PacWest Financial Management Newsletter
1st Quarter 2004

Volume VIII, Issue 1

April 1, 2004

•	Economic News
•	Financial Planning Quiz
•	U.S. Stock Market
•	Fixed Income Markets
•	International Equities

Featured Articles

•	Retirement Plans for Small Businesses
•	Building a Retirement Plan for Your Business
•	Retirement Plan and IRA Figures At-A-Glance

Economic News

The employment report was the big story in the first quarter. The market shrugged off a couple of weak reports in January and February that showed job creation was well under expectations. By March, the failure of the numbers to show any improvement wore thin and the market headed South. The lagging indicator of employment has usually picked up at this point under normal recovery cycles. This has investors questioning whether the trend of outsourcing jobs abroad will eventually have a negative impact on the domestic economy. The worries seemed to be somewhat alleviated when the report released right after quarter end showed 308,000 jobs were created, easily surpassing the 123,000 that were expected. While the employment picture is starting to look better after the latest data, more reports are needed to validate the trend.

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Financial Planning: 2004 Numbers

1. What is the maximum lifetime contribution for a 529 plan?
A) $55,000
B) $100,000
C) Depends on the state that sponsors the plan
D) No limit

2. Which of these factors alone, by one estimate, will make a U.S. tax filer most likely to face paying Alternative Minimum Tax (AMT) in 2005?
A) Claiming 3 children as dependents
B) Having adjusted gross income (AGI) between 500K and 1 million
C) Having AGI of more than 1 million
D) Having high state taxes, which you deduct
E) Don't know

3. What proportion of the top-performing 10% of equity mutual funds in the period 1970-1980 were also among the top-performing 10% of equity funds in the decade 1980-90?
A) 7%
B) 17%
C) 37%
D) 57%
E) 77%

4. What percent of men and women who reach age 65 will spend some time in a nursing home?
A) 25% of men, 25% of women
B) 25% of men, 33% of women
C) 33% of men, 50% of women
D) 50% of men, 50% of women

Answers
1. C) Some states have lifetime contribution limits of $250,000 or more. However, annual contributions of more than $11,000 ($22,000 if contributing with a spouse) are subject to gift tax. By making a special election, you may contribute as much as $55,000 tax-free in one year ($110,000 with your spouse), but that contribution will be treated as if it were being made over a five year period.

2. A) According to an analysis by a well respected public policy research group, beginning in 2005, approximately 35% of filers claiming 3 dependent children (of whatever income) will face the AMT. Only 27% of filers with AGI greater than $500,000 will face AMT.

3. B) The author of A Random Walk Down Wall Street found that if you had chosen a fund that was in the top 10% of funds from 1970-1980, the likelihood of it repeating as a top-performing fund in the next decade, was 17%. This suggests that picking outperforming funds in advance, based on past performance is difficult.

4. C) According to Ric Edelman, in his book, The Truth about Money, more than half the women and about one-third of men who reach age 65 will spend some time in a nursing home, with the average cost of a home being about $66,000 per year. According to another source, the average nursing home stay is about two and a half years, but there is a 10% chance that care may be needed for more than 5 years.

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U.S. Stock Market

After a solid 2003, U.S. stocks could not get much accomplished during the first quarter of 2004. Terrorism concerns weighed on the minds of investors due to the March attacks in Spain. Additionally, profit taking was inevitable after the solid run experienced last year.

For the first time in quite sometime, the S&P 500 outpaced the NASDAQ composite. The S&P 500 gained 1.3%, while the NASDAQ lost .5%. The Dow also struggled during Q1, losing almost a percent. The small cap Russell 2000 leads all US indices by advancing over 6%. This continues the trend of smaller stocks outpacing the large ones over the last four quarter, and in general over 5 years.

As discussed last quarter, the environment is still ripe for equities. Interest rates are low and should remain at these levels for another quarter or two. Additionally, earnings continue to improve. Although year-ago comparisons will be more difficult for many companies to surpass, businesses are still expected to post solid growth this year. We think the possibility for larger stocks to outperform mid and small cap stock is fairly high.

There certainly are risks on the horizon. Valuations, though not overly excessive given this low interest rate environment, are a minor cause for concern. Additionally, the race for the White House is much closer than anticipated by many at this point. President Bush has been very friendly to equity holders, while Senator Kerry most likely would not be as responsive. Another issue for many companies is the high cost of their raw materials and crude oil. At some point, this rise could hurt consumer confidence and spending.

Overall, we see stocks having a volatile, but positive year in 2004. However, this outlook would change given a significant rise in interest rates. As always, we will continue to purchase fundamentally sound companies trading at good valuations in your accounts.

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Fixed Income Markets

The movement of interest rates during the first quarter of 2004 was all about job growth. The weak non-farm payroll numbers in January and February brought the 10 year treasury note rate from 4.25% at the end of 2003 to 4% in January and ended at 3.85% at the end of March. But on April 2 the employment numbers took a sharp upward turn, with 308,000 new jobs added in March (159,000 in January, 46,000 in February). The 10-year Treasury note increased to 4.14%.

Another key factor in the decline of Treasury note yield is due to the heavy buying by foreign central banks, especially Japan and China. They do not want a more expensive currency that may discourage buying from US consumers and businesses.

In the beginning of 2001 the Fed Fund rate was at 6.5%. It is now at 1%. Real interest rate continued its decline into 2004. Comparing with benchmarks such as GDP growth and current account deficits of other countries, the relative interest rate in US is also very low. The upward movement of rates is inevitable. However, Chairman Greenspan has stated, “With inflation very low and substantial slack in the economy, the Feb can be patient in removing its current policy accommodation.” Depending on strength of the employment growth and inflationary pressure, rates may stay low for the balance of 2004.

For most of the fixed income purchases in 2004 we have concentrated on inflation adjusted corporate notes, step-up and other short bonds. Protecting principal is very important to our clients and to us. Significant extension of maturities is not prudent at this point.

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International Equities

Along with the U.S. markets, the international markets went on a roller coaster ride in the quarter. After a good run last year investors hesitated to drive prices of stocks up further. Terrorism continued to stoke fear in investors and tragedies such as the one in Spain in early March caused markets to drop. International markets did manage to get a boost in the last few weeks to end the quarter with a decent gain. The EAFE index advanced to 3.7%. Japan lead the way returning over 16% as their economy continues to show improvement.

Asia continued to be an area of interest to many investors as Taiwan and South Korea were two of the other leaders in this group. Although the Hong Kong index advanced 5.5%, the less developed Chinese market was nearly the mirror opposite and lost about 5% as the government tries to cool the economy. Other countries continued to show economic improvement and many have benefited from high commodity prices, increased trade, and job growth. Investors realize that the outsourcing of U.S. jobs could be a positive contributor to the economies of some developing countries.

The U.S. dollar stabilized this quarter after last year’s downturn and consequently currency gains weren’t as big of a contributor this quarter. Going forward, the U.S. dollar won’t make as big of an impact on U.S. based returns, but valuations and growth rates are still relatively attractive in foreign markets.

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