Market Commentary

Between Storms

April 2010

"Storms make the oak grow deeper roots." - George Herbert
"Vows made in storms are forgotten in calm." - Thomas Fuller

It's spring, and we are enjoying a brief respite between storms. We are told that more rain is coming. We write with the same sense that this is what is happening with your portfolios: we are enjoying a respite between storms.

We are glad that there is some sunshine on the American economy once again. As we indicated along the way over the course of the last year and a half, powerful government stimulus efforts have prevented a forestalling of economic activity in our country that had they not been implemented, would likely have meant a much worse economic downturn than the one we have experienced. In normal times this type of action would lead to a strong possibility of inflation. Currently, however, there continue to be very strong deflationary forces at work in our economy: people and companies focusing on paying down debt, increased caution of lenders, and a very difficult unemployment situation. In a sense, the government's unusually powerful inflationary forces are doing battle with the economy's unusually powerful deflationary forces. It may look calm, but there's even more than usual happening beneath the surface at this point in time. As powerful as the government stimulus has been, we don't think it will prevail against these very strong forces at work to slow our economy and keep prices flat to down for the next year or even two. Because there is so much going on beneath the surface, we think that there is a very high probability that volatility – up and down both - will once again emerge.

In the stock market, a terrible down period that ended a year ago last March has been followed by a powerful rally. The S&P 500 fell 56% from its peak in late 2007; even with this rally however it still remains 23% down from its high point. At this point most of your portfolios have pulled back to near where they peaked in late 2007. This we conclude is the happy result of our partnership with you: first, prudent asset allocation and strong manager selection on our part, as many of the managers we work with pulled back as they sensed less opportunity, and also went in and bought opportunistically last year when other investors were selling. Second, you have shown fortitude and resilience in sticking with your investment program during a very tough couple of years.

We do think that the stock market and economic environment will continue to be choppy, and have crafted what we think is an appropriate combination of quality, opportunity, and caution in your portfolios. We continue to incrementally tilt your portfolios more internationally, as we think that the U.S. will not necessarily be the center of strong financial asset performance in the coming decade. This means owning reasonably priced stock in U.S. companies that sell their goods and services predominantly overseas, as well as owning the reasonably priced stocks of international companies and some measure of foreign country bonds as well. We are slowing adding somewhat more fixed income investments to the portfolio, particularly with managers who have track records of spotting opportunities available in the fixed income market due to company restructurings or unusual situations that demand strong credit analysis. We are also de-emphasizing commercial real estate even further in your portfolios as they come up for review, particularly after such a powerful rally, as we think the deflationary forces at work in our economy will create a drag on this asset class for some time.

Overall, it is one thing to "beat the market;" it is another thing to grow your wealth in a way that allows you to reasonably meet your long-term financial goals and to feel you can rely on it over time. As a mutual fund manager we work with says, "you can't eat relative return." We focus on real return, believing that only positive returns that get you past inflation, taxes and our fee are what will count for you over time.

In a way, like the oak tree in a storm, your portfolio also has grown some deeper roots during the past two years. Your portfolio has become more focused and concentrated through this crisis and recovery. More importantly, we also think it has become more flexible, and is designed to fit an investment environment in which the unexpected is bound to happen.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

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