December 2006

The Investment Climate

In the past, I have written to each of you when I felt there were important issues to address. In September of 1999 my letter explained why the price of stocks was very out of line with their earnings, so a sharp decline was near. I explained that stocks have lost 43% of their value before and it will happen again. Then I wrote a letter dated September 11, 2001 explaining what to expect from the markets after the worst terrorist attack to ever take place on U.S. soil. The markets recovered after Pearl Harbor, after the Kennedy assassinations, and after the surprise Gulf War so I felt it was only rational to expect the same from this most recent shared tragedy.

On October 22, 2002, near the end of one of the most severe stock market declines, I wrote a letter to all our clients explaining why it is irrational to think that stocks will go down forever. In fact, I explained all of the reasons why I was “rationally exuberant” about the future. A few months after that letter, the markets started up with the Dow Jones Industrial Average rising over 80% from its low through 11/15/06. The broader stock market as measured by the S&P 500 Index is up 77% from the low of October 9, 2002. Past performance is of course no guarantee of future returns.

Since 1926, on average, 70% of the years are positive for stocks and about 30% of the years are negative. The market has just gone up for 4 years, so what should we expect for 2007?

Reasons for Optimism:

Since World War II, there have been ten run ups on stock prices called “bull markets”. They averaged 1,584 days each with an average gain of 140%. The current rally (number 11) has run almost as long as the average but has only gained about 70%. The earnings of stocks are strong and not out of line in relation to the prices from a historic perspective. The US population has grown by 100 million since President Johnson’s administration and will grow another 100 million over the next 30 years before leveling off. The rest of the world is growing at an even faster rate so the supply and demand factors are definitely positive. The $260 billion U.S. budget deficit is about 2% of our $13 trillion economy and is below the average for the last 40 years. Personal income tax payments are up 30% since 2004. Housing price declines should end sometime in 2008, while commercial real estate continues to appreciate.

In the world there are 22 developed nations including the U.S. We produce about 50% of all of the goods and services in the world. As undeveloped nations like China and India join the ranks of developed nations, the free market system will continue to provide the greatest opportunities for the most people. More than half the value of all of the stocks in the world is outside the U.S. For the last 5 years, foreign stocks, as measured by the EAFE Index, have outperformed U.S. stocks by a wide margin. As our share of all of the goods and services produced in the world shrink, it only makes sense to invest globally.

Another reason for optimism is the relatively low interest rates we have today. Companies earn more because the cost of borrowing is low. Investors are not happy with money invested in Certificates of Deposit at 4 or 5%, so stocks become more attractive. As boomers retire, more of their net worth will be invested in stocks because the longer planning horizons of retirement require greater exposure to equities to protect them from inflation.

What Will Congress Do?

The new congress in Washington is likely to let the recent tax cuts expire in 2010, including the proposal to eliminate death taxes. Clearly we are getting out of Iraq – it’s just a matter of how soon. There are only two places left in the world that are not committed to the free market system – Cuba and North Korea. China, India, Japan, Europe and North America are absolutely in agreement on the danger terrorism presents. Terrorism however can’t hold back the tide of hopes and opportunities offered by free trade through out the world.

All of this information leads me to believe that history will repeat itself. Stocks around the world, on average over your lifetime, should continue to provide a premium return for the risk taken. Fixed assets like Treasuries, municipal bonds and guaranteed investments are needed to provide income and liquidity while stocks are down. Modern Portfolio Theory is now 17 years old. That formula has been making money for our clients for almost two decades and my guess is it will still be making money for people two decades from now.

What’s new at Pearson Financial Services?

Last year we consolidated all accounts using TD Ameritrade as our prime custodian, and Purshe, Kaplan, Sterling, Inv. as our Broker-Dealer. Thank you so much for your patience with this transfer process and for your continued confidence.

Recently, the Luxury Institute, an independent research organization, conducted a survey that polled 1,000 consumers who were at least 21 years old and had an income of at least $150,000. Average household income for respondents was $616,000 and average net worth was $3.8 million. Respondents were asked to rate on a scale of 0 to 10 only the firms they were familiar with on four issues: consistently superior quality; unique and exclusive brand; social status; and overall customer experience. The four values were averaged to get the final ranking.

