1.14.20092008 4th Quarter Client Newsletter Economic Update: How long will recession last? The current recession is likely to worsen before it improves. During the fourth quarter of 2008, unemployment rose to 6.7%, Christmas retail spending was down between 2 to 4% over last year and corporate profit estimates continue to be lowered. The housing market continues to worsen with housing starts and new home sales at 17-year lows. Through October, home prices had fallen 23.4% from their July 2006 highs (Case-Shiller Index). Unemployment will continue to rise. Consumer spending, home values, and corporate profits will continue to decline. As liquidity injections by governments and lower interest rates take hold, we look for modest recovery toward the end of 2009. Market Update: Higher in 2009 2008 was the worst year for stocks since the Great Depression (1931). The S&P 500 finished the year down 38.5%. The EAFE index (developed Europe, Australia and the Far East) fell 45%. Emerging markets declined an average of 54%. The only bonds that fared well were obligations of national governments and a few AAA corporates. Almost all other bonds were hard-hit. So what is in store for 2009? The massive flight to quality and safety in the form of US treasury bonds has temporarily rewarded investors (by preserving capital). US Treasury yields range from 0% to 2.68% (30-year US Treasury bond). With inflation traditionally at 3%, US treasuries provide a pre-tax negative real return – not an attractive investment! Long-term US treasuries are the next bubble ---- to pop. There is a huge amount of cash on the sidelines. Currently, individual investors have 42% of their investments in cash – the highest percentage on record. The $8.85 trillion which is currently held in cash, bank deposits and money-market funds is equal to 74% of the total market value of publicly traded US companies – the highest ratio since 1990. The American Association of Individual Investors (AAII) index says 55% of individual investors are currently bearish. This bearishness is a contrarian indicator. Confidence in the credit markets is slowly reappearing and financial institutions are beginning to lend again. This resumed liquidity is crucial to the markets recovering. We like investments based on risk-adjusted prospective returns. Equity markets are now priced to return 10 to 14% per year on average over the next 7 years (GMO). We believe that the stock markets in 2009 are likely to be pleasantly positive, although the journey will be volatile. Current stock prices probably do not factor in the full extent of earnings disappointments. In addition, there is likely more credit deleveraging pain to come (from commercial mortgage-backed securities, Credit Default Swaps (CDS), etc.) which would serve to pressure stocks again. Over the next 10 years, primarily because of the declining consumption of the Baby Boomer generation causing weaker profits than normal, we believe the stock markets will deliver an average annual return in the mid-single digits. At some point during the next 10 years, we believe we will see stock markets priced to deliver historically high returns of 15 to 20% per year. This will represent one of the best buying opportunities of our lifetimes. We will be prepared for it. Portfolio Update: Time to take risk In our last newsletter, we suggested that as confidence returns to the financial system, the probability of a bear market rally is high. Since November 21, the recent low, the S&P 500 has indeed rallied approximately 25% (through January 6). The combination of negative real returns from treasuries, greatly devalued stocks, huge amounts of cash, very negative investor sentiment and the thawing of the international credit markets suggests that the markets present a reasonable buying opportunity. We were buyers in November and December. We have added to positions in emerging markets, US high quality equities, and corporate bonds including high-yield. Some of the most attractive opportunities have been in the fixed income area where yield spreads (additional interest) over treasuries offer equity-like returns with less risk. Although 2008 was a very trying year, Aspen clients fared much better than the equity markets. We will strive to find you the most opportune investments in 2009. We thank you for your continued trust and support. Trevor K. Holsinger, CFP