A Word From The Advisor
A Roadmap for 2006

As we begin the journey into the New Year, we would like to take this occasion to thank our clients for the opportunity to serve as your investment adviser. To begin the year with a solid foundation, we feel it would be helpful to include a roadmap for investors to navigate through all the news, noise, and data that we are faced with on a daily basis regarding the markets and the economy. Sometimes just knowing the right questions to ask can go a long way in helping to understand the various dynamics that affect the stock and bond markets. Some of the questions that investors have been struggling with would include:

Can I make money on my investments in 2006?

At Oakwood Capital Management LLC, we like to establish reasonable expectations for our clients. We expect both the 2006 stock and bond markets to provide positive results while experiencing volatility, given the components of an unstable oil market, an active Federal Reserve, a softening housing market, and an unpredictable midterm election. Like the majority of investors, we are not counting on a replay of 2003, a bright spot that lit up the first full year of the latest bull market, with the S&P 500 Index, a representative index of the broad market, returning 28.69% in that year. Normal bull markets settle down after their early gains, and that has been the pattern for this current one as well. The average annual change in the S&P 500 Index for the past 50 years is an increase of 10.40%.

Oakwood’s expertise is based on in-depth research and fundamental analysis that allows us to pinpoint and select those stocks and bonds that will appreciate in all types of market environments. We also focus on risk management. For stocks, we control price risk and, to the best of our ability, identify and control operating risk. For bonds, all security choices are subjected to a rigorous array of fundamental and quantitative modeling to validate rate of return expectations, including return variance and horizon analyses. Oakwood’s strict investment discipline and carefully defined investment philosophy for all investment strategies provide our clients with security selection that allows for the maximum total return potential with the minimum amount of risk. We feel that the coming year provides many opportunities for capital appreciation through cautious security selection in our clients’ portfolios.

Why is there so much attention in the media regarding the present shape of the yield curve?

Normally, the yield curve, the graph of interest rate levels across all the various maturities, from the overnight Federal Funds rate to the 30-year Treasury bond, slopes upward, showing long-term rates that are greater than short term rates. This “positive” yield curve typically rewards investors who must wait for the return of their money with the uncertainty of inflation and is usually reflective of economic growth. However, as the Federal Reserve raises interest rates to calm inflation rate fears and to moderate economic growth the yield curve “flattens” and short term and long term rates have little difference between them. If and when short term rates become higher than long term rates, also known as an “inverted” yield curve, it implies the market is beginning to become more confident that the Fed will be successful through its tighter monetary policy, short term inflation is being controlled and an economic slowdown, even to the point of recession, is possible.

Taken in this context, the Federal Reserve, whose primary responsibility is to ensure maximum economic growth with low inflation, must balance economic and inflation barometers to achieve a proper balance. To date, we have seen favorable signs of low inflation, and the Fed’s opinion is that the economy is continuing to growth without moderation. Therefore, we feel that the Fed should be reluctant to lower rates for fear of sparking inflation. At Oakwood, we advantageously position our client portfolios to benefit from the current higher interest rate environment, and just like the Fed, monitor new information to determine future trends.

Why are the housing market and housing prices so important to the US economy?

Approximately one-third of the growth in the economy during the past year is a direct or indirect result of the boom in home construction, sales, and prices. The housing wealth effect operates with long and variable lags. When demand slows, most of the impact is initially felt through rising inventories, not falling prices. After the remarkable run-up of the past several years, homeowners will be reluctant to slash prices. Inventories were remarkably lean at the beginning of 2005, and the rise thus far has only brought them back into rough balance with the current level of sales. There are also long lags from the end of the pricing boom to the weakening of consumer demand. The growth in housing wealth and equity extraction accelerated in the past year. It will probably take some time for the funds already extracted to wash out of the system. Models of the wealth effect typically assume that it takes three years for household spending to respond fully to an increase in wealth. In addition, homebuilders are still reporting large backlogs, so it may also take time for residential investment to slow.

We realize that these are just a few questions that may be on your minds as investors. We invite you to freely communicate to us any questions, comments or concerns that you may have regarding the stock or bond markets, the economy, or any other investment questions as frequently as they come up. We invite you to send your questions to questions@oakwoodcap.com, where a member of our team will be available to respond to your inquiries.