WAGNER’S MUSIC IS BETTER THAN IT SOUNDS.

In April the U. S. economy generated 288,000 new jobs versus a consensus estimate of 170,000 new jobs. March’s new jobs figure was revised upward to 337,000 versus the previously reported 308,000. February’s figure was also revised upward.

There have been 1.1 million new jobs in the U. S. in the last eight months. The April unemployment rate was 5.6%, which is well above the level that the Fed considers to be full employment.

After the May 7th report the 10-year treasury yield jumped to 4.77%, its highest yield since July 2002. Stock investors, not liking the reality of higher interest costs, sold the Dow Jones Industrials down 124 points, or –1.2%.

This reaction is to be expected; however, given time, stocks will rise with much improved earnings prospects in a strong economy.

Since a stronger economy means higher interest rates with concurrent lower dollar prices for bonds, we thought examples of the actual effect on the dollar price of bonds would be helpful and have taken three on-the-run U S treasury bonds as examples. The date of the examples is April 23, 2004.

5-year 3 1/8% bond with 4/2009 maturity:

On 4/23/04 the yield to maturity – “ytm” – was 3.54%, the price was 98.1 and the dollar price per bond was $981. (The dollar price is the price multiplied by 10, and “ytm” means yield to maturity.)

– 4% ytm = 96.0 = $960
– 4.5% ytm = 93.9 = $939
– 5% ytm = 91.8 = $918
– 5.5% ytm = 89.8 = $898

10-year 4% bond with 2/2004 maturity:

On 4/23/04 the ytm was 4.44%, the price 96.5 and the dollar price $965.

– 5% ytm = 92.3 = $923
– 5.5% ytm = 88.7 = $887
– 6% ytm = 85.3 = $853
– 6.5% ytm = 82.0 = $820

30-year 5 3/8% bond with 2/2031 maturity:

On 4/23/04 the ytm was 5.23%, the price 102 and the dollar price $1,020.

– 5.5% ytm = 98.2 = $982
– 6% ytm = 91.7 = $917
– 6.5% ytm = 85.8 = $858
– 7 % ytm = 80.4 = $804
– 14% ytm = 40.0 = $400

On November 15, 1981 the U S Treasury issued 30-year bonds having a 14% coupon. If the above 5 3/8% bond were to yield 14% today, its price would be $400 – a loss of $620 per bond versus the price of the same bond on April 23rd.

The above three examples portray what will happen to bond values, your capital, when interest rates rise.

That was the message in our January 20, 2004 Commentary: “BUT WHAT IF INTEREST RATES RISE?” when we predicted rising rates.

In that Commentary we wrote:” Rising interest rates will result in lower bond prices, perhaps sharply lower bond prices as the interest rates and bond prices move in opposite directions.

We were astounded when we saw the following poll results:

Bethesda, Md. – June 26, 2003 – A survey conducted by Harris Interactive on behalf of ProFund Advisors LLC finds that, although most U. S. investors (57%) believe interest rates will rise in the next two years, nearly two-thirds (65%) are unaware that rising rates generally have a negative impact on the value of bond investments.

In that commentary we also pointed out “The U S economy has been improving in recent months after several very difficult years, and it appears to us that the recovery will be sustainable although there will be the inevitable setbacks.

A better economy equals higher interest rates that are better for bond investors when they can invest at new, higher rates. It is not good for bondholders who presently own bonds having longer maturities and/or lower credit ratings.

Rates, in our opinion, could work significantly higher although they have risen in recent months. Note that the Federal Reserve’s 1% fed funds rate is the lowest since 1958. The Fed has cut its rate 13 times since January 2001.

We believe Chairman Greenspan et al will increase the 1% rate at the Fed’s next meeting.

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From GRANT’S April 23, 2004 issue:

“…. J.P. Morgan Chase winds up with $36.8 trillion in notional value of derivatives contracts and 1.5 million separate and distinct securities positions with 240,000 different pricing series (as it did at the end of the fourth quarter), so be it.”

The fourth quarter ended on December 31, 2003, and $36.8 trillion in numbers is $36,800,000,000,000 – the highest number we have ever seen! It reminds us of the old saw “Think big but pay attention to detail.”

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On May 10, 2004 Citigroup agreed to pay $2.65 billion to settle a class action lawsuit to WorldCom shareholders that could have cost Citigroup $54 billion.

Charles Prince, Sandy Weill’s successor made the decision to settle as “I was not willing to roll the dice for stockholders.”

Further, it was reported that Citigroup would also set aside an additional $6.7 billion litigation reserve for Enron and other cases. Some question whether that is enough.

Jack Grubman, former analyst at Citigroup’s Salomon Smith Barney unit and Bernie Ebbers, WorldCom’s chief executive at the time, were Weill’s head honchos in the WorldCom debacle. They were mentioned in the May 11th front page articles of the Wall Street Journal and the Financial Times, but surprise, surprise, we could not find the name of Sanford I. “Sandy” Weill. How could that omission possibly have happened?

John W. Hamilton
jwh@hamiltonadvisors.com
May 18, 2004

CUSTOMIZED INVESTMENT MANAGEMENT SINCE 1980

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GOLF, ANYONE?

All his life, a most proper and dignified English Barrister Widower with a considerable income, had dreamed of playing Sandringham (one of Great Britain’s truly exclusive Golf Courses), and one day he made up his mind to chance it when he was traveling in the area.

Although he was aware that the club was very exclusive, he decided that he would ask the man behind the desk if he might play the famous course.

The club’s secretary inquired: “Member?” “No sir.”

Guest of a member?” “No sir.”

Sorry,” the secretary said.

As he turned to leave, the Lawyer spotted a slightly familiar figure seated in the Lounge reading the LONDON TIMES. It was Lord Willoughby Parham.

The Lawyer approached Lord Parham and bowing low said: “I beg your pardon, your Lordship, but my name is Higginbotham of the London Solicitors ‑– Higginbotham and Barclay. I should like to ask your Lordship’s indulgence. Might I play this beautiful course as your guest?”

His Lordship gave Higginbotham a long look, put down his paper and pipe and asked:

Church?” “Church of England, sir, as was my late wife.”

Education?” the elderly gentleman asked. “Eton, sir, and Oxford with a Blue and Honors.”

Sport?” “Rugby, sir, spot of tennis and Number Four on the crew that beat Cambridge.”

Service?” “Brigadier, sir, Coldstream Guards, Victoria Cross and Knight of the Garter.”

Campaigns?” “Dunkirk, El Alemain and Normandy, sir.”

Languages?” “Private tutor in French, fluent German and a bit of Greek.”

His Lordship considered briefly, then nodded to the club secretary and said: “Nine holes.

Fore!