2004 3rd Quarter Commentary
and Planning Ideas

October 21, 2004

I have enclosed your copy of Caves & Associates’ Market Review for the third quarter of 2004.  The review highlights continued slippage in returns of equities markets. Mildly negative returns for global stocks resulted from considerable uncertainty regarding global investment fundamentals, energy prices, Fed policy, the outcome of the U.S. presidential election, and Iraq .  On the flip side, bonds provided unexpected and surprisingly good returns as the strength of the global economic recovery was put into question (an overheated economy is bad for bonds, and vice versa).  The backside of the Market Review is a table of global investment returns for the summer quarter and year to date for nine months ending September 30.  A usual second enclosure has been omitted.  The “Economic Review and Market Perspective” provides a longer-term interpretation of current economic and market data and will be provided after yearend.

I have often stepped on my soapbox to advocate the need for broad diversification and proclaim the futility of market timing.  Also, Caves & Associates discourages focusing much attention on short-term investment results because a broadly diversified portfolio is structured for the long-term.  As we often state, there is no way to completely eliminate short-term risk from an investment portfolio.  As you review the data, think in terms of markets (plural), not “the market.”  You will notice that typically at least some part of your portfolio is providing positive results.  The third quarter’s results again illustrate the value of diversification and the difficulty of forecasting the performance of a particular asset category.

Our near-term outlook has moved from cautiously optimistic to guarded because of concern about the economic environment, the outlook for corporate profits, and the sideways (and even downward) trend of the U.S. stock market.  Over the longer-term, a number of global economic imbalances need to be resolved.  We have confidence that the resolution, though difficult, will not preclude reasonable returns in global financial markets. In somewhat of a paradox, the challenges for stocks should continue to provide the basis for acceptable future returns for bonds by diluting upward pressure on interest rates, as occurred last quarter. 

Nonetheless, it is impossible to consider every possible cause and effect with regard to markets.  Thus, we believe the more useful approach is to maintain a broadly diversified investment plan customized to your specific time horizon which can meet your investment objectives over a variety of potential scenarios.

Next, I would like to repeat what I said three months ago about the importance of reserves and good personal fiscal management.

In addition to maintaining broad diversification and discipline, we can’t overemphasize the importance of maintaining adequate reserves for all potential needs to withdraw from your portfolio.  These reserves should be invested for maximum capital preservation and should cover known needs such as cars, weddings, home remodeling, and on-going cash withdrawals (typically in retirement) as well as unknown needs (i.e., provide a general/emergency reserve).  We also encourage debt reduction and avoidance of variable rate debt (credit cards, home equity lines, and first mortgages that do not have a fixed rate).  Additionally, it is a good idea to assess and reduce expenditure levels (tighten your belt a little) and avoid relying on overly optimistic retirement planning assumptions.  Finally, return expectations should include an understanding that periods of increasing interest rates can be bad for both stocks and bonds.  We note that strong bond returns in 2002 were a great benefit for overall portfolio results in a year in which stock returns nose-dived.  Going forward, we need to be prepared for a “double whammy” at times, when positive returns for bonds may not be available to mitigate the inevitable rough patches for stocks.  At such times portfolio returns may be even worse than experienced in weak markets over the last few years and decades.  Reserves allow us to avoid selling at these inopportune times.

1.  The window for advantageous refinancing remains wide open, thanks to the bond market uptick.  
     If you have a variable rate loan, or a fixed that becomes a variable in a few years, now is the time 
     for action.

2.  No-load variable annuities have very limited application, but they can be a desirable portfolio addition
     for a younger, high tax bracket investor who has already maximized all other tax advantaged  
     investment opportunities.

3.  Work may hold one key to a longer life, and a quest for early retirement may be chasing the
     wrong dream. So reports Tara Parker-Pope in her recent Wall Street Journal column Health 
     Matters. A transcription of her June 28th article is enclosed and is strongly recommended reading.

The Blog Department has been overwhelmed by the November elections but will return, when we’ll probably mention again the need for better fiscal management in Washington .

“A wise person is hungry for the truth, while the fool feeds on trash.”

“You aren’t wealthy until you have something money can’t buy.”

“Investing is simple, but not easy.”

“Never let your sense of morals prevent you from doing what’s right.”

J. W. Eagan:          

“Never judge a book by its movie.”

“Learn as if you were going to live forever.  Live as if you were going to die tomorrow.”

In conclusion, we are providing these materials for your information and as a means to educate and stay in touch.   We hope you find this information helpful, and we would be pleased to hear your comments and questions.  Also, you are welcome to share our views with your family and friends if you think they will benefit.  Remember, these materials are available on our website, www.cavesassociates.net.

Thank you for your continued support of Caves & Associates.

Very truly yours,


Preston S. Caves, CFP, MBA, CFA