The top 10 firms from the list are, in order: TD Waterhouse (now known as TD Ameritrade), Smith Barney, Charles Schwab, Fidelity Brokerage, Deutsche Bank, Oppenheimer, UBS, A.G. Edwards, Bear Stearns and Lehman Brothers.

Nomination to be considered for Barron’s Top 100 Advisors List:

TD Ameritrade provides services to over 3 million investors worldwide and provides security protection up to $150 million per customer. Partnering with TD allows us to sustain our competitive cost advantage. Recently, Tom Bradley, President, TD Institutional, nominated our firm for the Barron’s list of the top 100 advisors in the nation. Barron’s is perhaps the most respected newspaper for the professional investment community with a worldwide circulation of over 432,000. 57% of the professional investors in the U.S. read Barron’s. We are honored to be nominated for this list and will inform you of the final outcome early in 2007.

As We Grow:

Our goal for the future is to provide our existing clients with an integrated approach to their financial needs including; financial planning, investment solutions, income tax planning, health care funding, real estate strategies and estate planning. There are now 12 of us here, under one roof to serve you. We are mainly service providers. We are large enough to provide all the resources you need, but small enough to give you the highest level of personal service. There is expertise and experience in every direction as new challenges arrive and are resolved.

We also need to grow our firm to provide our younger members with long term job security and a rewarding career. We are proud to announce that both Barry MacMartin and Bryan Bastoni, who have been with us 9) and 8) years respectively, have recently received the Certified Senior Consultant designation from the Institute of Business and Finance. With this in mind, please do not hesitate to refer your friends and neighbors to us by passing along our new enclosed brochure. We are confident they will be very happy with the attention they receive.

Introducing John Ward:

In addition, we are very excited to announce that John Ward has decided to partner with our firm. He will help us by providing provide family office services to new clients. He brings a great depth of financial experience to our team. He graduated with honors from Oxford University and achieved his MBA from Manchester Business School with distinction. His professional career includes being the chairman of Merrill Lynch’s International Banking Group, Chief of Staff- Citibank – Merchant Banking Group and Director – Ameritrade Holding Corporation. John was introduced to us, and very highly recommended, by Tom Bradley, President – TD Ameritrade Institutional.

Global markets are on an upswing, so John’s international financial background adds additional expertise at an opportune time. There are investment opportunities worldwide. It does not make sense to limit investments to U.S. equities only.

Serving as a Media Source:

In the last few years, our firm has been recognized on a national level. I have been interviewed for articles in the Wall Street Journal, Worth Magazine the Robb Report, CBS Market Watch, US News and World Report, Research Magazine, National Underwriter, Retirement Weekly, Kiplinger’s Retirement Letter, Consumer Reports Money Advisor, Investors Business Daily, 2nd Home Journal, Palm Beach Daily News. The Stamford Advocate, Registered Rep Magazine, Milwaukee Journal Sentinel, Investment News, Advisor Today, Kiplinger Personal Finance and Financial Advisor Magazine. I am a special writer for Cape Business Magazine and have written articles for the Journal of Financial Service Professionals, Investment Advisor Magazine, and Financial Planning Magazine. I also wrote a book about trust and investment planning, which we would be happy to send to you without cost. It is also a great gift to give to a friend or neighbor who might benefit from a relationship with our firm.

In Summary

We feel that there is plenty of room for incremental growth in the world’s equity markets. The last six years have included: one of the biggest declines in stock prices ever and its subsequent recovery; a war that has lasted longer than our involvement in World War II; and terrorism on a scale never seen before. It is safe to say that the next six years will swirl around key issues like – China, oil, interest rates and terrorism. There is absolutely no reason to believe that future challenges will be any more insurmountable than those of the recent past.

Our firm is stronger than ever and while we need your referrals to grow, we pledge that our service and commitment to you, our existing clients, will in no way diminish. I hope the New Year will be the best one possible for you and your family.

Sincerely,

Seth M. Pearson, CFP
Certified Financial Planner