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May 16, 2006
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An Eclectic Eye on the Continent

Henderson European Focus Fund's Stephen Peak has beaten his peers by ranging across market caps, styles, and sectors

Considering sending some of your assets on a European trip? The Henderson European Focus Fund (HFEAX ) traverses the Continent seeking performance from stocks of any size, style, or country of origin. Lead manager Stephen Peak uses a bottom-up stock-picking approach based on fundamental analysis to hone in on top-10 holdings like Norwegian oil-rig company SeaDrill and Italian asset manager Azimut.

European equities have been unjustly overlooked, according to Peak, who says the shares offer not just diversification, but also pockets of opportunity. "The U.S. economy has been a better economy, no question," he says. "But this fund is not called the European GDP Fund."

In fact, the London-based portfolio has turned in average annualized returns of 43.1% for the three-year period ended Apr. 28, according to Standard & Poor's. That compares to 30% for its style peers and 27.3% for the S&P/Citigroup PMI Europe Index. The fund has posted average annualized returns of 34.26% since its Aug. 31, 2001, inception, and it carries a four-star overall S&P rating.

EURO-EXPENSIVE.  While the portfolio keeps 28% of its assets in British-based holdings, as of quarter-end Mar. 31, it also has exposure to the emerging nations of Eastern Europe. One top-10 position, Russian oil giant Gazprom, in April passed Microsoft (MSFT ) as the world's third-largest company by market value, behind only General Electric (GE ) and Exxon Mobil (XOM ).

Still, a continental jaunt doesn't come cheap, as the fund's 2% expense ratio is higher than its 1.57% peer average, according to S&P. The fund also charges a maximum front-end sales load of 5.75%.

Peak recently spoke with BusinessWeek Online reporter Marc Hogan about the fund's recent purchases, and his approach to stock-picking. Edited excerpts from their conversation follow:

To start, let's talk about what the fund does. What's your investing philosophy?
The fund has three clear objectives. One is to make money, one is to outperform the market, and the other is to beat the competition. If you can do all three, then those are the components of success.

How do we achieve those objectives? Again, there are really three clear elements. One is that this is a bottom-up stock-picking fund. It's not run by a committee that allocates money to Germany, France, or anywhere else. Having said that, there's diversification geographically, and it's diversified by industry and sector. It's all about having diversification, but with a good focus on money-making ideas.

Key point two is the style of the fund. As you know, most commentators like to put people in a nice little box. This is not a growth fund. It's not a value fund. The best word I can use to describe it is "blend." In other words, if there are great growth ideas, fine, we'll have great growth ideas. If there are great value ideas, we'll have great value ideas. My job is to be the chef: I change the recipe to go wherever the best ideas are.

Point three is really the capitalization spread of the fund. I am an all-cap investor, so I will look at the biggest companies in Europe, the Vodafones (VOD ), all the way through to companies you've never heard of that have $100 million to $300 million by capitalization, and the midcaps in between. The portfolio will always be spread across the different areas, but we have the potential to be comfortable moving up-cap and down-cap as we go through different cycles of the market.

So is small-cap where you see opportunities now?
There are always opportunities in small-cap. In terms of companies, there are fewer big companies than there are small. Still, small-caps in general have had such a terrific run that it's becoming increasingly difficult to find great opportunities. You still can find some...but as far as fantastic opportunities that just blow your socks off, it's difficult to find too many.

If we can find good opportunities within large-cap, and there should be some, maybe we'll shift to large-cap even more. But it's not a plan or a promise. We have to react to the opportunities we see week to week, month to month.

Any recent examples?
We initiated in the last month a position in Bayer (BAY ). The company has just made a major acquisition, Schering (SHR). The story is a very simple one: Bayer is transforming from a chemical company to one that effectively, through the deal, becomes a pharmaceutical company, or life sciences, if you prefer. That has got ramifications for how you should view the business makeup, and we think ramifications for valuation. That's now a top-five position in the portfolio.

I noticed a couple of your top-10 holdings were in Norway. What drew your interest there?
We're not wedded to country picks, but you've got to have diversification. Norway has been a very successful area for us. We have one oil company holding there, which is Statoil (STO ). It's quite sensitive to the oil price in its structure. We've held that position for a while. Oil prices have done well, and many of the oil equities have been pretty decent performers over time on the back of that.

The other one we have is SeaDrill, an oil-services company. You're probably familiar with Transocean (RIG), a big U.S. name, and this is similar. But it's very much a younger company. We only bought it in the beginning of the year, and we think that the best is yet to come.

What are some other stocks you like right now?
Pfleiderer is a company we've held for a couple of years. It was a very small German company, operating in an unspectacular area, engineered wood products. When we came across this company, the industry was over capacity, but that was changing. Many of their competitors were indebted, and the banks were moving in and shutting off capacity. More pricing discipline was coming into the market, which was fairly good for Pfleiderer.

The [company] embarked upon a program of selling off noncore assets, focusing on the main business line. They have some interesting emerging European exposure, and everything looked good. But with any small company, you need an opportunity to buy the shares. Sometimes you find a great idea and you can't buy any shares. In this company, a major block of stock was sold by two Pfleiderer brothers. Not only did we find a good idea that had potential and we thought was significantly underpriced, we also had a way to consummate that. This company is now a $1 billion company, and we've held it all the way through. We still think it has upside potential.

I've mentioned a couple of German names already, but another of the ways we've done that is through the financials. We've been playing companies like Commerzbank (CRZBY ), where fundamentals are improving. On the whole, the German domestic economy itself has actually been showing signs of life.

How do you take into account the rising interest-rate environment globally?
It's a fact you bear in mind. I'm not a macro, or top-down, investor, but clearly you have to keep in account, What do we think about economic growth in that country? What do we think about interest rates globally? If you have a company with a lot of short-term debt and you think the short rates are going to go up to 10%, that's an issue. So that blows back and affects your stock selection.

What's your methodology for picking stocks?
It's very fundamentally based. I run a team of 12 investment professionals, all with some specific skill: specialist small-cap, specialist large-cap, etc. They run portfolios, and some of their ideas find their way into this fund. We spend most of our time seeing companies. Being in London is pretty helpful. It's a good crossroads of corporate traffic. We have a number of one-on-one meetings every day. That gives you the ability to meet the management, hear them talk about their strategy, and also in subsequent meetings check that they've actually done what they said they're going to do.

What we're really trying to do is to understand the business. What are the drivers? What are the issues of that business? Why are margins 2% when everybody else is over 10%? Is it because there's some cost structure that can be dealt with, or are the 10% margin companies going to migrate down to 2%?

We've got about 70 positions now, and I think they're pretty good positions. What drives me forward is I know there are some good ideas we don't have in the fund. I'm not sure where they are, but that's the day job.

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May 16, 2006
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Stocks Slip after Tame Inflation Data

Investors were digesting a mild April producer price index and initial housing starts. Also in focus: Wal-Mart and Home Depot

Stocks finished modestly lower Tuesday, as tame housing and inflation reports met with caution ahead of another inflation report due Wednesday. The market appears to be forming a near-term bottom after last week's sell-off, says Standard & Poor's Equity Research.

The Dow Jones industrial average edged lower 8.88 points, or 0.08%, to 11,419.89, despite gains by Disney (DIS ). The broader Standard & Poor's 500 index slipped 2.43 points, or 0.19%, to 1,292.07. The tech-heavy Nasdaq composite fell 9.39 points, or 0.42%, to 2,229.13.

Inflation figures were in focus Tuesday. The overall producer price index rose 0.9% in April, while the core index increased 0.1%. The tame core number should alleviate some inflation concerns, says Action Economics.

