The first quarter of 2005 proved in the end to be rather flat for equity prices as the major market indexes retreated slightly (S&P declined 2.1%) from the oversized gains of the 4th quarter. The growing trend of higher energy prices and interest rates seemed to keep investors in a cautious mood despite the fact that corporate profits continue to be excellent.

Other economic data released this quarter highlighted the burgeoning debate as to how fast the economy is growing; and will the Federal Reserve be able to keep inflation in check without raising interest rates too much too fast, stalling the economy. If you follow these economic events in the mass media it is a bit hard to keep up as one minute they tell us the Fed will need to increase rates faster to fight off inflation and a few weeks later they tell us the Fed will need to stop increasing rates because we are heading into an economic "soft patch". So let me try to filter out the noise.

Here is what I see on the macro economic horizon. Overall the economy continues to be relatively strong, even though it does not feel like it. Interest rates will continue to rise from their historic lows. Energy prices rose with relative significance this quarter but will likely begin to decline in the coming quarters as the pace of global expansion slows a little and recent increases in production capacity around the world will make its way into the pipeline. That being said I expect Energy prices to remain high relative to expectations for the next several years. US GDP growth estimates will decline slightly as it would appear now that 3.25 to 3.50 GDP growth for full year 2005 looks about right. US trade and budget deficits will continue to be problematic for future growth but rather benign in their current market influence. Employment growth and income growth will continue to grow modestly. As I have said before, overall, I think we are experiencing a rather normal moderate growth economy.

On the corporate front, company profits have been impressive and should remain so as companies and workers continue to be highly productive. Corporate balance sheets and cash flows are strong and the global economy is providing a competitive landscape in which to grow businesses. Good companies will continue to generate impressive cash flow that they will use to pay down debt, buy back stock, pay out higher dividends, initiate merger activity, and increase their capital spending, all of which are positive for stock prices if managed effectively. The US equity markets are fairly valued in my view, so in order to deliver better than average returns we will continue to look to those sectors of the economy that are likely to outperform the others, and we will continue to look for companies that are best suited for the moderate growth environment. Companies that have good balance sheets, consistent earnings, strong cash flows, good dividends, some pricing power, and management teams willing to put their cash to good use will likely deliver solid, albeit moderate, returns in this environment.

In talking with clients, other investors, and fellow citizens, there appears to be a growing uneasiness among investors. This negative market psychology is in many ways understandable and is keeping the market fundamentals in check. The world is a complex place these days and the global financial markets reflect this. Citizens and investors alike are trying to figure out where they fit in a rapidly changing global marketplace. In recent years, the stock market has been to extended highs and to grueling lows and back a bit in a relatively short historical time frame and as a result investors are a bit sea sick. When I was a wee lad sailing with my family, my parents would encourage me to focus my vision on the horizon when I was feeling a bit wobbly. I would encourage you to do the same. As always, thank you for your trust and please do not hesitate to contact me if you would like more information about the topics discussed here or if you have questions.