July 2006 Letter
As you know, since starting Covington Capital Management almost two years ago, we have been sending you periodic updates on our firm as well as articles on topical subjects which we hope you have found of interest. The enclosed piece deals with what is always a most difficult decision for all investors, namely how to determine when to sell a security. While we highlight one methodology, the mechanical sell discipline, at Covington we utilize a number of sell factors and anticipate that this topic will generate further discussion.
Speaking of making decisions, we want to bring you up to date on our thoughts regarding the current market environment. All major indices have traded sharply lower due to the Middle East crisis, its impact on spiking oil prices, slowing U.S. economic indicators (particularly in housing and consumer spending), and uncertainty about the Federal Reserve’s next move on interest rates. U.S. corporations are announcing second quarter earnings, and we will be paying close attention to remarks on future projections.
We do not believe that it is time to panic and/or make drastic changes in asset allocation. The market as measured by both the S&P 500 and the Dow Jones Industrial Average is down less than 1% for the year and has remained in a trading range environment for a number of years. We believe this trend will continue. U.S. economic growth will likely slow the second half of this year, but we do not believe a recession looms in the near future. If the Fed decides to halt interest rate hikes, this action will remove a major headwind for the markets. Valuation levels, particularly for high quality large companies, are reasonable by historic standards. We own many of these names and are confident that their track record for earnings consistency will not go unnoticed by investors. Growth outside the U.S. remains robust as evidenced by the Bank of Japan’s decision to raise interest rates from near zero for the first time in six years. While market uncertainty will likely persist in the near term, we are comfortable with our current allocation strategy which remains well diversified into a mix of stocks, bonds and cash equivalents.
All of us at Covington wish you an enjoyable and healthy summer.
Money Management
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