In other economic data, U.S. housing starts skidded to 1.85 million in April, below expectations. Separately, industrial production increased 0.8% in April, boosting capacity utilization to 81.9%, ahead of projections.

A different inflation gauge will likely draw attention Wednesday with the release of the consumer price index. The overall CPI is expected to rise 0.6% in April, while the core index rises 0.2%.

On the corporate side, Wal-Mart (WMT) was higher after the retail giant said fiscal first-quarter profit rose 6.3%. That followed a lackluster earnings report Monday from rival Target (TGT ).

Home improvement retailer Home Depot (HD ) was lower after reporting 19% higher first-quarter profit. Office-products retailer Staples (SPLS ) was down on a 26% jump in first-quarter profit.

After the bell, computer maker Hewlett-Packard (HPQ ) posted higher-than-expected profits for its fiscal second quarter. Shares were up in after-hours trading.

Outside of earnings, General Motors (GM ) was lower after the United Auto Workers voted to approve a strike against the auto giant's former unit Delphi.

Oil company Occidental Petroleum (OXY ) was lower after saying its production contract with Ecuador ended following a dispute with the South American country's government.

Meanwhile, General Electric (GE ) and Chevron (CVX) were higher after a regulatory filing showed billionaire investor Warren Buffett's Berkshire Hathaway bought stakes in the companies.

In the energy markets, June West Texas Intermediate crude oil futures closed up 12 cents at $69.53 a barrel, rebounding modestly from recent declines ahead of Wednesday's inventory data.

European markets finished mixed. In London, the Financial Times-Stock Exchange 100 index edged up 4.9 points, or 0.08%, to 5,846.2. Germany's DAX index slipped 5.11 points, or 0.09%, to 5,851.92. In Paris, the CAC 40 index rose 16.84 points, or 0.33%, to 5,081.69.

Asian markets finished lower. Japan's Nikkei 225 index tumbled 328.49 points, or 1.99%, to 16,158.42. In Hong Kong, the Hang Seng index fell 101.73 points, or 0.62%, to 16,393.11. Korea's Kospi index slid 31.87 points, or 2.25%, to 1,382.11.

Treasury Market

Treasury yields eased on the mild economic reports. Prices for 10-year Treasury notes rose to 100-06/32 with a yield of 5.1%, while 30-year bonds climbed to 89-08/32 for a yield of 5.22%.

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May 12, 2006
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May Showers on Wall Street

Soaring commodities, solid economic data, and a falling greenback are clouding the markets with inflation worries

Spring was in the air on Wall Street, as the Dow Jones industrial average climbed to levels not seen in six years. On May 10 the Dow average finished at a new six-year closing high of 11,642.65, within 100 points of its all-time peak. Then the clouds thickened on May 11, when the Dow and other major indexes took their biggest tumble since Jan. 20. The next day, losses deepened.

What caused the sudden slide? Early in the week, the markets gained on strong earnings growth and optimism that the Federal Reserve might pause from its interest-rate tightening cycle. Then a perfect storm of surging commodities futures, solid economic data, and a weakening U.S. dollar brought inflation fears back to the foreground -- leaving some experts to believe the Fed might not be done after all.

AT A CROSSROADS. "What has investors worried is that the Fed will move further on rates and that inflation will erode the profit picture," says Joseph Battipaglia, executive vice-president and chief investment officer for Ryan, Beck.

Based on technical measures, stocks may have reached a critical juncture. During similar pullbacks in March and April, the broader Standard & Poor's 500-stock index found support at its 50-day moving average, says Chris Johnson, managing quantitative analyst at Shaeffer's Investment Research. The index was looking to find its footing there again during trading on May 12. "We really are at a crossroads," Johnson says.

Even after the two-day slide, the Dow average was still up 6.2% since the beginning of 2006, outpacing gains of 3.4% for the S&P 500 and 1.7% for the Nasdaq, thanks to strength in industrial names. Expectations about the Fed have played a key role in stocks' strong start this year, analysts say. For example, on Apr. 18, the S&P 500 enjoyed its biggest one-day surge in about a year, following Federal Open Market Committee minutes showing most of its members expected an end to rate hikes soon.

SECOND-QUARTER SLOWDOWN. Stocks have also benefited from another quarter of upbeat earnings reports, including results from Apple (AAPL ), General Motors (GM ), and Google (GOOG). On May 10 the S&P Investment Policy Committee said it expects companies in the S&P 500 to report an overall 13.9% year-over-year gain in first-quarter profits. That would mark the 16th consecutive quarter of double-digit earnings growth.

Still, earnings growth is expected to slow in the second quarter. And high-profile warnings, such as the lowered outlook from PC maker Dell (DELL ), could keep a lid on tech stocks.

Surging commodities prices have been sparking worries about inflation and dampening stocks. Gold futures jumped to $719.80, a 26-year high, on May 11, while copper, nickel, and zinc hit new records (See BW Online, 5/9/06, "Copper's Golden Hue").

INFLATION FEARS.  Crude oil futures were at $73.32, nearing the all-time high set in April. The high prices call into question the idea that the Fed will take a break from rate hikes, some analysts say. "Markets finally seem to be getting the message," wrote David Lynch, North American economist at Merrill Lynch, in a May 12 report. "The recent surges in energy and base metal prices have little to do with growth fundamentals and a whole lot to do with speculative action."

Strong economic data have also fanned inflation fears. A report released on May 12 said import prices jumped 2.1% in April, well above the consensus of 1.2%. The same day, the March trade deficit of $62 billion was narrower than the Commerce Dept.'s previous assumptions. "We believe that this report should add to inflation concerns at the Fed," writes John Ryding, chief U.S. economist at Bear Stearns.

Such numbers have taken on added significance as new Fed Chairman Ben Bernanke has repeatedly stressed his reliance on them. On May 10 the Fed raised the key federal funds rate 25 basis points, to 5%, as expected (see BW Online, 05/11/06, "Interest Rates: Look, Ma, No Pause!"). In an accompanying statement, the Fed said future tightening will depend "importantly" on incoming data.

WEAKER BUCK.  Next week's inflation data should provide some direction. The April producer price index is due on May 16, while the consumer price index follows on May 17. In both cases, energy prices are expected to push headline figures higher, says Action Economics. A surprise from either gauge, particularly excluding food and energy prices, would likely change projections about the Fed's next move.

Let's not forget the falling dollar (see BW Online, 05/03/06, "Will the Falling Dollar Hit Asia?"). Central banks in Europe and Asia have begun to lift rates even as the Fed winds down its own tightening cycle. Early on May 12 the dollar was down year-to-date 6.7% vs. the yen and 8.5% against the euro. "We think that there is more to come," writes Henry McVey, chief U.S. investment strategist at Morgan Stanley.

Economists are also keeping an eye on the slowing housing market (see BW, 05/15/06, "Why the Housing Bubble Won't Burst"). A weaker housing sector had been expected to reduce inflationary pressures and set a favorable backdrop for stocks and bonds, some analysts say. "Now people are starting to worry that the Fed isn't going to have the luxury to stop at its next meeting," says Brian Gendreau, investment strategist at ING Investment Management. "What the market really hates is uncertainty about the Fed."

SHIFTING GEARS.  Amid these concerns about inflation and the Fed, stocks are headed for a 5% correction, says Peter Cardillo, chief market analyst at S.W. Bach. "I don't think it'll be long-lasting," he says. "Metals and mining stocks will probably continue to do well, but even they probably will be subject to some sort of correction."

Other analysts are more optimistic. Stocks may have a "floor" below which they're unlikely to fall, writes Jeff Kleintop, chief investment strategist for PNC Advisors, in his May investment outlook. "Will the old adage 'sell in May and go away' prove to be prescient this year as stocks follow the typical midterm election-year pattern of summer weakness?" he says. "We think this is unlikely without further gains."

