In recent weeks, leading indicators for economic growth have declined, further suggesting that there is an increasing risk of a recession. Though stock prices have already begun to “discount” this coming period of economic decline, we believe there is an increasing possibility that corporate profits may fall further than estimated — along with stock prices.

As you know, we have positioned your portfolio much more defensively due to this unsettled economy by significantly reducing your stock exposure, particularly in
those sectors that are most vulnerable to economic decline. So far, this effort has reduced your overall portfolio’s volatility relative to stock market indexes — and is designed to continue to do so.
An additional phase of portfolio protection against a further decline in stock markets is to institute the use of short selling. Over the past 18 months, we have mentioned the possibility of short selling in the case of the onset of a recession related “bear” market — an increasing possibility. In a nutshell, stock sold short rises in a falling market, acting as a hedge for your overall portfolio. The most efficient manner to institute short positions is through the use of Electronically Traded Funds (ETFs) that hold a basket of stock sold short. Our focus would be on those ETFs that hold either the most vulnerable market sectors or the overall market. These investment vehicles are typically very liquid, allowing us to buy or sell with ease. As with stock positions, we would incorporate the use of stop loss orders to manage downside risk. If and when we use these tools to protect your portfolio’s value, we would do so in phases and would limit overall exposure to anywhere between 10-30% of your normal stock allocation.
In the event that economic leading indicators, the European debt crisis and political stalemate continues to move in negative directions, we may begin employing these tools. If you prefer that we do not implement this strategy for your portfolio, please let us know. If in the past you expressed that you prefer that we do not, we will follow that directive. Of course, if your opinion has changed, please let us know as well.
We hope this “short” update finds you well. If you have any questions or would like to get together for a portfolio review, please let us know.

Sincerely,

James E. Demmert
Managing Partner