Global Asset Allocation
· What Worked? 
Large Cap equities turned in one of their best performances over the past few years with the benchmark S&P 500 Index increasing 6.70% in the fourth quarter of 2006.  Capitalizing on the themes of a slowing economy, weaker dollar, and benign inflation, Large Cap stocks were able to build on their momentum from end of the previous quarter, with help from a restrained Federal Reserve, to extend their rally pushing the S&P 500 Index higher for the year and moving the Dow Jones Industrial Average into record territory. For the Large Cap multinationals, the weaker dollar, due to the effects of currency translation, helped push profit expectations higher adding a boost to the stocks. 

 Large Cap

Fixed Income

· What Worked?

The fourth quarter was remarkable for the fact that nothing from the economy or from the FOMC had materially changed from the previous quarter. That didn’t stop rates from dropping further with the 5-year Treasury Notes moving as low as 4.39% before pausing long enough to hear the Fed Chairman utter words of caution. During the quarter the recent investments in Government Securities, including modest Ginnie Mae Mortgage exposure in non-taxable accounts, outperformed the corporate bond market. This flight to quality also benefited the short ladders that populate most accounts. With the Fed Target Rate anchored at 5.25%, new cash could extend 3 years which is still providing quality investment at yields over 5%. Municipal Bonds also preformed well as interest rates dropped, helped by a slowdown in issuance and relentless demand for quality insured bonds.

· What Didn’t Work?

When rates decline, the accounts benefit in two ways. First is from having locked into higher yields and second from extending out on the yield curve where risk is rewarded. This is called “reaching for duration” and is a primary drive of sequential returns. Because of the lack of evidence to support Treasury yields below 4.5%, erasing nearly all of the last four Fed rate hikes, the Treasury Yield Curve never steepened during the quarter. This was felt in accounts that are positioned to capture the highest yields, at the expense of sequential returns. And while the condition still prevails, namely that 3-year Bonds pack a higher yield than 10-year Bonds, it’s hard to argue with the strategy. Corporate Bonds also underperformed Treasury Bonds as the economic conditions favored the equity markets for the corporate investment appetite.

· What Next?

The mid-cycle slowdown felt in the last half of the year has played out and is increasingly likely to have a benign influence on the Bond Market. This leaves interest rates too low for comfort and worthy of a pause in investment should signs of growth or employment move appreciably higher. As the year ends, this is already being felt in the Producer Price inflation report and the stable Civilian Unemployment Rate. The overall profile of Fairport Fixed Income portfolios will continue to reflect the long term view that inflation will rise and economic growth will remain at its long term potential, roughly 3%. Although it doesn’t appear that the FOMC is poised to raise rates any time soon, this uncertain environment creates volatility, which in turn brings new opportunities to invest cash from new accounts and from recently matured bonds.

Quality Corporate Bonds and Agencies (Fannie Mae, Freddie Mac) with yields over 5% still look attractive on a relative and historical basis. Since being invested and compounding interest is always better than being in cash, opportunities will be sought to capture favorable swings in interest rates with each subsequent move higher used to also position the accounts a little less defensively.

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Economic Landscape

· What Worked?

Last quarter the prevailing economic themes revolved around a nearly synchronized economic slowdown. Beginning with modest softening in the measurements for Unemployment and Job Growth and ending with offsetting results between Producer and Consumer Inflation measures, it was also widely shared to be headed for a “soft landing.” This environment, characterized as a mid-cycle slowdown, played into the Fairport view that the economic backdrop in the U.S. was sustainable because the necessary ingredients, growth in global savings and lower interest rates, would prevail to stave off unconvinced Central Bankers from raising interest rates. It worked; driving optimism that the Fed might even lower rates in the foreseeable future pushed bond yields below levels not seen since the beginning of this year. And that, in turn, reduced costs related to corporate restructuring, resulting in higher profits and favorably impacting equity price behavior.

· What Didn’t Work?

Further rate hikes from the Federal Reserve Board became a distant memory, but the Fed Chairman declined to share the optimism and no matter how much they tried, investors couldn’t ignore it. The primary concern is inflation, and although the Fed Governor provided little evidence of its pressures, there were signs of it throughout the quarter. Mostly driven by commodity inflation, the global economies that have themselves become more efficient managed to keep prices bound to a range. But the realities of living within a supply-side universe that promotes cheap currencies and other export friendly fiscal schemes outweigh the benefits of those efficiencies. In the U.S. the broad corporate restructuring, conservative guidance, and industry friendly government policies have improved profitability but have also mired productivity, as measured by Capacity Utilization, at worrisome levels. These factors together provide a historical precondition to higher inflation. Likewise as the global capital markets revel in the current high profit/low inflation environment, the asset inflation they produce will also provide weight to the currently developing debate.

· What Next?

