The Fed is targeting inflation and starting to become concerned with recent rises in PPI and CPI. They have made it known that they are targeting a CPI rate of 1.5% to 1.75%. Let us hope that they are successful at achieving inflation in this range for many years to come.

Many problems may beset the economy, but few are as insidious as inflation. We should strive to avoid a rise in inflation and in inflationary psychology because such a psychology creates large dislocations in economic activity. Hoarding, shortages and price gouging are just a few of the many effects of inflation.

The Federal Reserve has given clear signals that interest rates will rise about four more times in 2005, bringing the Federal funds rate up by 1/4 % each time. Too many rises in short term rates, especially if the Federal reserve is unsuccessful at keeping inflation low, could led to hard times for global stock markets. In that situation, we will raise the cash component of the portfolios, and sell short for those clients who wish to do so.


Amplifying all actions of the Federal Reserve is the upcoming retirement of Chairman Greenspan. If he retires, who will succeed him? How will the markets respond to the new chairman? What type of tests will be visited upon the new chairman? How will he or she respond? The U.S. Federal Reserve Chairman is the most important financial personage in the world. It is of great importance that an appropriate choice is made, and that the individual has the respect of the markets. This respect must be matched by the economic knowledge and insight to lead the U.S. economy in the appropriate direction. He must have the respect of world financial and political leaders to act as coordinator of the response to economic and financial panics and crises.

We will not be surprised to see stock market dislocations if there is an uncertain or inadequate communication about the new candidate and his qualifications.

In summary, the change of Fed Chairmen could have an unsettling effect on U.S., and even other stock markets, if it is handled in an unsophisticated way, or if the market participants see the new appointee as too political.


Intel, the giant U.S. semiconductor company, has announced the production of the first continuous silicon laser to begin late in 2004. The company is a few years away from producing computer circuit boards, medical equipment and communications networks using silicon instead of the crystals currently used. This technology will be much cheaper than conventional lasers and will be a disruptive technology with a positive effect. Keep an eye out for the positive effects of this technology in years to come.


China continues to grow at a rate in excess of 8% per annum. India is growing at an annual rate of over 7%. Much of Asia is benefiting from the growth of these two countries. Europe is growing at a slow rate and the U.S. is growing at a slowing rate, but faster than Europe.

In Europe, there are positives. One is that politicians in Europe have recognized the lack of wisdom of some of their more paternalistic policies. These policies have served to slow economic growth, and have the unintended consequence of diminishing prosperity among the poorest members of society. By discouraging capital formation and economic growth, new jobs are not being created, and the poorest are being hurt by the lack of new employment opportunities.

Recently, most European countries, with the exception of France and Germany, have begun to compete for new business by lowering taxes to attract new business and new jobs. France and Germany have complained, but the others have proceeded, and now France and Germany may be interested in joining the party. Can we expect to see them incentivize new employment in their economies with lower taxes? I believe it is these initiatives that have led to a recent stock market rally in Europe. Another positive is the fact that the U.S. dollar has risen against European currencies this year. This event has reduced fears that Europe cannot compete because of their strong currencies.


U.S. GDP growth will decline, but still be respectable at 2% or 2.5%. Politics will keep budget deficits high for a long time. Everyone is talking about social security as the Republicans try to take away the Democratic advantage that Roosevelt gave them by attracting young people to social security self-investing.

The Republican strategy is to attract young people with social security self-investment and to keep the middle and upper classes in their camp with permanent tax cuts, while keeping retired people happy with a Medicare drug benefit enhancement at the same time. If it passes, it will be very expensive.


Thus far in 2005, European and Indian mid and small capitalization stocks have far outstripped big capitalization companies. This has been the trend in the U.S. for many years. Most of the time, small and medium sized companies do much better than their big brethren.

Much of this is due to the law of large numbers. It is hard to grow by 15% or 20% per year if you have $10 billion in revenues, but relatively easy if you have $100 million in revenues. Big companies often have to make big acquisitions, or many small acquisitions, to grow at a decent rate. Recent studies show that 61% of all mergers undertaken by major companies in the last five years have been bad for the shareholders [as measured by the stock price]. Is it any wonder that small and mid sized companies provide better returns for shareholders?

We have always favored mid and small sized stocks because their valuations are often much more modest and their growth rates are usually much faster than big companies. We continue to have this bias.


China- China has fast growth but much corruption and a very confused and inadequate banking system. Further, the necessary transparency for investment is usually lacking, meaning that financial statements, and pronouncements by management are often incorrect (and not just a little incorrect).

India- Mid sized companies are doing well here. Transparency has increased, but it is still far from ideal. Financial statements are usually accurate, but self-dealing and misrepresentation by managements is still common. It’s ok to invest here, but proceed with caution.

Smaller Asian countries- These vary in their growth and transparency. Korea and Taiwan can be very attractive. The Philippines, Indonesia and Thailand are sometimes attractive.

Europe- Small and mid sized companies in Western Europe can be attractive. Eastern Europe is more problematic. Laws are less solidified but growth can be much faster, often due to outsourcing from Western Europe.

Precious Metals- Precious metals are looking more attractive all the time due to irresponsible moves by major powers. The Dollar has resumed its decline and gold will rise substantially.

Energy- Our major theme for years and remains a big part of our strategy. Two types of vehicles are:
1. U.S., European and Canadian listed companies with growing reserves.
2. Income producing energy trusts, and pipeline companies with good and growing income payouts.

Small companies- Look for ones in fast growing economic sectors. For example, diet and nutrition, medical technology, software, Internet services, energy services are attractive areas.

Foreign currencies- the Swiss, Norwegian, British, Australian, Canadian and Euro currencies all will rise as the U.S. budget deficit inexorably rises, and the U.S. dollar falls.


We look forward to plenty of investment opportunities over the remainder of 2005. Energy, precious metals and small growth stocks should do well under most scenarios. We believe that the rally in the U.S. dollar is over, and that foreign currencies may offer good profits. The U.S. budget deficits will continue to grow and grow. This is very bad for the U.S. dollar. We see foreign currencies as a major source of profits for U.S. dollar investors. For non U.S. dollar investors, we see short selling opportunities in U.S. and other stocks. We see long positions in energy, precious metals stocks and growth stocks as a major source of profits.

If inflation is in check, we expect Asian stock markets to do well. If inflation heats up, we expect interest rate increases. Rate increases may hurt foreign markets but they could create profit opportunities via short selling.

In the next few weeks, I will be attending several energy and growth stock conferences. Further, I will be traveling to Canada to visit several companies. I had to delay my February trip to China and India due to a bout with the flu but we plan to visit both countries in the spring.

Please let us hear from you with comments and ideas. Thanks a lot.