As we reflect back on 2005, we’re reminded of the numerous tumultuous events that highlighted the year – the London subway bombings, two devastating hurricanes, rising oil prices, the ongoing war in Iraq, higher short-term interest rates, and the appointment of a new Federal Reserve Chairman to take effect later this month. Yet through it all, the US economy continued to grow at a strong pace with an annualized GDP growth rate for the third quarter at 4.1%1, and growth projections for the fourth quarter at a rate of 3.2%2 . Similarly, US and global financial markets shook off much of the bad news, and also delivered positive returns across all categories for the year.
Despite an average rise of 22%3 in gasoline prices during the year, overall inflation continued to remain in check, as the Consumer Price Index, less food and energy rose a modest 2.10%4 for the year through November. The US economy also generated 1,736,0005 new jobs in 2005 and the unemployment rates stood at 4.9%6 in December. Further, industrial production was up 2.8%7 and capacity utilization was up 1.6%8 for the year. All of these indicators point toward a US economy that is continuing to grow and generate new jobs.
The bond markets were characterized by uncertainty throughout much of the year, as the Federal Reserve continued raising short-term interest rates. At the end of the year, the yield curve became slightly inverted as short-term interest rates rose, while long-term rates remained flat. The broad investment grade bond market, defined by the Lehman Aggregate Bond Index returned 0.59%9 for the quarter and 2.43% for the year. High yield bonds continued to slightly outperform investment-grade bonds as the Lehman High Yield Bond Index returned .67% and 2.74% for the quarter and year, respectively.
For US equities, during the second half of the year, we witnessed the re-emergence of growth stocks relative to value stocks. For the first time in nearly five years, growth stocks outperformed value stocks. The Russell 1000 and Russell 2500 Growth Indices returned 2.98% and 2.72%, respectively, as compared to their Value counterparts which returned 1.27% and .92%. This was also a year in which small and mid cap stocks slightly outperformed large cap stocks, with mid cap stocks being the strongest performer. The Russell 2500 Growth & Value Indices returned 8.17% and 7.74% while the Russell 1000 Growth & Value Indices returned 5.26% and 7.05%.
In 2005, a strong case continued to be made for exposure to foreign fixed income and equity markets. The International equity markets posted higher returns than US equity markets for both the fourth quarter and for the entire year of 2005 with the returns for the MSCI EAFE index being 4.12% for the quarter and 14.02% for the year. Within the Developed International Markets the top performer was Japan with a strong 11.86% for the quarter and 25.54% for the year. Those investors who ventured into Emerging Markets found the returns even higher with the MSCI EAFE Emerging Markets Index returning 7.20% for the quarter and 34.54% for the year. Additionally, global bond markets outperformed the U.S. fixed income markets for the year with the Lehman Global Bond Index returning 4.38%. The strong returns generated by these markets demonstrate the importance of retaining institutional investment strategists to construct and manage globally diversified portfolios.
Looking ahead to 2006, the US economy is expected to continue to grow at a solid rate of 3.4%10. While we may well experience new and unanticipated world events in the coming year, which could potentially impact global financial markets, we understand that these uncertainties lie at the heart of investment risk. We also understand that, over the long term, investors are likely to experience superior returns as a direct result of maintaining exposure to the risks inherent in global financial markets. Most importantly, in both good times and bad, investors need to remain focused on their long-term objectives. We believe the highly capable investment management team we have assembled on your behalf can help you navigate successfully through volatile global markets, and maintain your portfolio to meet your long term goals and objectives.
1 Bureau of Economic Analysis of the U.S. Department of Commerce: Gross Domestic Product 3rd Quarter 2005 Final Release, December 21, 2005.
2 Bloomberg Monthly U.S. GDP Forecast of the 60 top economists surveyed by Bloomberg from November 30th – December 8th, 2005.
4 Bureau of Labor Statistics Consumer Price Index Summary Release for the month of November 2005 released on December 15, 2005
5 Bureau of Labor Statistics – Employment Situation Summary for 2005
6 Bureau of Labor Statistics – Employment Situation Summary for December 2005 issued January 6, 2006.
7 Federal Reserve Statistical Release on Industrial Production and Capacity Utilization dated December 15, 2005.
9 For all index returns referenced herein please review the chart of 2005 Q4 Index Returns and accompanying footnotes
10 Bloomberg Monthly U.S. GDP Forecast of the 60 top economists surveyed by Bloomberg from November 30th – December 8th, 2005.