The timing was right for markets to shift gears, others say (See BW Online, 4/26/06, "A Savvy Seasonal Stock Strategy"). Wrote Barrington Research analyst Alexander Paris on May 10: "With the economy slowing and the earnings season over, it is a logical time for the market to start making a transition, which generally involves some kind of correction of narrow trading range." A spring shower may be natural, but it remains to be seen if this dip is part of a larger storm or just a squall.

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May 12, 2006
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Stocks Fall on Inflation Fears

Import prices surged unexpectedly, stoking inflation worries after the worst day for the major indexes since Jan. 20

Stocks finished sharply lower Friday for the second straight day, as a surprising jump in import prices drove up Treasury yields and kept inflation fears in focus. Sustained dollar weakness contributed to these worries, says Standard & Poor's Equity Research.

The Dow Jones industrial average fell 119.74 points, or 1.04%, to 11,380.99, ending the week down 0.5%. The broader Standard & Poor's 500 index fell 14.68 points, or 1.12%, to 1,291.24, a weekly decline of 1.6%. The tech-heavy Nasdaq composite dropped 28.92 points, or 1.27%, to 2,243.78, tumbling 3.4% for the week.

Some analysts say they are increasingly worried the Federal Reserve will have to continue raising interest rates. "With consumer spending growth likely to slow significantly, we still see good prospects for economic developments to unfold in a way that will allow the Fed to remain at 5%," says Joseph LaVorgna, chief U.S. fixed income economist at Deutsche Bank. "But given the FOMC's increased sensitivity to inflation risks, we admit to feeling less comfortable with that position."

Investors were weighing another set of economic data Friday. Import prices climbed 2.1% in April, above the projected 1.2% rise. Meanwhile, the U.S. trade deficit unexpectedly decreased to $62 billion in March.

Also on the economic docket, the University of Michigan's preliminary May reading for consumer sentiment tumbled to 79.0, from April's 87.4 final reading. That's well below forecasts, says Action Economics.

A busy economic calendar is set for next week. April consumer and producer price indexes are due, along with figures on housing starts, industrial production and regional manufacturing activity.

On the corporate side Friday, General Motors (GM ) was higher on an upgrade from hold to buy at KeyBanc Capital Markets.

Retailer Kohl's (KSS ) edged lower despite reporting a 34% gain in quarterly profit and raised its 2006 forecast on rising sales of home goods.

Expedia (EXPE) was sharply lower after the Internet travel agency posted 51% lower first-quarter earnings, citing an increase in marketing and administrative costs and a drop in U.S. sales.

In M&A activity, Best Buy (BBY ) fell on news the electronics retailer agreed to buy a majority stake in China's Jiangsu Five Star Appliance for $180 million.

Separately, Yahoo (YHOO ) was lower after reports that Chairman and CEO Terry Semel said the company rejected a bid by software giant Microsoft (MSFT) for a stake in the Internet media company. In the energy markets Friday, June West Texas Intermediate crude oil futures closed down $1.28 at $72.04 a barrel after the International Energy Agency lowered its forecast for global oil demand.

European markets finished sharply lower. In London, the Financial Times-Stock Exchange 100 index fell 129.9 points, or 2.15%, to 5,912.1. Germany's DAX index skidded 138.44 points, or 2.29%, to 5,916.28. In Paris, the CAC 40 index tumbled 112.49 points, or 2.14%, to 5,150.45.

Asian markets finished lower. Japan's Nikkei 225 index slid 260.36 points, or 1.54%, to 16,601.78. In Hong Kong, the Hang Seng index dropped 238.93 points, or 1.39%, to 16,901.85. Korea's Kospi index declined 19.5 points, or 1.33%, to 1,445.2.

Treasury Market

The jump in import prices pushed Treasury yields higher, says Action Economics. Prices for 10-year Treasury notes dropped to 99-17/32 with a yield of 5.19%, while 30-year bonds fell to 88-04/32 for a yield of 5.3%.

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May 10, 2006
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Parents' Day in the Sun

Flowers are fine for Mother's Day, but financial peace of mind is a gift that keeps on giving

Let's face it: Mom and Dad can do without a bouquet of flowers or necktie. For the upcoming Mother's Day and Father's Day holidays, give them a gift of financial peace of mind by making sure their finances are in order.

Parents of any age have a host of complex financial needs, from retirement accounts to estate planning. The Sundays honoring moms (May 14) and dads (June 18) should be spent relaxing, but try setting aside some of the other 363 days of the year to make sure these needs are all met. "Most parents want the gift of time, so planning the time to help them is the real value and what they'll appreciate most," says Patricia Konetzny, a financial planner in Maynard. Mass.

It's a two-way street. Being financially secure also happens to be one of the best gifts parents can bestow upon their children, financial planners say. "If we give them everything they want but become a burden in the future, we haven't really given them anything," says Linda Leitz, owner of Colorado Springs-based Pinnacle Financial Concepts and author of The Ultimate Parenting Map to Money Smart Kids.

This week's Five for the Money looks at what parents should have in place to simplify their financial lives for themselves and their loved ones. And yes, you can still send flowers.

1. Prepare for the worst.
While never a pleasant subject, wills are a must-have for all adults. Find an attorney to put together a will, trust, and power-of-attorney documents for your loved ones. Without a will, assets will be passed according to state law, rather than according to your parents' wishes.

If your parents already have wills, be sure they know where they're located. Also ask them when they last had their will reviewed. If it's been more than three to five years or a major change has occurred in their financial situation, it's time for a check-up, says Susan Elser, a fee-only financial planner in Indianapolis.

In addition to the typical estate documents, help your parents create a letter of intent. This should use simple, everyday language to make it easier to carry out their wishes in case the formal documents are unclear. "Sometimes an individual's desires are muddled in the legalese," says Adam Leavitt, president of Red Rock Financial Advisory in Tulsa, Okla.

2. Name names.
What's in a name? Quite a lot, it turns out. It's a good idea to double-check who is designated a beneficiary on retirement accounts and insurance contracts. "Qualified retirement account beneficiary designations cannot be overridden by a will, so if the owner forgot to change the name of the beneficiary to the desired person, then the funds will go to an unintended beneficiary," says Don Martin, owner and founder of Los Altos (Calif.)-based Mayflower Capital.

Such a review is particularly important for parents who divorced and remarried, Martin says. And if someone who was widowed forgets to update beneficiary designations, then their previously deceased spouse's estate would inherit the retirement account. That adds an extra layer of taxes, fees, and hassles.

Trouble can occur even when parents are both still alive and have remained married. Parents who name a trust for a child as a beneficiary in their wills must also change the beneficiary forms for their retirement accounts and life insurance policies. "Otherwise, upon their deaths, the trust won't get funded," says Elaine Scoggins, president of Tampa-based Scoggins Financial.

3. Collect their records.
Many people can barely keep their own files straight, so imagine the challenge of sifting through someone else's during a time of crisis. "Frankly, the administrative specifics after death are more time-consuming and emotionally draining than the 'official' topics," says Mary Clair Allvine, a financial planner with Chicago-based Brownson, Rehmus & Foxworth and author of The Family CFO.

Ask your parents to provide a list of their investment, bank, and insurance accounts, along with contact information and account numbers. Also find out where they keep important documents and assets. Dave Ragan, a financial planner at Denton (Tex.)-based Grunden Financial Advisory, recommends every family have an "I Love You Book." This binder or notebook would include all bank accounts, credit cards, liabilities, assets, doctors, and other information.

