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Lessons of '05: Prepare financially for emergencies

As we start the New Year, I want to reflect on last year's events and look forward to this year's potential. In many ways last year was a tough one. The battle in Iraq continued unabated, energy prices soared, hurricanes devastated the Gulf coast, some prominent companies went bankrupt and the Federal Reserve raised short-term interest rates eight times from 2.25 percent to 4.25 percent over the year. Despite all this, the U.S. economy maintained a solid pace. Let's take a look at some 2005 statistics:

  • Payroll employment expanded by 1.84 million through November.

  • Hourly pay rose 3 percent.

  • The unemployment rate fell from 5.4 percent in December of 2004 to 5.0 percent this last November.

  • Total U.S. pretax corporate profits rose by 15.7 percent from the third quarter 2004 to the third quarter 2005.

    Despite generally good economic news, it was a tough year for equity markets. The Dow finished the year down 0.6 percent, the Standard & Poor's 500 was up a measly 3.0 percent, and the Nasdaq was up only 1.4 percent. Bonds also had a weak year with a 2.7 percent total return on the 10-year Treasury note. Somewhat offsetting the bad news of low equity returns was the drop in price-per-earnings ratios. For example, the price-per-earnings ratio on the S&P 500 dropped by more than 2 percentage points. I consider this to be good news because I think it removes risk from the equity market and creates upside price potential if earnings continue to rise.

    Looking ahead, I expect steady gains in various economic measures like Gross Domestic Product and employment. The resilience of the U.S. economy in the face of sky-high energy prices and the hurricanes is impressive. Productivity growth has remained high and companies have kept costs under tight control. This augurs well for both inflation and profitability in 2006. The huge surge in energy prices had no discernable impact on inflation excluding energy.

    The overall Consumer Price Index inflation rate started the year at 2.9 percent and rose to 3.5 percent in November, but the CPI excluding energy inflation rate actually fell from 2.3 percent at the start of the year to 2.1 percent currently. I think this inflation control will allow the Fed to stop hiking rates shortly, especially if energy prices stop rising or, better yet, fall. I also believe that tight cost control is a powerful tool to continue to grow earnings and, at the same time, to reduce risk to employees and investors.

    At some point this year, I firmly believe this will restart a rising equity market. Maintaining a long-term strategy with a well-diversified, balanced portfolio that is positioned to take advantage of market rallies remains the best course of action.

    Wilsey is a registered principal with Linsco/Private Ledger, a member of the SIPC. "Smart Investing with Brent Wilsey" can be heard Saturdays at 8 a.m. on KFMB AM 760 and Tuesdays at 12:30 p.m. on Channel 8 news. Contact him at brent.wilsey@sddt.com. Comments may be published as Letters to the Editor.

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