Outlook Newsletter - March, 2010
By James H. McBride, Managing Partner

The current market correction has pulled the markets back nearly 10% from their early January highs. While long anticipated, the volatility and fear that this correction fosters has many feeling the uncertainty of a weak economic future. I started my career in 1967 and can affirmatively say that I have seen this type of paranoia at least once per decade since then. It always follows a significant market decline and is always based on a fear that “it’s different this time.”

The war between “traders” and “investors” continues to be waged as it has in each of the past recoveries from recession I have experienced. Traders view the future in terms of charts, resistance/support levels and skepticism about the future while investors see the future opportunity in terms of corporate profits, savings rates and inflation control. At present we are still in a trading phase where all news is viewed through negative eyes. We believe that the conversion from a trading phase to an investment phase will occur within the next several months, and news will then be viewed in a positive light. The better the news, the better the markets, specifically for the S&P 500 stocks.

This new cyclical bull market is still healthy and the current correction is playing out just as we need it to progress for renewed optimism about future market performance. The massive deleveraging that began on 9/18/2008 and ended 3/9/2009 introduced a fear factor seldom seen over my 40+ years as an investment advisor. It now seems certain that investor culture has once again moved back from the excessive spending and leveraging of the first decade of the new millennium to savings and cautious investing in good companies and good profits based growth for the future. There is now $7 trillion in savings and money market accounts. As the investment phase of this bull market begins, this is more than enough fuel to drive our markets forward and strengthen growth for years to come (Hays Advisory Institutional Research, 2/18/10).

Strong corporate profit and revenue growth with better than 75% of companies reporting results so far better than analyst expectations has formed a solid base for continued sustainable economic recovery (Investment News, 2/10/10). It’s a new global world we now live in and much has been written about emerging and developed international markets having better growth opportunities than U.S. markets. Six of the ten largest companies in the S&P 500 (Apple, Exxon, GE, IBM, Johnson & Johnson, Proctor and Gamble) get more than 50% of their sales revenue outside the U.S. (Reuters, 12/1/09). Some of today’s largest S&P companies trace their origins to past recessions (FedEx, GE, Microsoft, Burger King & Heinz, etc.) (Capital Research, 12/31/09). And from my own research, 15 of the largest companies in the world are based in the U.S. and companies based outside of the U.S. employ more than 5 million workers in the U.S. and pay them more than $400 billion annually. There is still plenty of opportunity for growth here in the U.S. and we continue to see U.S. markets as the key component of High Falls’ investment portfolios.

Our asset allocation strategy in 2010 continues to recommend 20-25% of assets invested in non-U.S. markets, but stability and growth in U.S. markets forms the core of our allocation. We think that large S&P 500 companies paying good dividends (2.5%+ dividend yields) will perform best over the remainder of this year as money moves from low-yielding savings and money market holdings to good quality value stocks. Diversified portfolios encompassing all sectors of the U.S. and foreign markets continue to be the best risk management strategy for most investors.

American cynicism over the stagnation in Washington and fear over the excessive debt load via government stimulus packages notwithstanding, U.S. markets historically bounce back to a growth environment due almost exclusively to our free market system. I believe history will repeat itself once again – deleveraging of this magnitude is both healthy and necessary to offset the excessive leveraging of the past. We have dodged a bullet once again, but the road ahead is full of dangerous pitfalls. It will take years, not months, to repair the damage of the debt burden (can you think higher taxes) and the inevitable inflationary pressures to come. But, we Americans are resilient and innovative, and we will continue to lead the world forward in the foreseeable future. We need only to trust our own common sense and see the future as an opportunity and not a liability.

We do not expect the Federal Reserve to increase interest rates much, if any, this year. When rates do start to increase, however, look for bonds to depreciate significantly in value. Our strategy requires the use of some fixed-income components mixed with high yielding master limited partnerships (6.5%+ yields) and bond-oriented ETFs. We do foresee a double digit increase in the S&P for the year as a whole and are carefully positioning managed portfolios to attain total returns consistent with the combination of income and growth opportunities.

For questions or additional information on this newsletter, please contact us.

The projections of returns for specific investment types are estimates and projections and therefore prone to error. Actual returns may differ significantly from projections. Your experience will differ from the performance of specific asset types to the extent that several types exist in your account, and to the extent that your specific investments perform differently than the average of that asset type. Whether any of the asset types mentioned above are suitable for your account must be determined individually, and your portfolio may not contain some of the asset types described. These views represent an appraisal of possible events. Outcomes and performance is not guaranteed. The investments listed may go up or down in value, and they are not suitable for all investors. Securities offered through Ensemble Financial Services, Member FINRA (formerly the NASD, SIPC).