What about parents' safe deposit boxes? Parents should "consider giving an adult son or daughter a second key and access privileges to the box," says Mathew Gelfand, president of Bethesda (Md.) -based MDG Financial Advisors. He cautions that this may require a visit to the bank. Moreover, many financial planners suggest moving securities out of safe deposit boxes and into brokerage accounts.

The Internet era has brought with it a proliferation of passwords. These, too, should be kept in a safe place where children can find them if necessary. "Since many people have a variety of online accounts, access to passwords may become critical in a time of emergency," says Penny Marlin, president of Delray (Fla.) -based Marlin Financial.

4. Ensure they've got the right insurance.
Insurance needs differ from person to person, but it's worth a moment to check whether your parents have the policies they need. Parents who qualify should sign up for the new prescription drug benefit plan (see BW Online, 05/05/06, "New Medicaid Complications"). Some planners also recommend picking up supplemental health-care insurance.

Long-term care insurance (LTC) may be right for many parents. "Parents over 60 should certainly consider themselves candidates for good LTC coverage," says Wexford (Pa.) financial planner Robert Choiniere. He suggests children think about funding the LTC, because it can help prevent the erosion of the estate they will presumably inherit.

As for homeowner's insurance, make sure the properties your parents think are covered actually are. Mark Gleason, a financial planner with Burbank (Calif.) -based Wescap Management Group, recalls a recent case of fire on a property with two dwellings. "It turned out the insurance only covered the one dwelling that didn't have the fire," he says. Planners also recommend owning an umbrella policy, which offers extra liability insurance in case of auto accidents or lawsuits.

Then there's life insurance. Older parents who don't need their policies should either give them to their children or sell them to a third party, Gleason says. Both options are typically better than simply surrendering the policy and cashing it in, which has the lowest expected value.

5. Check their retirement accounts.
After talking about wills and beneficiaries, asking your parents about IRAs and such should be a snap. Parents over age 70½ need to be making their required distributions from IRAs and pension plans. If they're still working, they should fully fund their 401(k) plans up to the level of the employer match. Many planners also recommend Roth IRAs for those who qualify.

Just as with insurance, investment needs will vary. "The main question is, do they need income from their investments to live on?" asks Argyle (N.Y.)-based financial planner Marjorie Randles. If so, they need to invest in income-producing securities. She uses iShares exchange-traded funds, like the iShares Dividend Index Fund (DVY ), which has a relatively low 0.4% expense ratio.

Still, even older parents should be sure their portfolios are not too conservative. As with any investor, their assets should be diversified across a number of different asset classes. "They may still live a very long time, and growth above the inflation rate should be a part of the portfolio objectives," says Gleason.

Many planners also suggest keeping a cash account for emergency expenses. It should contain at least three months of living expenses, they say. Depending on the economic environment, it might take too long to sell off real estate or other assets, so ready cash can help pay off debts, taxes, or other unexpected costs.

Talking with parents about important financial matters can be easy to put off. Still, you'll be glad you did -- and they will, too.

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May 10, 2006
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Stocks Slip After Fed Hikes Rates

The Fed raised a key interest rate by 25 basis points, as expected. Earnings from Cisco, Disney, and Toyota were also in focus

Stocks finished mostly lower Wednesday, after the Federal Reserve raised the federal funds target rate by 25 basis points to 5%, as expected. Trading was choppy following the news, but the market did not show a clearly positive or negative reaction by the close, says Standard & Poor's Equity Research.

The Dow Jones industrial average edged up 2.88 points, or 0.02%, to 11,642.65, paced by a 4% gain from General Motors (GM ). The broader Standard & Poor's 500 index slipped 2.29 points, or 0.17%, to 1,322.85. The tech-heavy Nasdaq composite fell 17.51 points, or 0.75%, to 2,320.74.

The Fed said economic data will determine future action. "Some further policy firming may yet be needed to address inflation risks," the Fed said in a statement, adding the word "yet" to the language from its Mar. 28 statement. This word gives the Fed more flexibility, says Action Economics.

The statement leaves the door open to another 25-basis-point hike at the June meeting, some analysts say. "We think the economic and inflation data will push the Fed to make that rate move in June," says John Ryding, chief U.S. economist at Bear Stearns. "On the tone of the statement, the discussion of policy was more linked to the Fed's assessment of the economic outlook than was previously the case."

Other analysts say the statement was more hawkish than expected. "It appears the Fed is leaning toward another rate hike at the June meeting, but we believe that a slowdown in the economy this quarter will still allow the Fed to pause when it meets again on June 28-29," says Joseph LaVorgna, chief U.S. fixed income economist at Deutsche Bank. "The economic data take on paramount significance, which is why tomorrow's retail sales report is so important."

On Thursday, April retail sales are expected to increase 0.9%, says Action Economics. Also on the economic docket, initial jobless claims are seen easing 2,000 to 320,000 for the week ended May 6.

Before the Fed's decision, earnings news was front and center Wednesday. Tech bellwether Cisco (CSCO) was lower after the networking equipment maker reported a slight drop in fiscal third-quarter profit due to expenses related to its acquisition of Scientific-Atlanta.

On the positive side, Disney (DIS ) was higher after posting a 12% rise in second-quarter profit, boosted by strength in its ABC broadcasting unit.

Among automakers, Toyota (TM ) was modestly lower after the Japanese company said its fourth-quarter profit rose 39%. Competitor DaimlerChrysler (DCX ) rose on an upgrade from hold to buy at Deutsche Bank.

China's biggest Internet search provider, Baidu.com (BIDU ), was up sharply on better than expected first-quarter results.

Retail chain Federated Department Stores (FD ) was lower after posting better-than-expected first-quarter earnings on flat same-store sales.

Among other companies in focus, H&R Block (HRB) was lower after guiding its 2006 profit downward. The tax preparer said total clients served in U.S. retail offices for the 2006 tax season fell 2%.

Companies set to report earnings Thursday include cable giant Viacom (VIA ) along with retailers JCPenney (JCP ) and Kohl's (KSS ).

In the energy markets Wednesday, June West Texas Intermediate crude oil futures rose $1.44 at $72.13 a barrel, despite weekly inventory data showing an unexpected increase of 300,000 barrels. Meanwhile, Iran's President Mahmoud Ahmadinejad rejected Western concerns over its nuclear aspirations as "a big lie."

European markets finished lower. In London, the Financial Times-Stock Exchange 100 index fell 22.2 points, or 0.36%, to 6,083.4. Germany's DAX index lost 22.34 points, or 0.36%, to 6,118.38. In Paris, the CAC 40 index declined 33.91 points, or 0.64%, to 5,278.27.

Asian markets finished mixed. Japan's Nikkei 225 index slid 238.98 points, or 1.39%, to 16,951.93. In Hong Kong, the Hang Seng index fell 53.4 points, or 0.31%, to 17,080.59. Korea's Kospi index edged higher 0.65 points, or 0.04%, to 1,451.09.

Treasury Market

Treasury yields recovered from session lows after the Fed statement. Prices for 10-year Treasury notes edged higher to 95-08/32 with a yield of 5.12%, while 30-year bonds rose to 89-21/32 for a yield of 5.19%.

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May 9, 2006
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Dow Hits Six-Year High Ahead of Fed

Markets awaited the Federal Reserve's statement on interest rates coming Wednesday. Also in focus: Dell and GM

Stocks finished mixed in light trading Tuesday, weighed down by a profit warning from Dell (DELL ) but bolstered by General Motors (GM ). Caution hung over the market ahead of the Federal Reserve policy statement Wednesday, says Standard & Poor's Equity Research.

