Granite Group Advisors -


2006-01-01 :: 2006 4th Quarter Commentary

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Looking Back

The fourth quarter was one of the biggest return quarters we have seen in some time. The worst performing asset was Large Cap Growth with a measly 5.9% return. The best performing U.S. sector was again Small Cap Value with a 9.0% return. It was generally a broad based movement upward for all stocks. International again led the way with an EAFE return of 10.35% for the quarter. As we had stated in our late 2005 and 2006 commentaries, this year was an all around great year for stocks. Fears lead to some volatility in the spring months but as many of those fears slipped away the markets rallied accordingly, making the 2nd half of 2006 one of the best runs since 2003.

Fixed income yields fell quickly as the bond gurus passed on the belief that the Fed would actually start lowering interest rates in the beginning of 2007. As of the writing of this commentary, the ten year is at 4.7%, down and slightly inverted to the 2 year Treasury at roughly 4.8%. This was another year of general weakness in the fixed income markets as spreads between Corporate's, Treasuries and even High Yield tightened dramatically making return tough to come by.

Hedge funds went through some interesting growing pains this year. Not withstanding all the individual firm blowups, even absolute return funds had their difficulty as well. Their were a record number of firm disasters this year, the best known being the Amaranth natural gas bet that went awry. This phenomenon opened the eyes of many investors that most hedge funds are not actually hedged and have in many cases higher risks than general stock market investing. Absolute return funds also had their difficulties. As the 2nd quarter ended most funds had very little positive return and with the rise in interest rates they looked less palatable than cash. The second half of the year saw them bounce back and gather moderate single digit returns that made them more comfortable in investor’s eyes.

Real Estate as we had predicted saw a slight bounce upward as the low interest rate of mortgages made them more attractive. The REITs also showed some positive signs but the jury is out on the continuation of such.

Commodities seemed to peak somewhere in the first half of the year and then petered out through the back half and we believe that the bull run is over.

Looking Forward

We remain optimistically bullish for 2007. Equities should have another good year. The factors surrounding that belief are the following: Economic slowdown will be less than most believe and it will be the housing market that pulls the growth down more than other sectors. The Fed will probably do nothing in the interest rate arena until at least the 4th quarter. In addition, we should see a record number of mergers, acquisitions and private equity takeovers. It is more probable than before that growth, which has lagged for years, might see resurgence, and be the best sector as the Value cycle has reached a point of fair value as well as P/E multiple expansions should begin. In our favor, since 1939 the 3rd year of a presidential term has returned an average of 19% in equities.

We expect bonds to remain relatively flat this year and all return generally gathered from coupon rather than return. We will probably vacillate between raising interest rates and lowering interest rates but a general treadmill from beginning to end.

Real Estate has fallen off a bit from its highs and with its slight rebound in the 4
th quarter many investors are optimistic. We are not optimistic about this asset class as we think it will continue to soften but perhaps not as dramatically as it did earlier last year.

Absolute return hedge funds will continue to be more important than fixed income and are a better choice than debt at this time. Absolute hedge fund of funds will continue to do better on a risk return basis than their counterparts.

We are now neutral on commodities, we believe the bull run is over but will probably move upward and downward based on varying economic data as well as quantitative technical trading.

This is going to be an interesting year for all markets as we travel down slowing economies and interesting monetary policies. The first week of trading is a very accurate predictor for the year’s returns. We will probably jump off to a quick start and then sell off for a few weeks as we continue the equity bull run. We believe Growth rather than Value will be the best performer and we also feel the U.S. has a chance of rebounding to leadership in return vs. the global markets. Earnings will remain important but only to the point of showing continued growth.

Have a Happy and Prosperous New Year!!

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