In recent weeks, stock markets have provided a welcomed recovery with indexes edging closer to their April highs. However, within this climate, there is growing investor concern regarding the upcoming and historically dangerous months of September and October, the November election, the US fiscal "cliff" and, of course, the ongoing European crisis. It is no wonder that investor intelligence polls show a growing sense of nervousness among both individual and institutional investors. As we approach the fourth quarter, we thought we would share some research insights that you might find helpful.

Though September and October have historically been bad market months in some years, in others they have been very good. In fact, last fall most market indexes had their best October performance in decades. It is not the calendar that the global stock market is concerned about – it is the events within it. On that note, our research suggests that the US fiscal "cliff" very well may be another, even more exaggerated, Y2K – something that creates great anxiety as it approaches, but in the end is resolved with little fanfare. Lastly, our research suggests that the Euro Zone crisis is not over, but that the damage to its stock markets likely is complete. We view today's European markets as an analogy to the US market in early 2009: the average stock was down 55% and had begun to recover (though the economy didn't get better for a few quarters afterwards). One certainly should be wary of Greek stocks or Spanish bonds. However, there are great blue chip European companies whose shares are selling at 50-60% discounts and have great profit growth and strong balance sheets. It is always a possibility that global markets are due for a normal correction (8-10% decline). However, at this point, we do not see the potential for a more significant market decline, such as 2008 (-50%) or even the summer of 2011 (-25%). But what if we are wrong?

As always, we continue to be a manager of risk through our Active Risk Management (ARM). As we have mentioned in the past, our team is not concerned with the risk of normal volatility (8-10% declines), but rather are focused on mitigating the risk of catastrophic loss. Therefore, we continue to manage your portfolio's risk through asset allocation, sector management and the use of carefully placed stop loss orders (unless you have instructed us not to employ stop loss orders). In the past, ARM has significantly reduced downside risk. Of course, when markets are in their early recovery process, ARM can initially reduce upside performance. Ultimately, we believe that this process smoothes out volatility and mitigates catastrophic loss, while providing positive returns. Speaking of positive returns?

Our research suggests that, in the not too distant future, global stock investors will be handsomely rewarded. In fact, as we stated earlier in the year, we may be entering a new bull market in global stock prices – a period when stocks have an upward bias and lower volatility for a number of years. A number of data points support this thesis: (1) Stock prices have reached valuation levels that in the past have ignited multi-year bull markets. (2) Stock indexes are at the same level today as 13 years ago! The last time this occurred was in the late 70s, which was at the beginning of the 1980s bull market. (3) The housing market is 30% of economic growth. In the US and throughout the world, the real estate market has begun its recovery. (4) Regardless of one's political persuasion, we feel that a sea change may be upon us in regard to action on the US balance sheet problems. Either candidate for president, along with his team, will be forced to make difficult choices and formulate a plan for lower deficits, lower unemployment, and stronger economic growth – all great for stock prices.

We hope this update finds you well. If you have any questions or would like to get together for a portfolio review please let us know. Additionally if you have experienced any significant changes in your financial circumstances, please take the time to update our team.

Sincerely,

James E. Demmert
Managing Partner