INSIDE FINANCE:
The Market Gave No Quarter


By Robert M. Jaffe, MBA, AAMS
May 6, 2005

The First Quarter 2005 has departed with no tears shed. The global situation, year-to- date, although not a cause for tears, has been no friend to the markets. We still face the "triple threat" …the price of oil, terrorism and turmoil in the Middle East, and concerns over the fluctuating value of the dollar tied to the twin deficits - the U.S. federal budget and the current-account (our imbalance of trade).

The first quarter 2005 performance was disappointing with the major indices closing in negative territory: The Dow -2.59%, NASDAQ -8.10%, and the S&P 500 -2.59%. (The Wall Street Journal, 4/1/05). My sense is that this year will produce single-digit returns. That is not to say that we could be surprised on the upside, but given the current environment, I believe this is a realistic expectation. In my opinion, these are the leading causes.

1. The Middle East and the Specter of Terrorism - The U.S. has increased its efforts to thwart further attacks through Homeland Security and restructuring federal agencies, but the results have yet to be tested. Iraq continues to be a drain on the budget as it democratizes, and we can only hope that the insurgency will be put out of business in a timely fashion. Part and parcel is the Israel/Palestine conflict, the Iranian theocracy and Afghanistan.

2. The Price of Oil - All of the forgoing keeps oil prices high and markets edgy. High oil prices impact consumer spending which in turn may slow economic growth resulting in lower corporate earnings and profits. Nevertheless, our economy continues to expand. Fed Chairman Greenspan opines, "higher prices eventually should soften demand for energy and boost supply." (WSJ -4/06/05). I subscribe to the theory that (Economics 101) higher commodity prices lead to inflation and therefore higher interest rates.

3. The Twin Deficits - A learned friend and client, a highly respected consultant to the chemical industry here and abroad, puts it this way. He states that our largest exports have been chemicals and pharmaceuticals, and 95% of our chemical production for the past 20 years has been from petroleum and natural gas. Our natural gas reserves have pretty much dried up, and it has become uneconomical to produce from petroleum at current prices. Our exports in the field have dwindled, thus contributing to the huge current-account deficit, now approximately 6.3% of GDP (WSJ-4/6/05). Foreign investors are holding trillions of dollars of dollar-denominated reserves - liquid U.S. government securities, corporate bonds and stocks. So even though the dollar is cheap in relation to the euro, the yen and the British pound, we're buying a hell of a lot more than we're selling, pouring more dollars into foreign banks.

Now to other terrible twin, the federal budget deficit currently about 3.5% of GDP (WSJ-4/6/05). The government is spending more than it is taking in due to a number of factors, utmost of which are the tax cuts of 2001, financing the war as well as a host of entitlement programs. Bottom line, the combination of the "twins" tends to make foreign investors cautious, both banks and individuals, which could result in less confidence in the U.S. market in the short-term. This is where it hits you and me. If foreign investors diversify out of U.S. holdings their market value could decline leaving us with less in our portfolios. Much to ponder, but keep in mind, these are the sort of events markets have experienced for centuries and survived with flying colors in the long run.

Please Email bob@cfsias.com with your questions.

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INSIDE FINANCE will appear regularly, addressing financial matters of interest to our readers. Any questions? Email bob@cfsias.com

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member NASD/SIPC. Cambridge and CFS are not affiliated.

The preceding article is for informational purposes only and should not be used as the primary basis for an investment decision. Indices mentioned are unmanaged and cannot be invested into directly. Past performance does not guarantee future results. All examples given are hypothetical and do not reflect actual investments. The views expressed in this article are those of the author and are not necessarily those of Cambridge. Bob Jaffe is Managing Director of CFS Investment Advisory Services, LLC in Totowa and has been a Clifton resident since 1984. Active in community affairs, Bob is Past Board Chairman of the North Jersey Regional Chamber of Commerce and a member of its foundation board. He serves as a commissioner on the Clifton Rent Leveling Board and the Committee for Individuals with Disabilities. He is Vice President of the Clifton Rotary Club. Representatives of Cambridge do not offer tax or legal advice. Consult a professional for your personal situation.