8.15.20092009 2nd Quarter Newsletter Economic Update: Cloudy skies ahead Last fall and early spring, the world was bracing for a depression and there was very tangible panic. Now with the depression averted (for the time being), we are merely in a deep recession. A resumption of real economic growth is not likely with rising unemployment, an increase in the personal savings rate, and reduced supply of financing for capital expenditures. The unemployment rate is currently 9.5%. More importantly, collectively, the unemployed, part-time workers, and those who have given up looking for work sum to 16.5% of the work force. The personal savings rate is up from 0% to 7% in the last year. Every dollar put into savings is good long-term, but it is detrimental to the economy near-term. If the economy is comprised of 70% personal consumption and the savings rate has increased 7%, the impact to the economy is 4.9% (70% x 7%) less consumption. The savings rate increase is not temporary. The economy will not grow if the underemployed don’t have money to spend, and the employed choose not to spend. Market Update: No new Bull market Since the March 9 lows, the S&P 500 has added 38%, yet it is still down 42% from its October 2007 high. At the March lows, the market was pricing in a depression; since then, the recent rally is a sense of relief that we are merely in a severe recession and the financial news is bad, but less bad than anticipated. This bear market rally is merely a correction from deeply depressed levels within a bear market. Bear market rallies are followed by corrections or sell-offs. The stock market is overpriced based on historical metrics, especially with limited economic growth prospects going forward. The S&P500 is currently priced to return 7.8% annually over the next 10 years compared with an historical average of 9.6%. The “fair value” for the S&P500 is 761 instead of 900, a mere 18% over-priced. At the bottom of every major bear market in the last 200 years, price/earnings (P/E) ratios have been below 10. The current P/E ratio is 14. Current equity valuations are not low enough to warrant aggressive equity allocations on a permanent basis. Portfolio Update: Safety first We anticipate a challenging third quarter, primarily due to: (a) corporate earnings failing to meet heightened expectations, (b) a realization that we are not out of the woods with mortgages and jobs and (c) profit taking from the second quarter advance. If we do get a correction, we anticipate a year-end rally based on renewed expectation of an economic recovery. We believe the risks of being in the market today outweigh the potential rewards. We continue to maintain a cautious stance with a bias towards fixed income (bonds) at this time. We will invest in stocks as we see opportunities over the next few quarters. We currently like the prospects for long-term US government bonds, gold and the US dollar, all of which we expect will benefit in a flight to quality in the face of a market decline. We thank you for your continued trust and support. Trevor K. Holsinger, CFP