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Third Quarter, 2009


Perhaps now even the most pessimistic gloom-and-doomers will have to grudgingly concede that countries around the world are successfully pulling away from Armageddon-like scenarios of global economic collapse. In fact an unusual aligning of economic events has occurred which makes today’s investment environment extraordinarily favorable for global stock markets and for the U.S. corporate bond market as well.

Since all investment markets and global economies are in a continuous state of flux, we know the favorable conditions which we list below won’t last all that long from today but, for the moment (the next six to nine months, perhaps) the big picture investment environment looks very good. At some point, concerns about the magnitude of deficit spending plans for years to come may spook investors but that prospect is not being reflected in today’s investment markets.

Here are some general observations:


1. Inflation at home and abroad is approaching or is already at zero (always with some exceptions) as evidenced by consumer price indices and producer price indices. The Federal Reserve prefers to gauge inflation by the “core price” index which excludes volatile food and energy prices. According to this modified inflation gauge, core rates at home and abroad are also continuing to decline towards zero.

It is quite surprising to observe that inflation expectations are also well contained. It is possible to place bets in the market on the future direction and level of inflation. According to two such indicators which we monitor, inflation over the next ten years is currently expected to range between 1.7% and 2.3% per year.

2. Interest rates at home and abroad are at decades lows enabling businesses, municipalities and national government to lower interest costs as a percent of their revenues. In many cases, including the U.S. government, debt servicing burdens have declined even as debt levels have increased.

3. Most economies around the world are in the early stages of recovery with an unprecedented amount of slack in their manufacturing sectors. As governmental stimulus programs around the world kick into high gear beginning now and continuing through 2010, corporate profitability is expected to dramatically increase for the next one or two quarters. Global economic confidence indicators are already enjoying sharp increases as stock markets around the world continue to rise.

4. Across the country, larger U.S. corporations are awash in cash. The stock and bond markets are very receptive to new securities offerings, and large-scale mergers and acquisitions are on the upswing. We believe these trends will add to a growing investor enthusiasm in domestic and global investment markets.

5. For the year ended June 30, 2020, $1.9 trillion in new treasury securities have been issued. Fears about how the marketplace could absorb all this new debt have, so far, proven to be unfounded. During this recent twelve month period, yields on 2-year, 10-year and 30-year treasuries have declined. Since June 30 the Treasury has embarked on some of its largest bond offerings ever. Treasury yields during the third quarter have nevertheless declined even further. The world is awash in liquidity and growing levels of national debt continue to be funded without any current signs of strain or investor panic.

6. The treasury yield curve, an indicator of future economic growth, is projecting a very positive economic environment in the months ahead. That indicator is substantiated by recent manufacturing surveys which show that new orders, backlogs and prices are rising to the point of economic expansion in the industrial sector.

7. The International Monetary Fund and the World Bank have both recently revised upward their global growth projections for the fourth quarter of 2009 and for all of 2010. Emerging markets stand to reap the most economic benefits from the current environment as their economic growth rates are higher than those of the industrialized world.

We could go on. There are other positive factors at this point in time that back up the argument for this being an unusually attractive investment environment. We are not, however, Pollyannas wearing blinders to shield us from a daunting list of looming problems. We recognize that there are many dark clouds on the horizon that could wipe out investor enthusiasm and return the stock and bond markets to their recent recession lows or below. We are not immune to these concerns. But, to invest client portfolio on the basis of fear about future possible disaster scenarios with indeterminate time frames for their realizations would cause us to remain in treasury bills or money market accounts virtually all the time.

Instead, we invest client money (and our own) on the basis of facts and not on the basis of investment noise, those never ending opinions of people who tell us not only what the future holds but also when to expect it. When the facts change we will adjust client asset allocations accordingly.

Asset Allocation

We are currently maintaining the equity portion of client portfolios near the high end of the permissible range as determined by their Investment Policy Statement. Within the equity portion we continue to move towards a 50% weighting in non-U.S. companies as growth prospects outside the U.S. are frequently superior to our own. In addition, gold and precious metals type holdings are being targeted to represent approximately 5-10% of client portfolios. Some additional comments about gold are presented below. The balance of client portfolios is invested in bonds or bond funds of relatively short maturity.

Investment Returns

We present returns from a variety of indices and investments representative of the types of holdings in client portfolios. Generally speaking, most investment markets experienced their strongest gains of the year during the third quarter. We have presented in the table below the third-quarter numbers for your information. Risk taking was strongly rewarded; near-cash investments such as money markets, CD’s and treasury bills generated the lowest returns while “safe” longer-term government securities fared only slightly better.

