Issue #10

2006 has drawn to a close. What will 2007 bring? A review of ’06 and ’07 predictions too, was a bit too ambitious for Issue #10, so unlike last issue, we will keep both brief.

Reflection: so what happened in 2006. We thought that 2006 would be a strong year in the early months, but weaken as the year went on. Close to the opposite happened. The market was volatile in February, May and June before settling down for an impressive 6 month rally from July-December of more than 15% for most indices.

Bonds moved all over the map, but basically rallied with the stock market the last half of the year and the yield curve inverted. An inverted yield curve is when short term bonds pay more interest than long term bonds. Inversion is abnormal and signifies that the bond market believes that the economy is slowing and that short term interest rates declines are on the horizon.

The major stock indices finished strong, the Dow gained 16.3%, the NASDAQ 9.5%, and the S&P 500 gained 13.6%. Tacking on about 2.2% of dividends on the Dow and 1.8% on the S&P 500 helped to secure 2006 as a bonafide big year for index funds. Active managers were less fortunate and unable to maintain the index beating prowess of 2004-2005. Today the market gave further indication of an economic slowdown as commodity prices, namely copper, collapsed 7.7%. Copper is often referred to as Dr. Copper, as it has historically been a reliable indicator of economic activity, rising when growth accelerates, and falling when economic growth declines.

Predictions for 2007
We trust that most of our predictions will be wildly inaccurate, but gosh, we need to have some fun too! We like to remember that our business isn’t too much different from shooting baskets or hitting a small ball going 90 miles per hour, if we can do it well, 1/3rd to 1/2 of the time, our client’s returns will be very good indeed.

Predictions are inherently macro-economic in nature, and difficult to predict. At the end of 2005 if someone had said that oil prices after Katrina would remain above $60 for the next 16 months and that the stock market would gain more than 15% in that time period, few would have believed it. But indeed, that is what happened.

The first five predictions are likely to happen, the second five are unlikely to happen, but we wouldn’t be surprised if they do indeed happen!

Likely to Occur

Prediction 1:
Exchange Traded Funds:will continue to grow leaps and bounds. 144 ETF’s were launched in
2006. $410 billion was invested in ETF’s at the end of 2006. The trend is going to continue.
From the 400 ETF’s available, the number will grow to 700 by year end. The fallout from this
trend is that do-it yourself investors, and independent financial advisors will have more tools
than ever to more efficiently invest client capital. Hedge funds and ETF’s will continue to provide
increasing alternatives to the mutual fund world.

Prediction 2.
Chindia: Chinese and Indian growth will be pronounced to be slowing – sending commodity and
global markets into broad sell offs – only to see end of year restatements that that growth appears
to have only slowed to 9%-10% from 10.5% in ’06 and 10.2% in ’05.

Prediction 3:
Economy: the U.S. will slip into a mild recession in Summer 2007 after the Fed begins to notice
and responds with a þ pt interest rate cut in July.

Prediction 4:
Energy: oil will tread water between $53 and $70 per barrel but Oil stocks will post 10%-20% gains
while being very volatile.

Prediction 5:
Risk: volatility will return to the markets and investors will again need to get used to 1%-2% daily
price swings.

Unlikely to Occur – but it wouldn’t surprise us if:

Prediction 6:
Hillary: will decide not to run.

Prediction 7:
Gold: will tread water for the first six months of 2007 and break to $800-$1000 in the 2nd Half of
2007 on fears of inflation, recession, and Iraq.

Prediction 8:
Politics: presidential candidates delay entry into the race in order to conserve cash, and see what
the big 3 (Clinton, Obama and McCain) are going to do. But their patience will be costly as some
Governors enter the presidential race outmaneuvering the big 3.

Prediction 9:
Tech: consumers will be offered PC Televisions but have too much trouble networking them initially. Skype will fail to matter much for EBay. Hosted software applications and Internet 2.0 will accelerate, and some cool new things will gain traction (like maybe yackpack – instant voice messaging).

Prediction 10:
Google: something bad will happen along the road to a google-centric world, but not enough for
Yahoo’s sake.

Our next letter will come out around January 16th. Have a great start in this new year!
Daniel Barnes, CFA

Barnes Capital is a Registered Investment Advisor located at in downtown Lafayette. With RB Capital Management, Barnes Capital develops custom tailored portfolios for its clients. Specialized in retirement income portfolios, financial planning in an integral part of our process. Call 925-284-3503.

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