The Dow Jones industrial average rose 55.23 points, or 0.48%, to 11,639.77, a six-year closing high. The broader Standard & Poor's 500 index edged higher 0.48 points, or 0.04%, to 1,325.14. The tech-heavy Nasdaq composite slipped 6.74 points, or 0.29%, to 2,338.25.

Some analysts say it doesn't matter if the Fed has to raise interest rates, as long as inflation remains under control. "With 75 points on the S&P left to go before we reach our 1,400 target for the year-end, we are staying invested," says Henry McVey, chief U.S. investment strategist at Morgan Stanley. "Controlled inflation is a key component of our call, and if it turns out that the Fed is behind the curve and inflation is not controlled, that would undo our bullishness."

Investors were contemplating earnings news Tuesday. Dell (DELL ) was lower after the computer maker cut its forecast for first-quarter earnings and revenues. Chipmaker Intel (INTC ) was also down on the news.

On the positive side, General Motors (GM ) led the Dow higher after restating its first-quarter earnings. Deutsche Bank boosted its rating on the stock from sell to hold.

Fast-food chain Chipotle Mexican Grill (CMG ) was higher after the company reported higher-than-expected earnings and a 19.6% jump in same-store sales.

Amusement-park operator Six Flags (PKS ) was higher despite reporting earnings that fell short of analyst estimates.

Meanwhile, Fluor (FLR) was higher after the construction services company reported unexpectedly strong earnings and raised its outlook for fiscal 2006.

After the close, Cisco (CSCO ) and Disney (DIS ) were among companies set to post quarterly results. Federated (FED ) and News Corp. (NWS ) will report earnings Wednesday.

M&A action continued. Swiss bank UBS (UBS ) reached a deal to buy Brazilian financial services company Banco Pactual for up to $2.6 billion.

Elsewhere, telecom giant Verizon (VZ ) reportedly made a $38 billion bid for the stake it doesn't own in Verizon Wireless.

On the economic docket, wholesale sales rose 0.7% in March, while inventories rose 0.2%. The report, while solid, won't affect the markets, says Action Economics. Investors were also awaiting the Fed's next interest-rate decision Wednesday, as well as Thursday's reports on March business inventories, April retail sales and weekly jobless claims numbers.

The Fed will likely raise the federal funds rate by 25 basis points to 5%, and keep its options open for the June 28-29 meeting, analysts say. However, Fed policymakers will need to remain wary of inflation, says Action Economics.

In the energy markets Tuesday, June West Texas Intermediate crude oil futures closed up 92 cents at $70.69 a barrel amid Iran worries.

European markets finished higher. In London, the Financial Times-Stock Exchange 100 index rose 48.5 points, or 0.63%, to 6,105.6. Germany's DAX index gained 12.74 points, or 0.21%, to 6,140.72. In Paris, the CAC 40 index added 29.78 points, or 0.56%, to 5,312.18.

Asian markets finished lower. Japan's Nikkei 225 index fell 100.76 points, or 0.58%, to 17,190.91. In Hong Kong, the Hang Seng index slid 167.8 points, or 0.97%, to 17,133.99. Korea's Kospi index slipped 1.79 points, or 0.12%, to 1,450.44.

Treasury Market

Treasury yields retreated from session highs after a modestly well-bid three-year note auction, says S&P MarketScope. Prices for 10-year Treasury notes fell to 95-06/32 with a yield of 5.13%, while 30-year bonds dropped to 89-12/32 for a yield of 5.2%.

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May 5, 2006
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For Whom Toll Tolls

Luxury homebuilder Toll Brothers' lower sales outlook might not signal a bursting bubble. But is the air leaking out gradually?

To housing bears, the latest news from Toll Brothers (TOL ) might have seemed like a dead canary in a coal mine. On May 5, the luxury homebuilder announced lower expectations for fiscal 2006 sales and a 29% decline in the value of orders for its fiscal second quarter, which ended Apr. 30.

On closer inspection, the housing market may not be in toxic territory, however. Toll Brothers' outlook probably isn't a sign of a housing crash, analysts say. Rather than pop like a bubble, the housing boom will more likely wind down slowly -- which could still have serious repercussions for the U.S. economy.

UPPER END.  Investors, for their part, were taking the Toll Brothers news in stride. Shares of the high-end homebuilder and its peers rose after a milder-than-expected jobs report. The data spurred speculation the Federal Reserve might soon stop hiking interest rates, which would keep a lid on mortgage rates Toll Brothers finished up about 4%, rising by $1.21, to $30.85. Other homebuilders, such as Centex (CTX ), D.R. Horton (DHI ), and Pulte Homes (PHM ), were up between 3% and 4% (see BW Online, 4/20/05, "Why Housing Looks Rickety").

For one thing, Toll's sales guidance didn't change all that much. The Horsham (Pa.) company projected it would deliver between 9,000 and 9,700 homes in fiscal 2006, a reduction of just 200 from its prior forecast. Taken from the upper end of the range, that's a change of only 2%. Toll Brothers also said the value of its second-quarter signed contracts dropped to roughly $1.56 billion, from $2.2 billion a year earlier.

Markets were already anticipating such declines, some analysts say. Standard & Poor's equity analyst William Mack says the announcement hasn't changed any of his 2006 estimates for the company. "It's pretty much a nonevent," Mack says. "We had expected the slowdown that we're now seeing play through." He maintains a four-star, or buy, rating on the stock.

SOFTER DEMAND.  In a conference call, Toll Brothers CEO Robert Toll sounded an upbeat note while acknowledging weaker demand, as the company enters its ninth straight month of slower sales. "We do not believe this slower market is the beginning of hard times," Toll said. "That is too inconsistent with our sales in several markets and with several new community openings."

The recent news is only the latest drip of weaker data trickling out from Toll Brothers since late last year. Indeed, if there was an unofficial end to the housing shares boom, it was on Nov. 8, 2005 (see BW Online, 11/9/06, "Housing: Red Alert, or a Wake-Up Call?"). That's when Toll Brothers warned of "some softening of demand in a number of markets." Shares tumbled 12%, closing at $33.91, and the fallout also beset stocks in related industries, from retailer Home Depot (HD ) to appliance maker Whirlpool (WHR ).

Bears had their day again earlier this year. On Feb. 7, Toll Brothers said its orders dropped 21% from a year earlier for its first fiscal quarter, which ended Jan. 31 (see BW Online, 2/7/06, "Is the Bell Tolling for Housing?").

OIL PRICES.  As a luxury builder, Toll Brothers may be situated differently from its competitors. On Apr. 10, JMP Securities downgraded the stock from market perform to market underperform, citing weak demand. "We are concerned that the demand for luxury homes is more discretionary," analyst Alex Barrón wrote.

Still, Toll Brothers isn't the only builder seeing business soften. On Apr. 11 the National Association of Realtors projected existing-home sales to fall 6% this year, to 6.65 million, from 7.08 million last year. New-home sales are expected to drop 10.9%, to 1.14 million, from 1.28 million in 2005. "We'll probably see sales ease a little bit further due to the increase in mortgage interest rates, but pretty well stabilizing," says Walter Moloney, a spokesman for the real-estate trade association, which is set to update its forecasts on May 9.

A decline in real-estate values could weaken the U.S. economy, where home equity has filled the gap between income and consumption, according to Morgan Stanley chief economist Stephen Roach. "The U.S. housing market has been pushed into bubble territory," Roach wrote on May 5. "In late 2005, fully 55 metropolitan areas were experiencing house price inflation of 20% or higher." He indicates that rising rates and surging oil prices could provide the pin that bursts the balloon.

TURNAROUND TIME?  Meanwhile, not all the figures are so gloomy. In April, real estate showed the fastest growth in new business activity among 14 service industries, according to the Institute for Supply Management's report on the non-manufacturing sector, issued on May 3.

