TREES INVESTMENT COUNSEL VIEWPOINT (Q4 2005)

 The time has come.  While the economy has been chugging along at a more than reasonable pace, we have to admit our posture is now turning cautious.

"How can this be?" you may ask.  Being an intelligent and well read individual, you know that economic indicators have been strong for some time.  The US economy is essentially at zero natural unemployment with the low rate of 5.0% joblessness.  Additionally, GDP growth has averaged approximately 4% for the past 2 1/2 years, significantly higher than the norm of 2-3%.  We have mild inflation and low interest rates, both encouraging signs.  Moreover, corporate America seems to be in excellent shape with solid balance sheets and cash to invest in the future.

This is not the whole picture, of course; there are overhanging issues.  The yield curve is flat, which some fear is an indicator of a recession, and oil prices remain high.  Furthermore, the consumer, the champion of growth and the largest contributor to GDP, is bound to slow spending now that the refinancing cash out spigot is off.  This is our biggest concern.  With consumer spending accounting for approximately 70% of GDP, we doubt that the remaining 30% (business investment in capital, government, and the difference between exports and imports) will be able to make up for the slowdown/decline in the consumer.  Nonetheless, the American economy never ceases to amaze and we are not entirely downbeat, just cautious.  Either as a result of a slowing economy or an unforeseen external event (terrorist, mother nature, etc.) we would not be surprised to see a 10%+ decline in the stock market.

 Following our intuition, we have decided to make some modifications to your portfolios.  With lower than historical market return expectations (mid-single digits) and 10-year Treasury rates just above 4%, we see little opportunity cost to holding cash.  Money market returns are now 3.5-4%+, up from less than 1% a little over a year ago.  In equities, we have cut back areas where we have experienced strong growth that has pushed our industry exposure far beyond industry averages (materials) and taken opportunities to exit holdings where we are less confident.  We are also less aggressive about putting money to work in bonds, especially at the long end, since there is little additional yield in most cases and if rates are to go up more, as many suspect, bonds will naturally decline in value.  So when you look at your portfolios, you are likely to see a little more cash than is typical.  We feel the current risk reward warrants some dry powder to take advantage of future opportunities.

M. Jay Trees
Jackie E. Moss
January 24, 2006