Second Quarter, 2010

The Markets

2nd Quarter, 2010

During the second quarter, the stock market caught the jitters, as investors worried about the European debt crisis and its impact on global and domestic economies. That said; it’s important to remember that markets don’t go straight up or down. Sometimes, they need to digest prior gains or losses.

Benchmarks

12/31/2009

06/30/10

% Change

Dow Jones Industrial Average (^DJI)

10,428.05

9,774.02

¯6.27%

Standard & Poors 500 Index (^GSPC)

1,115.10

1,030.71

¯7.57%

NASDAQ Composite Index (^IXIC)

2,269.15

2,109.24

¯7.05%

10-year Treasury Bond*

3.84%

2.97%

¯ 22.66%

Federal Funds

0.00%

Unchanged

London Gold

1,104.00

1,244.00

12.68%

*Remember, when interest rates go up, bond prices go down.

Moving through the summer, investors must decide if the current downturn is simply a correction orsomething more. In doing so, they must consider the short- and long-term impacts of government spending, including the current stimulus efforts.

Short-term, the government is likely to continue its stimulus efforts to keep the economic recovery moving. The positive impacts of these efforts are beginning to show up in 2Q earnings and financial reports. Generally speaking, corporate America is in pretty good shape, balance sheets are strong, and inventories are building in anticipation of sales growth. Employment gains should follow. We believe this is a correction, notsomething more.

In 2010, the government will spend $3.6 trillion, of which $2.2 trillion will come from taxes and $1.4 trillion (39%) will be borrowed. Ultimately, this borrowing will be repaid by future generations. This is a bad public policy, which fails to hold the current generation of policymakers accountable for their actions.

Long-term, the government cannot sustain spending at current levels, which means there must be a major shift in fiscal policy. Like them or not, it is likely the growth of the Tea Party Movement is an early sign of impending change. Also, since entitlement programs[1]account for $1.461 trillion (41%) of government spending, it’s likely they will be overhauled sooner, not later.

Long-term, a shift toward a more conservative fiscal policy would be healthy for the economy and financial markets. But, there would be some pain involved, as the government adapted to spending within its means.

Dodd-Frank Wall Street Reform & Consumer Protection Act

Recently, this major piece of financial legislation was signed into law. Although it includes 20 areas of focus, there’s one provision we believe will be especially helpful for the investing public.

The Securities & Exchange Commission (SEC) may hold broker/dealers that give investment advice to a fiduciary standard of care, following a six-month period of study.

Today, everyone calls himself a “financial advisor” or something similar, and most investors do not know that there is a difference between broker/dealersand registered investment advisors. Neither type is right or wrong, but they are different.

A broker/dealeris licensed to sell securities. In the process, it makes recommendations that sound a lot like investment advice, but are simply incidental to its business of buying and selling securities. A broker/dealer is held to a suitability standard in dealing with clients. This means it must make recommendations that are appropriate to a client’s goals, circumstance, and risk tolerance. A broker/dealer earns commissions when it buys and sells securities.

A registered investment advisoris licensed to provide investment advice and manage portfolios. Many hold professional designations, like Certified Financial Planner™ or Chartered Financial Analyst. Investment advisors are held to a fiduciary standard in dealing with clients. So, in addition to making appropriate recommendations, they must always act in your best interest and fully disclose conflicts of interest. An investment advisor earns hourly or annual fees for its services.

If the SEC determines that broker/dealers giving investment advice should be held to a fiduciary standard, it will help the investing public. Specifically, it will eliminate their need to know whether a financial advisor is a broker/dealer or registered investment advisor because it will assure that all are held to the same high standard.

Equity Strategy

“You buy stocks for long-term capital appreciation and future income.”

During the first year of a bull market, it’s classic for stocks prices to get way out in front of the economy and corporate profits. While the second year is generally positive, it’s a time when the economy and corporate profits play catch up. As before, we believe the current downturn is a correction within a bull market, notsomething more. Also, we believe the Fed remains firmly committed to keeping the recovery moving.

At this time, we recommend clients accumulate and hold common stocks of major companies that are acknowledged leaders in their industries. These companies are recognized by superior financial strength, earnings growth, and return-on-equity (as compared to industry peers) and most pay cash dividends. Based on the challenges facing our economy, we believe these companies will be the most predictable and consistent performers.

Fixed Income Strategy

“You buy bonds for safety and current income.”

We believe there are higher rates ahead for two reasons:

v The Fed is holding its key funds rate at “zero percent” to keep the economy moving. At the same time, it’s urging Congress to maintain its stimulus spending and extend the Bush tax cuts into 2011. Ultimately, this will pump a lot of fuel into the economy and that has the potential to become inflationary. If inflation emerges, the Fed will shift gears and raise rates.

v The government must finance its $1.4 trillion spending deficit by issuing Treasury bills, notes, and bond, and state governments must finance their deficits by issuing municipal bonds. Then, as the economy recovers, corporations will want to finance growth by accessing the credit markets. Very simply, increased demand for money should push rates higher.

Accordingly, we recommend clients hold bonds meeting our investment guidelines. Also, we recommend they “park” cash earmarked for bonds in cash equivalents, preserving principal and the flexibility to capitalize on higher rates as they emerge.

[1]The three major entitlement programs are Social Security, Medicare, and Medicaid. All are teetering on the brink of financial disaster, but Medicare is in the worst condition.

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