Homebuilders may eventually be poised for a turnaround, some analysts say. "The rapidity of the decline in earnings and margins back to a more sustainable level of demand is likely setting the stage for the builders to experience a significant multiple expansion once the dust has settled," Citigroup (C ) analyst Stephen Kim wrote in a May 3 report. He has a buy rating on homebuilders, despite forecasting modest earnings declines through fiscal 2007.

Toll Brothers' lowered sales guidance might be the most recent indicator of a gradually slowing housing market. But that's not the same as a popped bubble -- or a dead canary.

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BusinessWeek.com
May 5, 2006
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ETFs: Sliced, Diced, and Razor-Thin

These exchange-traded funds are super-specialized and promise new opportunities. But are they right for you?

There are new exchange-traded funds in town. The Barclays' iShares Silver Trust (SLV ) tracks a hot commodity, while the First Trust Advisors IPOX-100 Index Fund (FPX ) is a collection of the latest IPOs. The latest ETFs tap previously untouched niches and make exotic investment plays available to ordinary investors (see BW Online, 3/27/06, "Funds to Cover Every Angle"). While they can jazz up portfolios, most investors should think twice before buying.

ETFs, baskets of securities that trade throughout the day like stocks, are no longer a low-cost way to get exposure to broad indexes. Assets in these funds swelled to $321.3 billion at the end of March, up from $151 billion at the end of 2003, according to the Investment Company Institute (ICI), the mutual-fund industry group. While the broader mutual-fund industry has increasingly come to embrace simplicity and diversification, the trend in ETFs has been a move toward greater sophistication and smaller industries.

WIN BIG, LOSE BIG.  Two sector-specific ETFs have been among the year's top performers. PowerShares WilderHill Clean Energy (PBW), which invests in companies promoting clean energy, has beaten the Standard & Poor's 500 index by 36.81% this year through Apr. 30. PowerShares Water Resources (PHO ) has outpaced the index by 15.9%. But both carry expense ratios of 0.6% -- hefty for ETFs. "If you're right, you will make a lot of money," ETFGuide.com publisher Ron DeLegge says of niche ETFs. "But if you're wrong, you might lose a lot of money."

With memories of the ill-fated late-1990s explosion of Internet funds still fresh, some analysts don't recommend specialized ETFs. "In the long term, the record shows that more expensive, more volatile, more narrowly focused funds don't do a very good job of serving shareholders' interests," says Morningstar (MORN ) ETF analyst Dan Culloton. Unlike traditional no-load mutual funds, ETFs carry a brokerage commission charge each time investors make trades, so they don't make sense if you're putting money away gradually.

Meanwhile, fund managers are serving even thinner slices of pie. State Street Global Advisors, the second-largest ETF shop behind Barclays Global Advisors, recently released a trio of ETFs focusing on individual industries: SPDR Biotech (XBI ), SPDR Homebuilders (XHB ), and SPDR Semiconductor (XSD ). "A lot of investors are looking for industry-specific plays, moving down from the sector plays," says Paul Mazzilli, director of ETF research at Morgan Stanley.

Fund companies aren't stopping there. In February, a new joint venture called Ferghana-Wellspring filed with the SEC to launch 12 ETFs. Dubbed "DAISies," for 'D' arrayed investment securities, the ETFs would each track an index concentrated on a different subsector of the health care industry. There would be an ETF for cardiology, another for ophthalmology, two ETFs for cancer, and so on. Ferghana-Wellspring is a joint venture between biotech-focused investment bank Ferghana Partners and Wellspring Partners, a financial-services entrepreneurial group.

'FAT CENTER.'  The Ferghana-Wellspring approach offers investors increased precision, says Bill Kridel, executive chairman and founder of Ferghana Partners. Rather than investing in giants like Amgen (AMGN ), Genzyme (GENZ ), Merck (MRK ), and Pfizer (PFE ), the DAISies would focus on "the fat center of innovation and growth," Kridel says. "This means you can slice and dice as an investor very finely," he says.

ETFs allowing ordinary investors to tap exciting, up-and-coming technologies aren't completely new. Launched late last year, the PowerShares Lux Nanotech Portfolio (PXN ) invests in nanotechnology shares like Biosante Pharmaceuticals (BPA ) and Veeco Instruments (VECO ) (see BW Online, 4/17/06, "How to Invest in Nanotech"). The $113 million fund has beaten the S&P 500 index by 11.5% this year through Apr. 30.

At the same time, other funds are finding a niche investing in the newest public companies. Kicked off on Apr. 13, the First Trust Advisors IPOX-100 Index Fund (FPX ) aims to reflect the market for U.S. initial public offerings, in the wake of closely-watched IPOs by companies like Chipotle Mexican Grill (CMG ) and doughnut seller Tim Hortons (THI ).

YOUR STYLE.  The fund invests in the 100 largest IPOs by market cap, buying the new stock on the seventh day after the IPO and selling it on its 1,000th trading day. The fund follows less than a year after Van Kampen's more narrowly focused IPOX-30 Index Portfolio, which is a unit investment trust, not an ETF.

Then there are ETFs that concentrate on styles. Rockville (Md.)-based Rydex Investments on Mar. 7 unveiled six Pure Style ETFs, which home in on either growth or value among small-, mid-, and large-cap stocks. The funds track indexes that screen out stocks with both value and growth statistics, which may increase volatility.

ETFs have also picked up on the commodities craze. On Apr. 28, Barclays Global Investments launched the first ETF focusing exclusively on silver. Barclays' iShares Silver Trust finished its first day of trading up 7% at $138.12, with a volume of 2.342 million shares. Its 0.5% price tag is higher than the 0.4% expense ratio for both its existing gold ETF, iShares Comex Gold Trust (IAU ), and rival State Street's streetTracks Gold (GLD ). Still, some analysts, among them PIMCO Chief Investment Officer Bill Gross, warn against buying metals now that prices have already soared.

NOW WITH LEVERAGE.  For investors seeking a more general commodities fund, Deutsche Bank's (DB ) DB Commodity Index Tracking Fund (DBC) opened in February. It's the first ETF to invest in a basket of futures on crude oil, heating oil, gold, aluminum, corn, and wheat. But it costs a steep 1.3%. Another ETF investing in crude futures, Victoria Bay Asset Management's U.S. Oil Fund (USO ), opened Apr. 10. It has an expense ratio of 0.5%.

The biggest new wrinkle for ETFs could be the use of leverage, or more sophisticated derivatives, options, and debt securities commonly used by hedge funds. ETFs using leverage are expected to gain SEC approval this year, according to a report released in April by Tiburon (Calif.) financial services consultancy Tiburon Strategic Advisors.

For several years, Bethesda, Md.-based ProFunds has been awaiting the regulatory go-ahead for both long- and short-leveraged ETFs. The ETFs would likely carry lower expense ratios than ProFunds' corresponding traditional mutual funds. ProFunds fueled speculation about the funds late last year when the company hired former State Street ETF innovator Gus Fleites as chief investment officer. A ProFunds spokesperson says the company cannot comment on the funds during their registration period.

CHOOSE CAREFULLY.  Finally, industry watchers say ETFs may soon cross into the final frontier: active management. All ETFs currently track indexes, but the SEC could approve actively managed ETFs as early as this year, according to the Tiburon report. "It's not will they be coming, it's when," says Tom Lydon, president of financial advisory firm Global Trends Investments. Still, questions remain about how such ETFs would address transparency, among other concerns.

Investors have plenty of ETFs to choose from. The number of ETFs on the market soared to 212 as of March, up from 119 at the end of 2003, according to the ICI. While more are in the pipeline, some experts think many investors should avoid ones that are highly specialized and cost more than the average index fund. Says Morningstar's Culloton: "Most people can live a long and happy life and be successful investors without a lot of these very nichey funds."

