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In the third quarter of 2005, news of Hurricane Katrina and Rita overshadowed domestic and international market forces. The stock market’s volatility, however, remained subdued as the economic outcome of these disasters remains to be seen. The economy was in fine shape through June, with GDP growth of 3.3%. Possible negatives in the fourth quarter could be partially displaced by positive economic stimuli associated with rebuilding the New Orleans region; some economists project a cost of $200 billion. However, this puts a strain on the abnormally high Federal deficits, already stretched by the continuing costs of war in Iraq. Furthermore, the run-up in energy prices, though due for a short term pullback, is likely to remain with us for some time due to global demand growth outpacing global supply growth. This acts as a brake on our increasingly consumer-oriented economy, where the “wealth effect” caused by regional housing bubbles has contributed to a negative U.S. savings rate for the first time in over fifty years. Additionally, heating bills may be much higher this winter, and changes in the U.S. bankruptcy law taking place on Oct. 17th will require that minimum monthly credit card payments increase from 2% to 4% of total balances. The consumer accounts for fully two-thirds of American GDP, and all of the above will negatively impact spending. Still, the Federal Reserve Board continues to raise interest rates as it is optimistic regarding the economy’s potential. On September 20th, the Fed raised rates for the 11th time in as many meetings to 3.75%, and will likely continue to do so through 2005.

Meanwhile, global economics are deeply affected by China’s continuing industrial growth. In China today, only 2 barrels of oil per person are consumed, to be compared with 15-17 barrels per person in Korea and Japan, and 25 in the U.S; China’s appetite for oil can only grow. Similarly, demand for metals in China should remain elevated for years to come as it builds its infrastructure and becomes increasingly urban. Also critical this quarter were the elections in the world’s second and third largest economies. In Japan, Junichiro Koizumi’s Liberal Democratic Party won a landslide victory favoring structural and economic reform with an emphasis on privatization. Germany’s September’s national elections, however, the free-market reform minded CDU Party did not receive a much hoped-for clear mandate; which may hinder the European recovery.

We conclude with an investment theme: As the baby boom generation reaches retirement, it will be shifting its investment focus from capital appreciation to income generation. Over the next seven years, the 60-65 year old segment of the population will be growing by more than 5% per year, while the rest of the population remains flat. This will likely favor high quality, high dividend yielding stocks going forward, as this population segment looks toward maintaining its lifestyle.

For the first three quarters of 2005, the Dow fell 2%, the S&P rose 1.4%, and the Nasdaq declined 1.1%.

Grant Rogers Elizabeth Allen

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