Opinion: Fear hobbles equity market in 2005

A quick recap: the Dow Jones Industrial Average was down 0.61 percent for the year (its smallest annual percentage change since 1926); Standard and Poor's 500 did at least show a small 3 percent gain; and the NASDAQ Composite fit right in the middle with a positive 1.37 percent change. Not numbers to get excited about.

Portfolio returns for many investors, especially those who employed a rational, diversified technique, outperformed the paltry figures the markets provided. By allocating funds by style and capitalization, including nondomestic holdings, thereby creating a portfolio of noncorrelated assets, returns should have been substantially above those of the domestic indices.

Foreign holdings added positively to portfolios. Full-year 2005 returns for foreign indices that we have used for our clients in the form of Barclay's iShares include: Japan (+27.67 percent), Brazil (+53.65 percent), China (+14.15 percent), Emerging Markets (+ 34.23 percent) and Latin America (+55.07 percent).

If investors included those in their asset allocations, their portfolios should have handily beaten the Dow, S&P 500 and NASDAQ.

Caution: Don't chase what worked last year, and remember to examine your portfolio for rebalancing. If you held those foreign issues, they probably have appreciated to the point that they are disproportionate to the rest of your portfolio and well exceed the upper range that you originally established for them. If you really want to “buy low and sell high,” then look to take some of your profits from the outperforming positions and place them in those that underperformed. Yep, it ain't easy, because it is not human nature to do so. It's that greed part of the fear-and-greed aphorism.

If it was fear that produced the less-than-stellar performance in U.S. markets, then what caused it?

Energy costs? Katrina's and Rita's devastation? Interest rate concerns? In an era in which the media trumpet the “glass is half empty,” could it have been that investors suffered an inundation of skewed news about how all those aforementioned items would wreck, or at least seriously damage, the economy?

The fact is that the economy continued in spite of all those difficulties, giving testimony to the resilience of what can only be described as the world's most powerful economic engine.

One cause for fear - not mentioned in the above list - might have been worry about our leadership. With partisanship in Washington more blatant than any time in my memory, and with bickering focusing on such weighty matters as steroid use by athletes and who “outed” Valerie Plame, the issues that should have been of greatest concern, but which revealed the lack of backbone among our fearless leaders, were not addressed.

Social Security financial viability, the runaway cost of Medicare (and the look-what-we've-done-for-you-so-keep-us-in-office prescription drug coverage), serious tax reform (just wait until the alternative minimum tax hits you in coming years if nothing is done to repeal or modify it), and as we all know, the profligate pork barrel spending that is pure giveaway, may all have cast doubts on the future of the economy.

Perhaps investors are simply worried that the Beltline crowd is leading us in the wrong direction - a direction pointing toward the social feel-good programs at the expense of personal responsibility and economic freedom that have resulted in the dwindling power of France and Germany.

It does not have to be so, but it could well happen if we simply watch and do nothing.

With interest rate increases likely to end after one or two more bumps, and with Alan Greenspan exiting the scene and Ben Bernanke taking the helm at the Federal Reserve, interest rate uncertainties and concerns should be calmed, and bonds should provide a decent return, serving investors best if held in tax-deferred accounts such as IRAs.

As for the equity markets, we do not look for a banner year for the overall markets; however, we do believe that in the domestic markets large company stocks, both growth and value, will have their day, encouraging investors to increase their allocations to those areas.

The likes of 3M, Altria, and GE, as well as a number of other large company issues should do well. If you have trouble identifying individual large company candidates, consider using exchange traded funds.

Here's to a prosperous 2006!

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company.

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