For a year overshadowed by a high level of uncertainty, 2004 turned out to be all about optimism. Investors who stayed the course were rewarded in 2003 and 2004 with the first consecutive calendar years of positive equity returns since 1999. Although many investors were focused on concerns about the outcome of the U.S. elections, geopolitical events in the Middle East, and the fear of rising interest rates, the fourth quarter saw uncertainty give way to optimism, and the equity markets staged a strong year-end rally.
Both the equity and bond markets were reassured by the Federal Reserve, who followed through with their commitment to a slow-and-steady policy of interest rate hikes. The Fed raised rates twice during the fourth quarter (five times during the year), leaving the Federal Funds Rate at 2.25% at the end of the year. Despite the 1.25% increase in the Fed Funds Rate, long-term rates remained largely unchanged, allowing the Lehman Aggregate Bond Index rate prices to show reasonable performance for the year.
As we move into 2005, two areas to keep a close eye on are the continued weakening of the dollar and growing U.S. trade and budget deficits. Many economists are concerned that a continued erosion of the dollar’s value in 2005, coupled with expanding deficits, could have an inflationary effect on the U.S. economy, which would trigger an increase in long-term interest rates.
An additional factor likely to impact the markets in 2005 will be the continued emergence of China and the rest of Asia as consumers of energy and metals. Both of these sectors were driven higher in the fourth quarter due to increasing overseas demand. Steel and copper prices have increased and crude oil hit an all time high of $55 per barrel in October. Since that high, crude prices have receded by over 20%, but continued demand in the region will likely keep pressure on these markets for the foreseeable future.1
The 2004 year-end rally has given the markets a positive push into 2005. Global events including the tsunami in the Indian Ocean and the upcoming Iraqi elections will give the markets new challenges in the months ahead. With most equity indices providing double-digit returns for 2004, many market analysts are calling for more modest expectations for 2005. We believe that our capable team of Managers and Strategists are well positioned to guide your portfolio through these markets, allowing us to maintain our steady focus on your long-term goals.
1 CNBC Market Dispatches: “How ‘04’s 7 big themes will affect stocks in ‘05” MSN Money website