Quarterly Commentary:
January 2005

Housekeeping

When we originally started our firm, we chose the name Wealth Management Partners to illustrate the comprehensive nature of our practice and advice. In the last five years, wealth management has become a well-worn catchphrase, and now every stock broker and insurance salesman is a “wealth manager.” Our vanity can only tolerate so much. After much deliberation, and clearly no imagination, we have renamed ourselves Prassas Capital, Inc. We will ask everyone to sign a new Investment Management Agreement with the new entity sometime during the first quarter.

We also have a new web site, www.prassascapital.com. Future commentary will be posted directly to the website. It will remain a work in progress for the next few months, but a considerable amount of information is now available at your convenience. We will regularly add or link to new topics and resource material, within the limits of an increasingly restrictive securities compliance environment.

The Quarter in Review

The Equity market for the fourth quarter, and arguably all of 2004, can be summarized in one word: November. Most money managers, haunted by lousy performance through Election Day, breathed an enormous sigh of relief by Thanksgiving. A fourth quarter gain of 10%, compounded with a 2% return in the first nine months, produced a 12% equity return for the year. Of this total return, November delivered 4.5% and a December returned 3.5%.

As stated earlier, we became increasingly bearish over the summer, reducing our maximum equity exposure in some accounts to about 40% of total assets. New money for the second half of the year was reallocated entirely to adjustable-rate bond funds.

We anticipated, but underestimated, the post-election rally. We are unrepentant. Our perception of mounting equity market risk compelled us to protect capital, and overruled any urge to chase what we believe was a bear rally. In fact, we sold our remaining equity positions throughout the fourth quarter

The price of our adjustable-rate Fixed-income bond funds declined somewhat as funds flowed into the equity market. However, we continue to collect those coupon payments. We sold long-term bond funds throughout the quarter. We closed out all REIT positions by year-end.

The Year in Review

Energy SPDR	47.0%
REITs	35.1
Russell 2000 small cap	18.6
Foreign Equites (EFA)	16.4
S&P 500	9.0
Nasdaq 100 (QQQQ)	8.6
Gold	5.4
Lehman Aggregate Bond Index (AGG)	3.9

Observations of 2004

• In spite of five Federal Funds rate increases; too much cheap money has been chasing too few investment ideas. Most asset classes are too expensive by historical standards.
• Continued low interest rates will lead to sporadic asset bubbles.
• Alternative assets, such as real estate, energy and commodities, and foreign equities, trounced the S&P 500.
• Small-cap stocks and REITS have outperformed the S&P 500 for the past six and five years, respectively.
• Despite the performance in 2003-04, the stock market is still down by 10% for the five year period 2000-2004, as measured by the S&P 500.

Our Hits and Misses

As the Fed embarked on monthly rate increases, and as oil prices skyrocketed, we foresaw a flat-to-declining equity market, with the possibility of a severe downdraft. As such, we set stop-loss limits and gradually re-allocated out of equities and into shorter-term fixed income instruments. We believe it was better to earn a “safer” yield of 5-6%, rather than stretch for much “riskier” capital gains. We made money when we bought long-term bond funds at the depth of despair in May-June. Bond prices recovered, but our goal was to lock in attractive yields with little risk to capital.

We shied from commodities, gold, and energy stocks. These sectors have a historical tendency toward volatility and sudden reversal, and we were not comfortable paying ever-rising prices.

Consequently, we did not fully participate in the equity rally of the fourth quarter. And, yes, our professional vanity is somewhat wounded. However, even in retrospect, we view that rally as irrationally exuberant, and are comfortable with our ultimate decision to emphasize risk instead of reward.

Ruminations on 2005

We start the New Year almost entirely in cash or short-term fixed rate instruments. This certainly violates the diversity principal. However, we abide by our primary tenet of managing risk first, and seeking reward when we perceive low or acceptable risk to capital. Additionally, we cannot buy low when we are always invested. A cash position allows us to buy bargains in a market correction.

Themes

The Equity markets are expensive by historical standards. Bullish sentiment is quite high, as measured by the CBOE volatility index. The S&P 500 is trading at a lofty 21 times price/earnings multiple (and the S&P, weighted toward large-cap stocks, underperformed most indices last year).

The bullish argument for 2005 is that the economy is solidly recovering, and that stocks will be supported by growing corporate earnings.

Baloney. Equity prices are high due to supply and demand – cheap money searching for return in a low-yield environment. In fact, the equity markets now require a robust economy just to justify current price levels. And, of course, as interest rates rise, price/earnings multiples will fall instead of increase. The economy will have to roar back on the order of magnitude of the dot.com era to offset such obstacles.

