2004 was an extraordinary year for the financial markets as investors bought stocks and bonds despite numerous obstacles that historically bring out the bears. The last time the world economies experienced higher sustained energy and commodity prices was in the 1970s, which led to double digit inflation and one of the worst decades for stocks and bonds.

The record US budget and current account deficits caused the US dollar to decline for the third consecutive year but this did not appear to slow down foreign investment into US markets. The US Federal Reserve increased short-term interest rates five times in 2004, and most econometric models forecast that this event would cause lower equity returns. On top of these problems there was an escalation of violence in the Middle East and one of the worst tsunamis in history that devastated coastal areas around the Indian Ocean.

The S&P 500 Index jumped more than nine percent in the fourth quarter despite these hurdles and the equity and fixed income markets produced respectable returns during the year. Why have investors been bullish?

Strong economic growth in the US and Asia bolstered corporate profits, enabling companies to pay down debt and increase dividends. Productivity gains from the Internet, improved telecommunication and new technologies have allowed companies to lower costs and absorb rising commodity prices. Service based economies have also become less reliant on energy and raw material prices.

While the declining dollar has been a headwind for Europe, Japan and other exporting nations, it has helped US competitiveness. Furthermore, most multinational corporations now export from low cost jurisdictions, such as China, whose currency is pegged to the US dollar. US short-term interest rates have risen but they remain at historically low levels while long-term interest rates in the US and Europe declined in 2004. Finally, equity valuations are reasonable relative to the past decade as the 2000-2003 bear market reduced price/earnings premiums.

Looking ahead, the Anchor portfolio managers have collaborated and peered into their crystal ball to forecast what the next year may have in store for investors. The following is a summary of the top ten factors that will impact the financial markets this year based on their analysis:

1 Declining Dollar. In 2001 the US had a $127 million Federal Budget Surplus. Now the US government is swimming in a sea of red ink with the current budget account deficit exceeding $400 billion. According to Bill Gale, an economist with the Brookings Institution, it takes 25 percent of GDP growth just to pay the interest on debt owned by other governments. This, combined with the current account deficit, will slowly force the dollar lower versus other currencies to record lows during the year.

The fall in the dollar will actually benefit manufacturing in the US and will act as a boon to large US multi-national corporations through currency translation gains. In turn the US Current Account Deficit will improve throughout the year and lessen pressure on the dollar. This will also negatively affect importers, as their margins will be squeezed from a lower translated revenue base and higher domestic costs i.e. Canadian miners, foreign manufacturers etc. Average exchange rates for 2005 may be:

USD/Euro $1.35

USD/Pound $1.92

YEN/USD 98

2 Energy Prices. Oil prices will remain, on average, high throughout 2005. Geopolitical tension throughout the Middle East will continue to leave a Terror Premium in the market. India?s demands for energy will likely replace any slow down in China. On aggregate worldwide demand will increase, only continuing to tighten an already tight supply/demand balance. Although Crude Oil prices have been strong in 2004, the fall in the US Dollar has limited the real gains to Petroleum exporting nations. This should fuel increased pressure for OPEC to raise the low end of their target range above $30.

Although current US supply is comfortably above its 5-year average, natural gas prices will remain relatively strong in 2005. Decreases in US natural gas production and continued fuel switching towards natural gas will cause the supply/demand picture to tighten. If we see a cold winter and or a hot summer expect some significant volatility in the natural gas market.

Anchor?s estimated average prices through 2005 should be:

Crude Oil $41.00/bbl

Natural Gas $6.50/mmbtu

3 Geopolitical Risk. There will be a major terrorist attack on US soil in 2005. It is not a question of ?if? but a question of ?when?. Iraq will turn into the ?New Vietnam?. Defence spending will not go away ? in fact it will likely increase in areas such as homeland defense and protection for the troops. Aerospace and defence companies will see continued and new government initiatives to outfit the army of tomorrow. Bush?s ?take the fight to the enemy? stance only increases the chance for greater military spending.

4 Consumer Debt. There has been a massive ?credit-fuelled? leveraging of the American consumer. In fact Americans are now over $10 trillion in debt. Nearly $1 trillion of that is in credit cards. Debt may not show immediate effects but it soon rears its ugly head. High debt and rising interest rates leads to pressure on the consumer and consumer spending that represents two thirds of the US economy. Simply put, the US is running out of money. Maybe the next ?Spitzer? attack will be on the credit card industry to tackle the hidden charges.

5 Real Estate Bubble. Easy credit has helped fuel rising real estate prices. Housing prices will moderate and likely fall in some overvalued locations. Rising variable rates increase the cost of home ownership so the ?buying spree? is over. Orange County, San Diego, Miami, and Las Vegas will see major declines in property value.

6 Health care. Healthcare costs and issues continue to be a hot topic. The increasing average age of the North American demographic continues to drive increased healthcare spending, and research and development. Rising costs will actually contribute to lower earnings growth and slower full-time hiring in the US.

7 Interest Rates. The Fed will continue its slow and steady rise in rates ? never more then 25 basis points at a time. The Fed Funds rate will rise five times and end the year at 3.5 percent. Rising prices from the ?push through? of escalating raw material and energy costs will drive the rising CPI and a three percent inflation rate.

8) Higher Raw Material Prices. The boom in commodity prices is not over. Global demand remains strong. A slow down in China will be moderate. In fact, overall global demand should increase as India and other Asian economies continue to develop at a rapid rate. Many materials (such as copper) have excessively low inventory levels. Commodities offer a great hedge to stocks and bonds as correlation of commodities to stocks and bonds are consistently negative. High raw material prices in 2005 will increase the general costs of prices sold (i.e. they will contribute to rising inflation). Pricing power, however, may not be sufficient to compensate for rising input costs and some companies will feel margin pressure.

9 Social Security. Social security will develop into a major issue in 2005, as the US governments projects a $3.7 trillion shortfall over the next 75 years. Bush will push for private accounts and win. This bolsters the equity market with inflows into equity investments.

10Increased Mergers and Acquisitions. 2005 may be known as the year of mergers and acquisitions. The dramatic fall in the US dollar has made US companies attractive to foreign competitors. S

Slowing growth rates will also force companies to look for external engines for growth, which should translate into more mergers and acquisitions. Look for China to bid for international energy and basic materials companies as they look to secure natural resources to fuel their growth.