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May 5, 2006
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Dow Hits Six-Year High on Jobs Data

April nonfarm payrolls rose less than expected, spurring hopes the Fed will pause its tightening cycle

Stocks finished higher on heavy volume Friday, buoyed by a milder-than-expected April jobs report. Investors hoped the data meant a break from the Federal Reserve's interest-rate hikes, with focus shifting to the Fed policy statement next week, says Standard & Poor's Equity Research.

The Dow Jones industrial average rallied 138.88 points, or 1.21%, to 11,577.74, a new six-year closing high, paced by General Motors (GM ), Home Depot (HD ) and Disney (DIS ). The blue-chip rose 1.9% on the week and was within 200 points of its all-time high of 11,750.28, reached on Jan. 14, 2000.

The broader Standard & Poor's 500 index added 13.51 points, or 1.03%, to 1,325.76, closing the week up 1.2%. The tech-heavy Nasdaq composite climbed 18.67 points, or 0.8%, to 2,342.57, boosted by Microsoft (MSFT , for a weekly gain of 0.9%.

Investors cheered a surprising employment report Friday. April nonfarm payrolls rose 138,000 in April, well below expectations and the smallest increase since October. The unemployment rate held flat at 4.7%, while average hourly earnings posted a 0.5% gain, up from an upwardly revised 0.3% in March. Despite the unexpectedly low headline number, the report was solid, says Action Economics.

The report should also feed into the Fed's concerns about inflation, some economists say. "There is nothing about this report that can be described as weak," says John Ryding, chief U.S. economist at Bear Stearns. "The trend in both household and establishment job creation remains fairly robust based on the average of the last three months."

The economic calendar remains busy for the coming week. Markets are awaiting the Federal Reserve's policy-setting meeting, April retail sales figures, March data on international trade and business inventories, and more.

In corporate news Friday, San Francisco-based PG&E (PCG ) was higher on a report Warren Buffett's Berkshire Hathaway (BRK.B ) is looking to buy utilities.

Homebuilder Toll Brothers (TOL ) was higher despite trimming its forecast for the number of homes it expects to sell in fiscal 2006.

French drugmaker Sanofi-Aventis (SNY ) was lower after posting a 54% increase in first-quarter profit, boosted by a sale of rights for one product to Pfizer (PFE ).

Elsewhere in earnings, Warner Music Group (WMG was higher after reporting a $7 million loss for its fiscal second quarter. Earlier in the week, the record company rebuffed a takeover offer from rival EMI (EMI.LN ).

On the brokerage front, Boeing (BA ) was higher after Merrill Lynch raised the price estimate on shares of the world's second-largest commercial-jet maker to $97 from $85.

In the energy markets Friday, June West Texas Intermediate crude oil futures closed up 25 cents at $70.19 a barrel, a day after their biggest two-day slide since 2004.

European markets finished higher. In London, the Financial Times-Stock Exchange 100 index rose 54.8 points, or 0.91%, to 6,091.7. Germany's DAX index climbed 73.97 points, or 1.22%, to 6,113.29. In Paris, the CAC 40 index gained 52.7 points, or 1.01%, to 5,286.4.

Most Asian markets were closed for holidays. On Tuesday, Japan's Nikkei 225 index rose 228.06 points, or 1.35%, to 17,153.77. On Thursday in Hong Kong, the Hang Seng index fell 13.05 points, or 0.08%, to 17,013.93. Also on Thursday, Korea's Kospi index rose 5.85 points, or 0.41%, to 1,441.02.

Treasury Market

Treasury yields retreated on the payroll data. Prices for 10-year Treasury notes rose to 95-11/32 with a yield of 5.11%, while 30-year bonds gained to 89-15/32 for a yield of 5.2%.

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May 4, 2006
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Falling Oil Fuels Stock Gains

Crude futures tumbled below $70 a barrel. Meanwhile, major retailers like Wal-Mart posted solid April sales figures

Stocks finished higher Thursday, helped by lower oil prices, firm retail sales and the latest round of earnings reports. Friday's nonfarm payroll report could determine how much further stock averages rise, says Standard & Poor's Equity Research.

The Dow Jones industrial average rose 38.58 points, or 0.34%, to 11,438.86. The broader Standard & Poor's 500 index added 4.4 points, or 0.34%, to 1,312.25. The tech-heavy Nasdaq composite climbed 19.93 points, or 0.87%, to 2,323.9, helped by solid earnings from Expeditors International (EXPD ) and Whole Foods Market (WFMI ).

Technical indicators are fairly upbeat, some analysts say. "We believe the NASDAQ 100 lagged as it is still working off a short-term overbought reading, but the intermediate trend remains positive," says Merrill Lynch chief market analyst Mary Ann Bartels. "The market is considered to be in an uptrend as long the S&P 500 stays above 1260."

April nonfarm payrolls are expected to rise 205,000, which could raise the likelihood of further tightening by the Federal Reserve, says Action Economics. Also Friday, March consumer credit is seen rising $4.5 billion.

Market players were digesting strong April retail sales figures Thursday. Wal-Mart (WMT ), Costco Wholesale (COST ), Pacific Sunwear (PSUN ) and Limited Brands (LTD ) were among retailers beating Wall Street projections.

Abercrombie & Fitch (ANF ), Nordstrom (JWN ) and even recently disappointing Gap (GPS ) also reported higher-than-expected sales.

The technology sector got a boost from Microsoft (MSFT ), which was higher following a decline Wednesday. The software giant announced a new targeted advertising push against rival Google (GOOG ).

In earnings news, manufacturing conglomerate Tyco International (TYC ) was higher after posting a fivefold increase in profit for its fiscal second quarter.

Paper maker International Paper (IP slipped despite posting a first-quarter loss of $1.2 billion.

On the downside, Eastman Kodak (EK was lower after posting a sixth consecutive quarterly loss. The film and imaging company also said it is considering selling its health unit, which includes medical printers and x-ray film.

Financial services company Prudential (PRU ) was lower after issuing lower guidance following an 11% drop in first-quarter profit.

Meanwhile, coffee chain Starbucks (SBUX ) was up after late Wednesday posting a 27% rise in second-quarter earnings.

In broker calls, Franklin Resources (BEN ) was higher after Bear Stearns upgraded the asset manager from peer perform to outperform (see BW Online, 05/02/06, "Franklin: Healthy, Wealthy, and Wise").

Friday's earnings calendar is relatively light. Companies set to report include Warren Buffett's Berkshire Hathaway (BRKA ), Sanofi-Aventis (SNY ) and Warner Music Group (WMG ).

On the economic front, the Labor Department said U.S. first-quarter nonfarm productivity rebounded to 3.2%, from a downward-revised 0.3% fourth-quarter decline. That's a little stronger than expected, but may not have much impact on the markets, says Action Economics. Initial jobless claims rose 5,000 to 322,000 in the week ended Apr. 29, also a little above forecasts.

Separately, U.S. personal income for March was revised lower to an increase of $49.9 billion, or 0.5%, over the same period a year earlier. That's a change from the originally reported gain of $88.8 billion, or 0.8%, due to improperly included Medicare payments.

In the energy markets Thursday, June West Texas Intermediate crude oil futures closed down $2.34 at $69.94 a barrel. A weekly inventory report Wednesday showed supplies unexpectedly rose 1.7 million barrels.

European markets finished higher. In London, the Financial Times-Stock Exchange 100 index rose 26.9 points, or 0.45%, to 6,036.9. Germany's DAX index climbed 70.36 points, or 1.18%, to 6,039.32. In Paris, the CAC 40 index gained 39.76 points, or 0.77%, to 5,233.7.

