Market Commentary

Cautious Opportunism

October 2009

"I like restraint, if it doesn't go too far." - Mae West

The long dry summer spell has ended. It's raining here in Berkeley. We write as markets all over the world have continued to enjoy a strong rebound from the lows we saw earlier this year. Your portfolios are up significantly this year and we are glad that the value of your portfolios has risen this year after such a difficult 2008.

As we had surmised, the sky did not fall. But, for awhile, the markets were saying that the sky was falling, and so, it kind of was. This is a subtle and important point. The noted sociologist W.I. Thomas pointed out in 1928 that "the more people perceive something as real, the more real it is in its consequences." The panic of 2008, was, by that definition, very real in its consequences – you saw it in your portfolio reports last year and in early 2009. What we have seen in the stock, bond, and real estate markets since then is a reaction of relief that all risk-taking did not stop to the extent that the world was sent into a kind of economic ice age. From this point of view, the unprecedented government interventions made in economies around the globe during the past year have had the desired impact of preventing the collapse of certain parts of our financial system, both here and abroad. The second-order consequences of these interventions, however, have yet to be fully identified, and that informs our thinking on your portfolios and on your planning every day.

We think it is reasonably clear that we will be in a deflationary environment for some time. This means that the price of things will be flat to down for what we think could possibly be the next one to two years. We tend to be early, not late, to the big inflection points, and we have prepared your portfolios for this. Some investors out there are preparing for inflation. We think it's early. All through the winter and spring, the concerns of Wall Street and Main Street were in sync, and we think that these concerns have decoupled in the last few months. While everyone was worried about unemployment, housing sales, deleveraging, and a retrenched consumer, now it seems only to be the person on the street who is worried about these things. Wall Street has taken heart in what we believe to be quite tepid recovery numbers and investors are truly relieved that the sky is not falling. Animal spirits are back in the markets. Investors are taking risk again, and are off to the next big thing – inflation. We say not so fast. This recovery will be years in the making and we think the ride to recovery will be bumpy, including in the stock markets. Your portfolios are currently structured to be flexible, and are prepared for a number of outcomes. The strength of the recent stock market recovery is real to many people, and so it also will be real in its consequences.

Diving a little deeper into your portfolio performance this year, we note that in many of the stock-oriented funds you own, the managers were busy buying both stocks and bonds earlier this year at lower prices. This has helped your performance in these funds as the market has rallied. We find it laudable that across our client base, while every portfolio is different, most clients' portfolio returns are stock-market-like, even as most clients are invested in a group of assets that hovers in the range of 50% stocks and 50% bonds, gold and cash. We like restraint, as Mae West pointed out, as long as it doesn't go too far. After all, you remain significantly invested in assets whose value will fluctuate and could go down in a bad market. On balance, however, this is a cautiously opportunistic allocation that over the past two years has created the results we set out to accomplish in the first place – better performance than a down market, and lagging performance in an up market –overall contributing to a return with less volatility for you and your families. We continue to target returns that will outstrip inflation, taxes, and fees and so grow your purchasing power over time. We think that we will continue to see volatility as the market struggles with the deflation/inflation question, and think you are appropriately invested at this time.

In the coming years, we think probably at least a year out, inflation is coming. It is simply impossible for governments around the world to push that much new money into the system without creating inflation; as the pace of that new money quickens in economic recovery, things will start costing more. We know that nothing dampens your ability to spend in the out years like inflation. At the right time, we anticipate adding assets such as more gold, more real estate, more stocks, and re-introducing commodity-based positions to your portfolios – just not yet. Of course, we will be in touch, and please be in touch as well with your concerns and questions about your investments and planning.

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

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