During the last quarter, a number of forces have caused our forecast for future economic growth to be reduced – namely the debt crisis in Europe and the BP oil spill. Economic recoveries are vulnerable at their early stages and this recovery is no exception. As the global economy has emerged from the Great Recession, it has done so with record levels of unemployment and debt. Any shock to the system during the first stages of recovery can de-rail the promise of future growth and potentially push the economy back into recession – or what is known as the classic “double dip”. Will the economy simply slow for a few quarters and then revive again? Or must we experience another recessionary period?

Our research suggests that the economic recovery will continue and that, while the risk of a double dip recession has become greater, it will not come to fruition. We base this forecast on the fact that corporate balance sheets are extremely healthy, inventory levels are still very low and economies in the developing parts of the world are still growing at a relatively rapid pace. However, we must be aware that global economic growth will likely slow for a period and adjust our investment theme to this reality.

In equity markets, we have reduced our commitment to some of the very economically sensitive companies in your portfolio and allowed those companies that thrive in a slower growth environment to be over-weighted – namely consumer staples, healthcare and utilities. We have also continued to employ the use of stop loss orders on those economically sensitive companies that you currently hold. Recently, stock markets have lost their upward trend that began in March of 2009. This is concerning and we are looking for assurance that it is not a long term phenomenon. We will be watching this closely. A further decline in stock markets would likely initiate your stop loss orders and reduce your stock exposure further in an effort to avoid the risk of catastrophic loss.

We believe that we are in a new era of increased risk and that our investment style must adapt to this changed environment. In the spirit of this change, it is difficult to see how a “buy and hold forever” strategy will work well for capital growth. Our work suggests that, to enhance wealth, we must be a bit more nimble than in the past and have a focus on risk management. Therefore, our investment style relies on changing the portfolio complexion more than we needed to in the 90s and early 2000s. We are also exploring alternative ways to manage downside risk – such as “shorting” stock exposure – which would ultimately allow a portion of your portfolio to rise during a falling stock market. We will communicate with you in much more detail before entering into such a strategy.

It has been a very challenging few years with many surprises. Fortunately, our research process and adaptability has allowed us to perform well relative to our peers. We want to thank you for your continued vote of confidence and welcome an opportunity to get together if you would like to review your portfolio.

Sincerely,

James E. Demmert
Managing Partner