Well, here we are at the start of another new year and once again we ponder about what's in store for 2005. But, before we attempt to sort out the future it might make sense to take a look at the headlines on December 31, 2004: (1) "Dollar Declines for a Third Consecutive Week Against the Euro and Yen on Manufacturing, Jobs Reports." (2) "U.S. Two- Year Treasury Note Declines, Capping its Worst Year Since 1999." (3) "U.S. Stocks Rise for Second Straight Year." Against the dollar, the Euro went out at 1.35 while the Yen finished the year at 102.71, the two-year and ten-year were 3.07% and 4.22% respectively, and stocks closed out 2004 as follows: The S&P 500 at 1211.92, up 9%, the Dow at 10,783, up 3.1%, and the NASDAQ at 2,175, up 8.6%. Most of the stock market gains came in the fourth quarter amid a drop in oil prices and the re-election of President Bush. So, with all said, some good news, some bad news, and some mixed news. Looking forward, we think 2005 will shape up nicely as time passes but there are three things that will have a lot of impact on how the year unfolds.

Let's start with interest rates which seem to be clearly on everyone's mind as number one. We believe it is likely that the Fed will raise rates modestly throughout the year with the funds rate projected to rise 75 to 100 basis points. But, wait a minute. Does this mean that bond yields will rise in tandem with Fed policy? Well, won't they? Last year the Fed raised rates by 25 basis points 5 times going from a funds rate of 1% to 2.25%. Bonds started out last year looking like this: 3 month=1%, 2's=1.82%, 5's=3.35%, 10's=4.25% and 30 year at 5.07%. (The consensus was for 10's to end the year at something above 5.00 %.)

Now, here we are a year later and this is what we look like: 3 month=2.21%, 2's=3.07%, 5's=3.61%, 10's=4.22% and 30 year at 4.82%. And, the consensus is for the 10 year to rise to 5.10% by the end of the year 2005. The bottom line of all this is that we may very well have a repeat of 2004 with the Fed working the short end of the yield curve with little influence on the longer end. In short, we believe the economy will continue to expand at a rate between 3.5% to 4.0% while inflation remains tame. The yield curve will tend to flatten further as the Fed raises short term interest rates beginning at its February 4th FOMC meeting.

The economy itself takes the number two spot. The pundits are quick to point out that we have come too far and the economy will run out of gas and sputter back to a slower growth rate while Japan and Europe will somehow leap from nowhere to somewhere. Most forecasters are suggesting a U.S. growth rate for 2005 of 3.5%, and while that is not bad, it is interesting to note that these forecasts have always been on the short side. As far as employment, we are of the opinion that 2005 will be a better year than 2004 as new jobs will exceed 2.5 million. Keep in mind that once new employment starts to take hold, it will feed on itself leading to more new jobs and more spending. So, are things perfect now? No, far from it. But they are a lot better and will get better throughout the year.

This leads us to the stock market which we think is the catalyst that will propel us to a brighter future. There seems to be a lot of conversation about how the equity markets are running low on fuel and approaching their highs for this cycle. Our problem with this scenario is that these folks who would like us to believe this are the same ones that missed the train ride beginning both October 2002 and October 2003, and now they want to be the first in calling the end of higher prices. Sure, it will be bumpy along the way but with record amounts of cash held by corporations, coupled with respectable dividend payouts, it seems almost certain that investors will find U.S. stocks a good place to place funds.

Bottom line: We think that 2005 will be an OK year for bonds but a great year for stocks. M&A activity will continue to be robust, energy prices will soften, and the real economy will do better.