The best evidence that the current mid-cycle slowdown won’t develop into a full blown recession is provided by the way it unfolded. The concerted effort of Global Central Bankers to raise rates in the competitive race to stave off inflation, first in the U.S. then Europe and finally much of Asia/Pacific, paid off in moderating growth. However most of the world also showed willingness to raise local interest rates in order to take liquidity out of the markets held over from the massive flood of cash used to stem deflation in the early part of the century. Much of this excess liquidity is still around however and finding its way into the markets, particularly those emerging economies of the European Union.  Does this create future worries? Absolutely. But with China, and particularly India, at relatively early stages of their respective economic renaissance, excess inflation is also being sopped up from economies grappling with excess capacity.

There is also Congress to convene in the New Year led by the newly elected Democratic Party that is promoting legislation that promises some deficit busting ideas. Although probably met with suspicion, the rhetoric would nonetheless reflect favorably on the currency perhaps providing a cyclical bounce next year in the face of global pessimism towards the greenback. Dollars could find a home in the markets, providing a temporary disinflationary lift to the economy and giving the consumer and corporations fresh reasons to invest. Although this could mitigate returns in Europe, Asia/Pacific strategies should benefit, especially Japan. Fluctuations in Industrial Production and National Purchasing Manager trends will hold down GDP; flexible tax strategies and avoidance of protectionist philosophy would also help, but run counter to historical Party behavior.  And as long as the yield curve remains inverted, the Fed is also less likely to stray from its current posture of “wait and see.”

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Personal Finance

Evaluating the Need for Insurance in Retirement

Once regarded as time to sit back, relax, and enjoy the fruits of a lifetime of labor, retirement increasingly comes with its own unique set of concerns.  As so much of what will happen is unpredictable, outliving your money becomes a tangible fear. Although you may improve your situation by taking good care of your health and living without extravagance, you should be adequately covered against unforeseen losses with the right kinds of insurance.

If you think of insurance only as a product to be bought and focus entirely on its costs, you may consider it a luxury you cannot afford.  When regarded as a vehicle for managing risk—at a time in your life when you probably will be more vulnerable to the risk of substantial losses and less able to recover quickly—certain types of insurance can be considered necessities while others can be viewed as optional. During retirement there are three major risks: risks to health, longevity, and to property. By addressing these risks before the age of retirement, you will not only feel more prepared for the unexpected, you’ll look forward to enjoying life as a retiree.

NECESSITIES

Medicare supplement (Medigap) or Medicare Advantage insurance. This coverage helps you to pay Medicare deductibles and the portion of hospital and medical charges that are approved by Medicare but not paid by it in a year when your total hospital and/or medical charges are high—something that can happen when you get older.  Those who are willing to pay more to have a greater choice of services generally choose a Medigap policy.  Those who prefer to save money and use a limited pool of medical service providers might prefer to use the Medicare Advantage program.

Prescription drug coverage. At a time when your need for prescription drugs may grow (on average, those in their fifties take three prescriptions, those in their sixties take six prescriptions, and those in their seventies take twelve prescriptions), be sure that you have insurance to cover a substantial share of those costs. In some cases, a retiree will have the choice of using a prescription drug plan offered by a former employer. In other cases, a retiree’s only choice will be to sign up for the new Medicare Part D drug plan. The latter is a voluntary program.

POSSIBLE NECESSITY

Long-term care (LTC) insurance. This insurance is designed to help you to meet the high costs of a nursing facility, assisted living, and/or home care that you might incur if and when you are not able to handle the activities of daily living such as bathing and dressing.

While LTC insurance might not be for everyone, it is very important to evaluate such insurance while you are young and healthy, generally in your early fifties. The cost of this coverage is based on your age and health at the time you apply for coverage. By waiting to consider LTC insurance, many people risk the onset of health conditions that may subject them to higher risk classes with higher premiums, or, even worse, may make them uninsurable for LTC insurance. One of the biggest mistakes made when purchasing LTC insurance is to inadequately cover for inflation of LTC costs. LTC insurance can be purchased as an employee benefit, through an association or individually. Group plans often provide discounts or underwriting concessions.

OPTIONAL
Additional life insurance. If you have sufficient life insurance coverage—under a group and/or individual policy—and/or financial assets to provide for your spouse and/or other beneficiaries, including enough to help them during the first year after your passing, you probably won’t need additional life insurance coverage. If not, shop among strong insurance companies for the plan that best meets your personal needs and is priced reasonably.

CONTINUING COVERAGE

In retirement, of course, you must maintain and budget for other insurance policies—such as for your home and cars—because retirement does not change your need to protect yourself against the risks of fires, floods, natural disasters, accidents, or other potential causes of losses.  However, you should examine these policies to see whether you should add or delete anything—or raise or reduce the values of specific items such as jewelry or electronic equipment. You may find that you are still paying a premium for an item that you disposed of years ago. It’s always a wise move to reevaluate your insurance needs as you transition into retirement.

January 2007— This column is produced in concert with the Financial Planning Association, the membership organization for the financial planning community, and is provided by Gregory P. Althans, a local member of the FPA.