August, 2005 Investment Letter

Periodic Investment Letter August

August, 2005

Dear Investors,

In spite of a national economy, which is showing little or no luster at the moment, for those of you whom I represent, your stock, bond and mutual fund portfolios continue to inch forward at rates which exceed money market rates of return. Yet, the U.S. Federal Reserve Board is definitely applying its brakes to the prospects for growth, namely through increasingly more and more onerous interest rates on the money it charges its member banks for the overnight use of funds, AKA the federal reserve rate.

The impact of this continues to ripple through the economy in terms of rising interest on consumer debt, as well as longer term mortgage rates. Another factor which is affecting longer term rates is the fact that China has recently decided not to use the U.S. dollar as the sole benchmark for its own currency valuation. It has gone to a basketful of currencies approach without disclosing the nature of mix of the currencies in the basket, except to say that the U.S. dollar is a strong component.

With an enormous and ever growing balance of trade deficit, the only thing that has saved the U.S. dollar from plunging to incredible depths is the extent to which other nations have decided to buy dollars to stabilize their own currencies and/or invest in U.S. treasuries and other debt instruments. This break with China on the dollar represents an early fissure. Taken alone it is not expected to amount to much. If on the other hand, it’s the beginning of the end for the dominance of the U.S. dollar as the major world trade currency, this could have devastating effects on the economy, the likes of which has not been seen in modern times. From what I can tell, the “smart money,” does not think this is the case.

My best guess is that the ultimate plunge is somewhere in the time frame of years to decades away, but just as certain to menace our economy in the future as a rock thrown in the air will eventually plummet to the ground. As one of my flight instructors was fond of saying, “Everyone is always worried about getting back down to the ground. I don’t get it. Everyone who ever went up came back down.” So it is with the U.S. dollar.

Just as certainly in the history of the world, the U.S. balance of trade must one day approach equilibrium. It can’t continue to spiral out of control forever. There will come a time when the world will say, “Enough! You can keep your dollars.” When that happens you don’t want to be long in the market. It could happen abruptly and without warning.

Having said all that, prudence seems to dictate that what we should expect in the near term is what we’ve been getting for months—lackluster, albeit stable, returns. The challenge is to pick and choose among available faire for the best bargains and opportunities, a growing challenge. In fact, for the fist time in over a year, I’m thinking that it’s time to move more toward cash, or near cash—such as money markets, as a parking mechanism to wait on the sidelines for better opportunities to present themselves. Bond returns have fizzled to lackluster levels in the past month.

As interest rates rise, which they seem bent on doing, per the Fed’s guidance, the return on bonds will become more favorable and may become “interesting” again, as they were a few months ago. However, at present, market ambiguities, mixed growth vs. slow down signals and an abundance of capital in the marketplace, which is being underutilized for productive purposes, has caused bonds to stagnate as well. Therefore, other than taking steps to further balance a relatively young portfolio, I would say that standing pat would be the wisest course at present.

That’s the way I see things at present.

. . . . . . For a longer term prospective, I’m working on a book, entitled The Truth About Investing, which I project for completion this spring, 2006. If you would like to ensure that you receive all published periodic investment letters for the next six months, and become an eligible test reader for this book (most likely seeing all or part of it prior to completion) you may enroll as a qualified test reader for a one-time charge of $25 (plus a small shipping fee) by pressing the button to follow.

Sincerely, Dan O’Connor

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