R  I  V  E  R   P  O  I  N  T 

R  E  P  O  R  T

 

 

  January 2006

 

  2005 WRAP-UP 

The low volatility of last year’s market was highlighted by overall lackluster returns in all the major stock indexes.  After a year of one-step forward and one-step back, the Dow Jones Industrial Average ended the year up only 1.7%.  Other benchmarks fared only slightly better with the S&P 500 Index up 4.9% and the NASDAQ Composite returning 2.1%.  Somewhat surprisingly, the “tread–water” market action occurred while the overall economy and business earnings turned in very solid results.  Economic growth finished the year at a 3.5% pace, easily above the historical average while corporate earnings produced double-digit growth in the 14% to 16% range.  Growth in cash flow was also strong and reflected in record stock buyback declarations of over $456 billion by U.S. companies.  Even interest rates behaved relatively benignly despite the Fed’s anticipated and “measured” hikes in the federal funds rate at every FOMC meeting.

No doubt the headwinds created by ever-increasing energy prices and the extensive damage wrought by Hurricanes Katrina and Rita had a dampening effect on equity performance.  And with real estate prices continuing to escalate in many areas, investors chose to chase what was hot.  Investors in fixed income had a difficult time as well during 2005 with the benchmark Merrill Lynch 1-10 Year Corp./Govt. Index returning 1.7%. 

2006 AND BEYOND 

The new year started off with a bang producing quick gains in all categories of equities.  On January 9th, the Dow hit the critical psychological hurdle of 11,000 but could not sustain it as fears of unstable energy prices persisted along with some early earnings disappointments.  Nevertheless, stocks still finished the bellwether month with clear gains. 

In his last act as Chairman of the Federal Reserve, Alan Greenspan pushed borrowing costs to the highest point in nearly five years.  Shortly after the Fed’s rate announcement, the Senate approved Ben Bernanke’s nomination to be the fourteenth chairman of the central bank.  This confirmation completed the historic changing of the guard at the Fed.  In retiring after an 18-year stint as chairman, Greenspan turns over to Bernanke an economy that is in good shape but faces challenges.  Many economists predict the Fed will boost the federal funds rate at least one more time – to 4.75%.  They believe that with Bernanke at the helm fighting inflation will remain the primary focus.

Moving into the year, our expectation for solid economic growth of about 3.5%, coupled with anticipated double-digit corporate earnings growth, bodes well for equities.  As demand for oil continues to slacken, energy prices are likely to stabilize near current levels.  Stock valuations relative to earnings are as low as they have been in 15 years, making them more attractive on a valuation basis than bonds and alternative investments.

Many investors feel that the winds of fortune are shifting away from the “value” stocks which have performed well over the last few years.  Price-earnings ratios of large company growth stocks are historically low, and we believe these stocks represent the best value in the market.  These large “blue chip” stocks have been the laggards over the last few years, underperforming medium and small-sized U.S. companies as well as foreign firms.  We believe that holding these large, high quality companies in 2006 should be rewarding. 

SECTORS AND STOCKS OF NOTE

At RiverPoint we continue to find the Healthcare sector attractive, in particular the medical equipment and health services industries.  A few companies that have recently reported earnings include UnitedHealth Group (UNH - earnings up 26%), Stryker (SYK - earnings up 22%), and Johnson & Johnson (JNJ - earnings up 13%).  In addition, the financial sector is beginning to warrant our attention as the Fed appears to be nearing the end of its tightening of the short-term Fed funds rate.  Many financial stocks are trading at 10 to 11 times their 2006 estimated earnings with dividend yields near the 10-year U.S. Treasury Bond.

 

 

 

 

          Market Summary

 

Dow Jones Industrial Average

 

 

1/31/06

 

10,865

 

 

YTD Price Change

 

  1.4%

Nasdaq Composite

  2,306

+4.6%

Standard & Poor’s 500 Index

  1,280

+2.5%

 

For information about RiverPoint Capital Management or to view our report archive visit us at www.riverpointcm.com.