what I had to say:”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, 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. During 2006, the situation in Iraq will evolve from its present low-level civil war status into political and economic chaos. Apart from the loss of life, the economic consequences for Iraq and the United States 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.”For the most part, this six-month old perspective still appears to be valid. However, the inflation rate for 2006, as yet, doesn’t seem to be as “tame” as originally expected. And, long term rates – mortgages and treasuries – have moved up considerably over those predicted at the beginning of the year. Generally, neither inflation nor higher interest rates are good for the stock market.The real concerns of objective observers of investment markets are not just related to what happens to the economy, interest rates, and inflation. Yes, these can be problematical for investors, but they’re a regular part of the investing business.The Wall Street Journal’s Alan Murray (January 12) targets what corporate leaders, of all political persuasions, are increasingly more concerned about – “the government’s failure to act on pressing problems,” which is creating headaches for businesses and “compelling them to act on their own.”He suggests that we should “expect to see more of this disconnect in the future. In today’s complicated global economy, business needs a strong, functioning government that can effectively address a host of important issues, including fiscal and health-care policy, pension policy, trade and currency policies, and intellectual-property right protection.”A key message for investors is Murray’s view of our national political leadership as, “anti-pragmatists;” they spend their time trying to score debating points for the next election. “If Washington can’t effectively address them [the issues mentioned above], business and the economy will likely suffer.”Right now the investment community is obsessed with the Federal Reserve’s interest rate policy, the direction of the economy, and inflation. While action on these issues is important, the really big issues of government fiscal responsibility, funding entitlement programs, and a coherent energy policy are the ones that are going to be determinative of a positive investment environment in the long run.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing, an independent Registered Investment Adviser. Mr. Loth can be reached by emailing firstname.lastname@example.org or calling (970) 328-5591.
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