Market Commentary

Optimism, Realism

January 2011

"A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty" – Winston Churchill

We write in the happy circumstance of your portfolios being up strongly for the second straight year, in most cases recovering the decline in portfolio values you experienced from late 2007 to early 2009.

We have not exactly been sanguine about the intermediate-term prospects for the U.S. stock markets - indeed, some would characterize us as downright pessimistic about that. We continue to believe that the stock market is in a long-term bear cycle that will probably last several more years. Nonetheless, your portfolios are currently structured with the aim of garnering a positive return even in what we think will continue to be an unpredictable environment.

Your portfolio performance over the past year has been accomplished through a series of cautious yet opportunistic investments in both bonds and stocks. Carefully screened and selected international bonds have performed well while offering more stability than the overall stock market. Opportunistic investments in the short-term debt of restructured companies helped your portfolios along. Savvy concentrated sector and country investments in stocks, particularly in financials and in Japan, have made a contribution to overall return. Smaller allocations to gold, high-yield bonds, cash, and foreign currency investment also played a part, adding both stability and performance to your portfolios. This diverse mix of careful asset selection enabled performance to largely keep pace with the stock market advance, even though overall stock allocation in your portfolios is materially below 50%. Looking ahead, we expect this diverse positioning to cushion your portfolio when we hit the next air pocket in what we still think is a long-term bear market.

We are glad that your assets have recovered to the point where the impact of the market decline is gone, and note that the S&P 500 is still 19% below the high it reached in October 2007.ⁱ However, we remain focused on our absolute goal of your positive return target over a long period of time, and we consider that goal to still be attainable.

What's next? Here in the U.S., we worry that, in the near term, stock market sentiment is overly bullish considering the underlying fragility of our financial system and our economy. In our experience, these types of bullish runs can last awhile, even when fueled more by optimism than strong fundamental underpinnings. Your portfolios have benefited from this phenomenon this fall, and if it continues you will continue to benefit but also most likely not keep pace with what we consider at this point to be an overly ebullient stock market. Because no one can know the short-term timing aspects of this, we stick to the fundamentals and to our long-term objectives for your portfolios.

A few years out, we worry about adverse consequences from an increasingly wide disconnect between economic classes in our country that will pressure this already fragile economic recovery. Inflation will add pressure too - while we don't see it appearing just yet, as the data points continue mostly deflationary, inflation will be an inevitable consequence of our fiscal policy here in the U.S. We also have concerns about overheating emerging economies that could be inflationary. We will adjust and prepare your portfolios accordingly as these larger and longer-term economic issues evolve.

Across the financial planning issues you face, we suggest a similar strategy: adjust and prepare. We look forward to continuing our work with you with the goal of building for you a sense of control and positive impact in your financial decision-making. As with your investment portfolios, we aim to help you reach your long-term financial objectives. We have been very impressed with your tenacity and resilience during this period of uncertainty. You have been willing to shift and change your outlook and make new and sometimes hard decisions as we've worked on core planning issues with you over the past several years. We know this is hard work.

William Arthur Ward, an American writer and self-described optimist who also saw combat as a G.I. in World War II, wrote in the last century: "A pessimist complains about the wind. An optimist expects it to change. A realist adjusts the sails." We'll continue to work with you in the coming period to adjust the sails as needed, moving forward in what we know will be a sometimes rocky and sometimes clear course.

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

ⁱSource: Google Finance, 10/12/2007 to 12/29/2010