                                                                              9 months ending

                                                          3rd Qtr.       September 30, 2020

Money Market Fund Proxy                    0%                      .2%

Russell 3000 Index (US stocks)        16.3%                   21.2%

MSCI EAFE Index (foreign stocks)    19.5%                   29.0%

MSCI Emerging Market Index            20.9%                   64.4%

Lehman Aggregate Bond Market         3.7%                     3.4%

MSCI REIT Index                              35.0%                   19.0%

Gold (Commodity)                              8.8%                   14.2%

Philadelphia Gold/Silver Mining Cos.  19.1%                   34.1%

Commodity Research Bureau              3.8%                   13.0%

CPI Inflation (12 months)                                                -1.3%


Continuing a seven-year trend, broad U.S. stock markets continue to underperform foreign markets. Client portfolio’s stock performance illustrates the positive contributions of a growing group of foreign based companies. The gains we’ve experienced since the March low may have constituted the easy money. Going forward, investors will be looking for progress with items like consumer spending, corporate sales growth and meaningful reductions in corporate manufacturing spare capacity in order for the stock market to continue its upward trajectory. We believe we are now transitioning to a “show me” stage and it’s reasonable to expect an increase in stock market volatility while waiting for proof that the recovery is starting to develop legs of its own.

A weak recovery following a recession isn’t necessarily a bad thing for the stock market. We recently sent an interim letter to clients (posted to the website) which noted that weak economic recoveries after recessions have had a tendency to coincide with strong stock market performance during the first twelve months of the ensuing recovery. The theory behind this observed relationship is based upon expectations of how long the Fed will wait before it starts to increase short term interest rates. Presently, Fed officials continue to stress that interest rates will remain very low for the foreseeable future while the economy continues to recover, thus maintaining a favorable environment for further stock and corporate bond market advances.

Our final observation for this equity section of our letter deals with the increasing attractiveness of emerging markets (EM) relative to the U.S. and other industrialized nations. Having avoided the banking crises that enveloped most of the industrialized world, EM countries “only” had to deal with the effects of a fairly typical growth slowdown. Now that a global recovery is under way, it’s no surprise that EM stock markets have outperformed all others. It is our opinion that the present combination of low interest rates, rising rates of industrial and economic development, and young population demographics has resulted in the EM countries being well positioned for dramatic future growth.

Fixed Income

The bond market presents some interesting performance divergences this year. As shown in the nine month performance table above, treasury securities and securities of governmental agencies (constituting the majority of the Lehman Index) have been relative underperformers. Last year, and during the first nine weeks of 2009, government and agency bonds substantially outperformed corporate bonds due to investor fears of an economic collapse. Since then, corporate bonds and/or bond funds have enabled the fixed income portion of client portfolios to experience strong gains.

At the height of the market panic, after the collapse of Lehman Brothers, an investor mood of economic doom prevailed in the bond market that envisioned a return to depression era permanent wealth destruction. Non-governmental bond prices collapsed along with stock prices. Stated in another fashion, corporate bond risk premiums rose to heretofore unseen heights. As the fear of depression and corporate bankruptcies eased, risk premiums began to fall. Falling risk premiums are the primary reason corporate bonds have outperformed treasuries this year.

One of the many remarkable things about this recession has been the precipitous drop in capital spending by corporations. Federal Reserve statistics have now revealed that corporations cut spending so drastically that shortages in a wide variety of products are likely once the U.S. returns to positive economic growth in this fourth quarter and beyond. Combining this situation with the full impact of the stimulus package next year, the stage may be set for a surprisingly strong economic rebound. Wages are down, employment ranks are lean and as previously mentioned, corporations have lots of cash for acquisitions. This also bodes well for the corporate bond market including high yield bonds. Until such time as inflation expectations start to rise and the Fed begins to signal that monetary conditions are about to be tightened, corporate bonds should continue to perform well.


A long-held belief that owning gold represents a way to protect oneself against inflation has now been disproven. Gold has been moving higher in dollar terms since 2001 while at the same time treasury yields and the rate of inflation have been declining. The evidence now clearly shows that gold may rise or fall during periods of inflation or deflation. A dependable correlation between the precious metal and economic cycles or the rate of inflation has ceased to exist! What does correlate pretty well is the relationship between gold and the rate of debasement of a country’s currency. Here at home, the creation of money as a stimulus action coupled with fears of trillion dollar deficits for years to come has been a strong contributor to gold’s dramatic rise in price this year. We believe gold should remain a component of client portfolios until such time as governments stop debasing their currencies.


The CPI continues to reside in negative territory (i.e. deflation) on a year-over-year basis which in turn is adding to the resolve at the Federal Reserve to keep downward pressure on interest rates for the foreseeable future. In the interest of full disclosure, the monthly CPI figures have turned slightly positive in the past six months.

As always, we welcome your comments and questions regarding the information presented in our quarterly letters. Please visit for additional information.





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