FILL’ER UP

We are not running out of oil. Not yet. Cycles of shortage and surplus characterize the entire history of the oil industry. This is the FIFTH time we have run out of oil since the 1880s
- Daniel Yergin, Chairman of Cambridge Energy Research Associates, Inc. (CERA)

Autumn 2006

It has been a lot easier lately to say “fill’er up” at the pump. I think we all feel a little more flush when filling up the tank doesn’t require a small home equity loan. Why have prices dropped so dramatically? It’s probably not that the world stage is any less troublesome. Maybe it’s just that the fear of shortages driving prices up over the last year finally met the reality of supply and demand. More on this topic later in the letter – first, the news from that other unpredictable market called Wall Street.

News

While no gusher, Wall Street’s mood was generally up with the Dow closing above 11,600 on September 20^th for the first time since January 2000! For the quarter, the major indicies were all in the black with the Dow up 4.74%, the Lehman Aggregate Bond Index up 3.81% and the MSCI EAFE (foreign) up 3.42%. September has been the worst month historically for losses in the market (worse than October) even though, the last four months of the year have produced a positive total return in 8 of the last 10 years. So with the S&P 500 up 7.01% through 9/30/06, our feelings about modest positive returns this year look like a reality. ¹

The economic press has had a field day this quarter with competing headlines of whether deflation or inflation is the problem or whether the housing bubble will implode or be a soft landing. You may have also seen or heard news about long term interest rates yielding less than short term rates. This phenomenon is called an “inverted yield curve” and results primarily from the Federal Reserve raising short term rates in order to fight off inflation. Remember inflation? The good news for you is that money market funds are back to earning 4-5%. The not so good news is that an inverted yield curve has been a good predictor of recessions. According to Burton Malkiel, who wrote the popular investing book A Random Walk Down Wall Street, “An inverted yield curve has preceded all recessions over the past 40 years.” ² Malkiel also states that of the last 8 recessions only 6 were preceded by an inverted yield curve. However, he says the two times the curve “got it wrong” were periods of relatively low inflation, like today. He concludes by stating that this curve is “not an omen of disaster” either and that while these signals should “never be ignored, this is a time for caution, not for being spooked!” Sounds like pretty good advice to us too.

¹ BigCharts.com, Standard & Poors, MSCI Barra and Lehman Brothers
² Nice Curveball! by Burton Malkiel, Barron’s 8/14/06

Commentary

It wasn’t more than a couple of months ago that it was hard to find gas for less than $3.00/gallon. Last week, I saw it for $2.10. Who sets the prices and why do they fluctuate so much? The middlemen, the refiners and distributors, look to each other for pricing in the same way the local stations look to each other and get out the ladders to change prices as soon as the other guy does. The barrel price of crude sold to those refiners is ultimately tied back to raw supply and demand, but oftentimes is overly impacted by negative news.

Lewis Walker, in his article Peak Oil Fears and Hype, says, “The press loves negative stories which engender fear.” ³ This fear premium could be most of the cause of the wild price swings. Not discounting concerns about the stability of oil coming from the Mid-East, Walker makes the case that most of the fear-based oil price rise is being generated by reports of world oil production topping out, or “peaking”. Even President Bush has been influenced by the “peak oil” news stating in the 2006 State of the Union, that “America is addicted to oil.” That speech also announced the Advanced Energy Initiative focusing on clean energy research.

America’s ingenuity in solving problems is legendary. The phrase, “Don’t bet against the American economy” comes to mind with peak oil too. Walker says in his article that, “We do know that past forecasts of peak oil have not been reliable, since human ingenuity has intervened to increase recoverable supply.” Every major economic shift like the one from agrarian to industrial, has created both challenges and opportunities. The change from an oil based economy will be no different. Even now, venture capital is finding a whole new class of funding to entrepreneurs involved in renewable energy and energy related biotech and nanotechnology. Whether we will hit peak world production of oil in the next 20 years is anybody’s guess, but we will certainly continue to hear more about alternative energy sources, increases in efficiency and “going green” in general.

³Peak Oil Fears and Hype by Lewis J. Walker; Journal of Financial Planning, Sept. 2006

Ideas

A long awaited tax break and making permanent other legislation scheduled to ‘sunset’ in 2010, was OK’d by Congress just before its summer break as part of the Pension Protection Act of 2006. First, the Congress made permanent of the 529 college savings plan. So, tax breaks for the 529s will not lapse after 2010. Next, they passed legislation allowing tax-free payouts of up to $100,000/year from IRAs to charity. ⁴ This change is for this year and next year only and has a number of restrictions; including a minimum age to qualify of 70½ and that the gifts cannot be to donor-advised funds or supporting organizations. Here are a couple of scenarios where this might make sense to do:

You haven’t taken your distribution from your IRA yet this year and you are planning to make some year end charitable gifts. Distributions from IRAs typically are taxable. The IRA charitable rollover is a tax free distribution AND it qualifies for your required minimum distribution (RMD)!
You would like to make a gift in excess of 50% of your adjusted gross income. This provision allows you to give over that limit, while having no impact on your regular income and other charitable gifts.
You do not itemize your deductions on your tax return. Under the new law, it makes more sense to make a gift to charity directly from the IRA rather than withdrawing the cash from the IRA (and paying tax on it) and then making the gift to charity.

Call us for more information and details about this unique strategy. Maybe the government will make this one permanent someday too!

⁴ Crescendo Notes; Fall 2006 Edition

Closing Thoughts

For our Schwab Institutional clients, you can now access SchwabAlliance.com through a link on our website.

The Lehman Brothers US Aggregrate Bond Index is comprised of a variety of taxable bonds, and is used as a measure, or benchmark, of the US Bond market.

The MSCI EAFE Index (Morgan Stanley Capital International Europe, Australia and Far East Index) is a widely recognized benchmark of non-US stock markets. It is an unmanaged index composed of a sample of company representatives of the market structure of 20 European and Pacific Basin countries and includes reinvestment of all dividends.

Indexes cannot be invested indirectly, are unmanaged and do not incur management fees, costs of expenses.

Registered Representative offering securities through FSC SECURITIES CORPORATION, member NASD/SIPC and a registered broker-dealer not affiliated with Clarus Financial LLC. Investment advisory services offered through Clarus Financial, LLC, a Registered Investment Advisor.

Quarterly Newsletters

Enter your e-mail address in the field below and click Sign-up to receive our quarterly e-mail newsletter.

Newsletter Archives

Autumn 2008 »
Maximum Optimist

Summer 2008 »
It’s Déjà Vu All Over Again

Spring 2008 »
March Madness

Winter 2008 »
Year In Review 2007

Autumn 2007 »
Roller Coaster Ride ’07

Mid-Summer 2007 » A Mid-Quarter Briefing From Clarus Financial

Summer 2007 » Mission Accomplished

Spring 2007 » Our Interests May Not Always Be The Same

Winter 2007 »
The Year In Review

Autumn 2006 »
FILL’ER UP

Summer 2006 »
Summer Doldrums?

Spring 2006 »
Presidential Cycle: market indicators for an uncommon 2nd term president