JANUARY 2009 NEWSLETTER

The bright spots in our economy and investment markets are few but there are glimmers. There are also extreme stresses on the system that will not be overcome in the near future. We know we are entering an extended period of decline in the economy (albeit the severity of the subprime mortgage and resulting credit crisis caught everyone off guard). We are continually reminded in the news and our everyday observations about how tough things have become already. Imagine it getting worse and lasting for a decade!

Despite this looming storm, two important measures of economic vitality have turned up recently. Free reserves in the banking system continue to increase dramatically to $281 billion as of January 14th from negative $400 billion in late 2008. The Weekly Leading Index compiled by the Economic Cycle Research Institute shows the economy turning up in July 2009. Since the stock market is forward-looking, it may turn up in advance, usually six months in advance of the economy itself. This potential rally may give us an exit point and an opportunity to regain some of our invested wealth.

Using history as our guide, we know that tough times and good times do not last forever. The problem is the tough times staring us in the face may last for three years, if not longer. The Great Depression and stock market slide lasted for three years with unemployment peaking at 25%. We may see an even longer slide since the Baby Boom is four times larger than any preceding generation. In order to survive this period we must adhere to the plan we have in place. My research shows that the people survived by having steady income or cash flow and relatively low debt. Your portfolio is built to provide cash flow. It probably does not make you happy that its value is much lower than at its peak. You can be happy that your portfolio is designed to provide the income you need to survive, if not thrive.

As mentioned above, we plan to take advantage of a bear market rally if it occurs. The important focus is to preserve wealth and stay calm as we wait for bond prices to come down. Expansionary monetary policy has injected $7.2 trillion into the system (via cutting interest rates; increased credit lines and guarantees to banks;) in an effort to spur the economy. This could also trigger the stock market rally we are watching for. These actions take time to work their way through our financial system, and for money to be both lent and spent. Recall that the market surged from 2004 through 2006 even though the Federal Reserve was implementing contractionary monetary policy by raising interest rates 17 times during this period! The Federal Reserve was trying to “cool off” the rapid rate of growth. This upward momentum was due, in large part, to the 12 consecutive interest rate cuts that were implemented during the period from 2000 to 2003 when the goal was to help the economy recover from the dot-com bubble bursting.

In reviewing the last 13 recessions in the United States, half of market returns were made back in the first 1 to 3 months after the bottom. Our plan is to continue to monitor for indications of this bounce and use it as an exit point from equities. Interest rates are now extremely low, which means that bond prices are extremely high. We must wait to buy long-term bonds at good prices. Bonds may then provide a stable income and even an opportunity for capital gain if bond prices again rise as interest rates fall.

If this sounds repetitive, it should. This has been our plan for almost a decade. The exact timing is always tough to get perfect. I know it can be difficult to keep your cool when those around you are losing theirs. I look forward to reviewing your plans with you soon and confirming you have a plan that meets your needs.

Respectfully,