Outlook for capital markets looks upbeat thanks to economic rebound

Smith Barney's U.S. Investment Policy Committee, a group of the firm's senior investment strategists meets weekly to review developments in the U.S. capital markets.

The Investment Policy Committee seeks to develop a core investment outlook, which is reflected in the strategy publications of its members.

The committee has summarized its current view on the markets through the first quarter of 2006. I have provided some of the key points that I believe investors may find useful.

The U.S. stock market opened 2006 with a relatively upbeat first quarter, as investors shook off some of last year's concerns about rising interest rates, high energy prices and an uncertain earnings outlook.

Most major benchmarks posted solid gains, both for the quarter and for the trailing 12 months.

Boosting market sentiment: Signs the U.S. economy is rebounding from a slowdown in the final quarter of 2005, thanks to a pickup in consumer spending, continued strength in business capital spending and hurricane-related rebuilding on the Gulf Coast.

Corporate earnings results, meanwhile, generally came in at or above expectations.

Bond markets remained under some pressure, as Federal Reserve officials kept a close eye on inflation and investors nervously watched both.

Although so-called core inflation rates - excluding volatile food and energy prices - remained relatively tame, the fed raised short-term interest rates twice during the quarter, pushing its target for the key Federal Funds Rate to the highest level in almost four years.

Yields on U.S. Treasury securities rose across the maturity spectrum, and most major fixed-income benchmarks posted losses for the quarter.

International equities, on the other hand, performed exceptionally well, particularly in the emerging markets.

Major market benchmarks first ended the quarter higher in most regions and countries, while a modest decline in the foreign exchange value of the dollar helped boost international returns for many U.S.-based investors.

The U.S. Economy

After growing at an annualized rate of 3 percent or better for 10 quarters in a row, the U.S. economy took a breather in the 4th quarter, as the damage and disruptions caused by hurricanes Katrina and Rita left their mark on the Gross Domestic Product. GDP expanded at a 1.7 percent rate in the final three months of the year.

Somewhat surprisingly, slower growth appeared to do little or no immediate damage to earnings. The Commerce Department reported corporate profits jumped at a better than 14 percent annualized rate in the fourth quarter, after falling slightly in the third quarter. For 2005 as a whole, the department's figures show earnings rose 21.3 percent.

However, the inflation picture seemed to improve as the quarter progressed, with the CPI rising just 0.05 percent in February. And excluding food and energy prices, consumer inflation appeared to remain well under control.

The so-called core CPI rose just 2.06 percent over the 12 months ending in February.

Less encouragingly, energy prices remained high throughout the early months of 2006, and were edging even higher as the quarter ended.

The spot price for West Texas Intermediate Crude reached $66.66 a barrel by the end of March, up from $61.04 at the end of last year.

For more information on market and economic updates, call 689-8704 or e-mail william.a.creekbaum@smithbarney.com.

• William Creekbaum, MBA, CFP, a Washoe Valley resident, is senior investment management consultant of SmithBarney, a financial services firm serving Northern Nevada at 6005 Plumas Street, Ste. 200 Reno, NV 89509.