The financial markets delivered patient investors substantial growth in 2006 after bouncing back strongly from mid-year volatility. Almost all segments of the markets ended the calendar year with a strong fourth quarter rally, resulting in a very happy holiday season as measured by portfolio results. The Dow Jones Industrial Average closed the year at 12,463.15, up 7.39% for the quarter and 19.04% for the year. The broad market, as represented by the S&P 500, finished at 1,418.30, up 6.69% for the quarter and 15.78% for the year.1
While the factors impacting market performance can be varied and numerous; it is clear that a key catalyst to this rally revolved around the decision by the Federal Reserve (“the Fed”) to leave rates unchanged at 5.25% during the second half of the year. In addition, corporate earnings growth showed double digit gains for fourteen straight quarters with a 2007Q1 current projection at 10.03%.2
Finally, oil futures finished the year at $61.05 per barrel, dropping from $62.91 at the end of the third quarter and remaining practically unchanged from the $61.04 price recorded at the end of 2005.3
During the fourth quarter, all equity and fixed income indices posted positive returns, led by the MSCI-EAFE Emerging Markets Index with a total return of 17.64% for the period.
Within the U.S. equity markets, small-cap stocks outpaced large-cap stocks, and Value continued to outperform Growth in both the large-cap and small/mid-cap segments. In the International spectrum, the MSCI EAFE Index (a proxy for developed international markets) gained 10.40% in the quarter. The U.S. Dollar continued to show weakness against the Euro, down 11.33% for the year with a loss of 3.94% for the quarter; while appreciating versus the Japanese Yen in 2006 by 0.80% after a 1.19% recovery in the last three months.4
The bond markets slowed their pace during the fourth quarter of 2006, as the Lehman Aggregate Bond Index returned 1.24% versus a previous 3.81% during the third quarter of the year. During the fourth quarter, U.S. Treasuries experienced an increase in yield, with the 10-year note moving to 4.70% from 4.63% and the 30-year bond moving to 4.81% from 4.76% in the previous quarter.5
Inflation for the month of November, as measured by the Consumer Price Index, was 2.0%, while the forecasted figure for December is estimated to be near 2.2%6. This level is beginning to stretch beyond to the Fed’s traditional comfort zone for the inflation measure, which is typically defined to be within a range of 1 – 2%. Unemployment, as measured by the jobless rate released by the Bureau of Labor Statistics in November, rose to 4.5% from a previous five year low of 4.4% recorded in October.
November 2006 was marked by mid-term elections in the U.S., and while it is hard to predict the longer-term impact the election results will have on the economy, it is reasonable to assume that with Democratic control of the House and Senate, tides of change may be on the horizon. At the same time, 2007 marks the third year of President Bush’s second term in office. Since 1945, stock prices have posted their best performances in the third year of Presidential cycles, rising 18% on average (versus an average of 9.0% for all four years).7
As we start a New Year, we remain confident in the strong capabilities and resources dedicated to the ongoing monitoring and management of your portfolio. As always, we welcome and look forward to the opportunity to spend time with you to address your unique financial goals.
1 Source: Wilshire Associates. These figures represent “Total Return” with dividends reinvested, which means the return includes not only the change in price for the securities in the index, but any income generated by those securities
2 Source: Bloomberg as of 12/29/06
3 Source: Bloomberg. Ticker symbol CL1.
7 Standard & Poor’s – Past performance is no guarantee of future results.