As such, we believe aggregate equity prices have much less to do with the economy, and everything to do with the cost of money.

Fixed income should arguably be separated into two components:

• Short-term (Federal Funds): We believe the Federal Reserve is a simple-minded creature, and will dogmatically increase rates in 2005, just as it lowered rates dogmatically a few years ago. This will, initially at least, flatten or invert the yield curve.
• Long-term (10-year Treasury): There is a lot of speculation why long-term rates are still so low. Some argue it implies an impending recession; others argue low inflation. Again, we believe it is simply supply and demand. Last month, the Treasury sold $400 billion Treasury bonds; Asian central banks bought $800 billion. Asian purchases are part of the falling dollar equation. When this math changes, long-term rates will rise. And long-term rates drive more economic issues, such as real estate and the bond market.

The Falling dollar has been a dominant theme, propelling the gold and foreign stock markets, and influencing the 10-year Treasury market. Unfortunately, speculating on the falling dollar is the most crowded trade on Wall Street. We believe the dollar will continue to fall in 2005; but at this point, the dollar is so oversold, we are compelled to wait for a rally to re-evaluate alternatives.

Strategy for First Quarter

To oversimplify a complicated world, we believe the investment environment in 2005 will be dominated by the direction of interest rates. Values in almost every asset class have been profoundly enhanced by low and falling rates. Like many, we believe the party is over, and expect rates to rise, possibly substantially, this year, and disrupt any other prevailing trends. If rates somehow continue to stay low, we expect a cycle of speculative bubbles to pop up or melt away.

We agree with herd that the trend of the dollar is downward, which will ultimately result in inflation and rising interest rates. We will look toward foreign stock and bond funds once the dollar rallies and prices become more favorable.

Regression to the Mean

We believe many of the trends of the last few years have essentially played out. We will avoid overbought sectors and reinvest in underperforming assets. We will also wait for a market correction to re-establish positions in the few trends we believe will persist.

We expect to trade more this year, as the emotions of the herd provide the opportunity for our buy and sell points. We will only buy when we can get our price. We will not invest on momentum, overstay or chase a position on the assumption that a trend will continue.

Asset allocation: We expect to reinvest our cash throughout the first quarter. Our ultimate positions and percentages will depend on price and relative value. We expect our equity allocation not to exceed 70%. We will add foreign bond funds and royalty trusts to our fixed-income mix of adjustable rate bonds.

Equities: We believe the small cap trend is over, or at least is too expensive. We will establish a domestic equity position in the S&P 500, which is weighted toward underperforming large cap stocks. A significant portion will be in foreign equity.

Fixed-income: We will stay short. We are comfortable with our adjustable rate funds, but we will not add to them. We will take a position in a few foreign bond funds, to provide stability and hedge against a falling dollar.

REITS have had an exceptional five-year run, culminating in a 35% return in 2004; and in our view are now perhaps the most risky asset class. We have sold all REIT positions.

Energy may have another strong year, particularly given the political instability of the Middle East. We are intrigued with oil and gas royalty trusts. Operationally, these are very similar to a REIT. The investor buys a proportional share in oil and gas property, and receives a share of the revenue. These are currently yielding 8-9%, and have appreciated significantly in 2005. We are buyers if we can meet our prices thresholds.

Tactics for First Quarter

Our Equity target positions are as follows:

• Diamonds (DVY) – dividend-paying Dow Stocks	10% (total portfolio)
• S&P 500 (SPY)	15%
• iShares International (EFA)	15%
• San Juan Basin Royalty Trust (SJT)	10%
• iShares Pacific ex-Japan (EPP)	10%
• iShares Goldman Sachs Nat’l Resources (IGE)	5%

Our Fixed-income target positions are as follows:

Short-term, price stability (20%)

• iShares Lehman 1-3 year Treasury bond fund (SHY). Current yield about 2.3%. Poor yield, but should rise as short-term rates increase. Some short-term holdings are necessary in a rising rate environment.
• Nuveen, Pimco adjustable senior lien notes (NSL, JFR, PFL). Exchange-traded funds, invests in corporate senior lien loans, leveraged by about 30% to enhance yield. Loan rates adjust annually, so price fluctuation in a rising interest rate market should be minimal. Currently yields about 5.5%.

Foreign bond funds (10%)

• Templeton Global Income. This is a closed-end fund, with very little premium and a yield of 4.9%.

Interest rate hedge, mutual fund (5%)

• Rydex Juno fund (RYJUX) is one of the only mutual funds that provide a hedge against long-term interest rates. We have allocated about 5% of total assets for our larger accounts. This fund was flat during the fourth quarter, as long-term interest rates ended 2004 about where they started. We will keep this fund, given our expectation of rising long-term rates in 2005.