Asian markets finished mixed. In Hong Kong, the Hang Seng index fell 13.05 points, or 0.08%, to 17,013.93. Korea's Kospi index rose 5.85 points, or 0.41%, to 1,441.02. Japan's Nikkei 225 index was closed for a holiday after on Tuesday rising 228.06 points, or 1.35%, to 17,153.77.

Treasury Market

Prices for 10-year Treasury notes edged lower to 95-01/32 with a yield of 5.15%, while 30-year bonds inched higher to 89-00/32 for a yield of 5.23%.

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May 4, 2006
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The Sweetest Spots on Earth

Eric Barden of Texas Capital Growth & Value Fund sees more gains ahead for small stocks, European companies, and cyclicals

Eric Barden and Mark Coffelt can steer Texas Capital Growth & Value Fund (TCVGX ) to invest in companies of any size, style, or nation of origin. With a world of choices, they have a sizable exposure to international stocks, from Europe to emerging markets. The managers also believe small stocks will keep edging out large ones, thanks to stronger earnings growth and easy access to financing.

Barden and Coffelt look for stocks that are inexpensive compared with their intrinsic value. Top holdings of their fund as of Mar. 31 range from energy company Peabody Energy (BTU ) to staffing outfit Manpower (MAN ) to outdoor-gear marketer Sportsman's Guide (SGDE ). Also in that mix are foreign holdings Korea Electric Power (KEP ), Fresenius Medical Care (FMS ), Nomura Holdings (NMR ), and Rio Tinto (RTP ). In addition, they're betting on growth in Austria and Germany via the iShares MSCI Austria Index (EWO ) and iShares MSCI Germany Index (EWG ).

Co-founded by Barden and Coffelt in 1995, Texas Capital Growth and Value boasts a four-star overall rating from Standard & Poor's. The fund has posted 10-year annualized returns of 14.8% through Mar. 31, vs. 8.95% for the S&P 500 index and 11.93% for its style peers. On a five-year basis, the portfolio's 20.58% annualized return handily beats the benchmark's 3.97%, as well as its peers' 8.85%.

Still, its 1.68% expense ratio is above the 1.45% category average, according to Morningstar (MORN ). The fund also charges a 5.75% front-end sales load.

Barden recently spoke with BusinessWeek Online reporter Marc Hogan about small-caps, energy stocks, and where the market may be headed. Edited excerpts from their conversation follow:

First, tell me about the philosophy of the fund. How does being a multi-cap affect your strategy?
We're a little bit different from most funds in that we don't restrict ourselves to any one particular area of the investment universe. Our primary job for shareholders is to maximize the risk-adjusted return. If this means that we need to have greater exposure to international stocks or small stocks -- or value, or growth -- then that's what we intend to do.

The first thing we do is try to ascertain where the maximum area of strength is in the market: Where's the sweet spot? Then we put our CFAs to good use and try to identify companies within that area that are trading at an adequate discount to intrinsic value.

A homebuilder, for example, at 10 times earnings may be relatively expensive to where that company has traded in the past. By the same token, an HMO company might naturally trade at about 20 times earnings. We're looking for companies that we think are undervalued relative to where they've been historically and relative to what their peer group or a private-market buyer may pay for that company.

So, where's the sweet spot right now?
International. Cyclicals, specifically energy and industrials. And basic materials. If you're not participating in those areas of the market, you're really not going anywhere. Within those sectors, our sense still is that the broad market is definitely outperforming the large-cap stocks, so we are fairly light in what most people would consider the blue-chip stocks (see BW Online, 04/17/06, "Blue Chip Blues").

Does that mean you prefer small stocks?
The primary driver for small-cap or broad-market outperformance relative to the blue chips is how available credit is. How accessible is easy financing for small-cap companies? It's not about interest rates, it's about the quality spreads, or the difference between high yields and Treasuries.

Basically, the benefit to being a blue chip is when times are tough, you can still get financing. Right now, even though interest rates are going up, there's still an abundant amount of liquidity out there. There's really no more efficient entity in the world at translating that liquidity into earnings growth than a small-cap company.

The small-cap story today is about earnings growth relative to large-caps, and that earnings growth is primarily a function of how easy it is for smaller companies to get financing relative to the larger companies. In today's environment, if your credit rating's low, you're still going to get financing.

Won't the Federal Reserve's interest-rate moves have some impact?
We don't really think the Fed matters to that dynamic. It's all about the spreads. When the spreads widen, that's the type of environment where the psychology will definitely be more constructive for blue chips and more problematic for small-caps. But that's going to be very near to a bear market. Large-caps outperform in the tough times. The Fed's taking their foot off the accelerator, but they're not slamming on the brakes.

Energy and commodity prices are rising. How does that affect your outlook?
Well, we definitely want to own energy stocks. We don't see that trend going away anytime soon. Analysts are still somewhat behind the curve in terms of anticipating earnings strength in the energy sector. We'll probably see $80 a barrel before we see $60.

The problem for me is that there's no real increase in supply on oil. You've got prices that are extraordinarily high by historic standards, but we still can't get past 85 million barrels a day in terms of production. As long as that's the case, and as long as demand continues to be so robust, the price has got to go up.

I've got a list of your top holdings. Which ones do you consider particularly noteworthy, and why?
Generally, we're going to like all of them for basically the same reasons. Right now the market wants earnings growth, so there's earnings growth at all these companies. On average, the portfolio's got a 37% five-year historic growth rate and a [price-earnings ratio] of 14. That's the profile we're looking for: undervalued growth stocks.

The top holding right now is Peabody Energy. That's really driven by the Powder River Basin coal. There's a preference for Powder River Basin production right now because it's lower sulfur content. The increase in sulfur-dioxide credits has made it much more expensive for utilities to burn high-sulfur-content coal, and that's driving demand into the low-sulfur-content coal-producing regions.

What do you like about iShares MSCI Austria Index, another top holding?
I love Austria. It's one of my favorite markets in the world. It's giving me developed-market stability, in terms of the political institutions being really established, but it's more emerging-market-type growth. It's more a function of what's going on in Poland and the Czech Republic.

European companies are finding labor to be much less expensive in some of these emerging regions, so they're moving a lot of their production toward Austria and some of the border regions. Austria is really at the crossroads. Germany is on one side, and the Czech Republic and Poland are on the other.

We also own iShares MSCI Germany Index. I'm really excited about Germany as well, because I think it's embarking on a process that's very similar to what the U.S. went through in the early '90s, in terms of downsizing. It's going to become much more productive as an economy over the next couple of years. Europe over the next five to 10 years is really going to be an area of strength in the global market.

Any other trends or sweet spots that we haven't touched on?
I love a lot of the health-care companies long term, but they're not working very well in this environment. Health care is going to be something that performs a little better in a defensive market, similar to consumer staples. We're very underweight consumers in general, both consumer staples and consumer discretionary. That might be the Achilles' heel of this economic environment.

The next big rotation, though, could be the financials. Historically, financials start to do very well once people perceive the Fed's about done [raising interest rates]. I don't know if it's one, two, or three more, but we're obviously closer to the end than to the beginning. At some point you would expect financials to outperform.

How about your market outlook for the rest of the year?
I think the S&P 500 is undervalued. Right now we're in the general proximity of the lowest valuation levels that we've seen in the last 10 years, so I don't see how anybody can call this market overly expensive. Certainly, it's been cheaper before, but not in the last 10 years.

My sense is that earnings growth continues to come in stronger than what people were anticipating. And I wouldn't be surprised to see 1600 by the end of next year on the S&P 500. Generally, I think things are a lot better than people think they are.