US Equity Income & Capital Appreciation Strategies
From Leverage to Deleverage

The fourth quarter closed with both the S&P 500 index and the Russell 1000 Growth index down -21.9% and -22.8%, respectively, and down for the year by -37.0% and -38.4%.

More than one year ago, Oakwood began to grow cautious on both the US economy and the market. The magnitude of the slowdown—and the reaction of the stock market—turned out to be larger than we expected, and yet we performed relatively well.

This is not a typical post-WWII-era recession in which the worst quarterly decline comes within two or three quarters of its start. This is more of a slow motion recession; almost five quarters old and we still haven’t seen the end of it. We are estimating that the momentum of the economy’s deterioration may ebb by the 2nd or 3rd quarter of 2009. Post-war recessions have more typically been characterized by inventory corrections accounting for about 80% of the slide in real GDP. The current recession, by contrast, is not just a consequence of the financial sector, but of excessive leverage in the broad US household sector. From the mid-1960s to the mid-1980s, the ratio of household debt to income was stable at 70%. By 2002, it rose to 101%. As of last year, the ratio was at an all-time high of 140%! This will require time to deleverage – liquidating assets, debt repayment, and rising personal savings rates. The trickiest policy challenge will be balancing this deflation with inflationary fiscal and monetary government policies to nominally reflate the economy.

Key economic indicators, among others, guide our (extremely) defensive decision making:

• Retail sales
  Over the July - November period, retail sales slumped at an unprecedented -7.4% annual rate, the first five-month decline in 50 years.
  
  
• Industrial production
  November capacity utilization came in the lowest since May 2003.
  
  
• Housing
  Continues to decline.
  
  
• Federal Reserve
  Cutting its fund rates from 1% to a range of 0-0.25%.
  
  
• Inflationary trends
  At their weakest since the 1930s, confirming that the Fed will be compelled to wage its largest deflation battle since the Great Depression.

Difficult times distinguish superior portfolio management
2009 will be a year of change. We plan to reposition the portfolios from a defensive posture to a more aggressive stance. We currently project this will occur mid-year, but the market and the economy will dictate optimal timing.

In the US Equity Income portfolios, we sold a number of stocks in the fourth quarter to capture tax losses to offset gains taken earlier in the year. New defensive sector positions purchased were in consumer staples and technology. The consumer staples company is a large snack and beverage company. The technology company, which is less sensitive to the economy than its competitors, is a leading global provider of management and technology consulting services and solutions. We also increased our weighting in the energy sector to equal the weight to the market; and reduced our weighting in the consumer discretionary sector to zero. At year end, we held above-average cash, which positioned us well for emerging opportunities.

For our Capital Appreciation clients, we added a biotech firm engaged in the development of cancer and inflammatory drugs. We also added an additional medical company, which is the leading maker of integrated cancer care systems and diagnostic imaging applications. We raised our energy sector weighting to slightly underweighted. We also made a few defensive purchases: the first, in the capital goods sector, is a leader in specialized contracting services for electric power, natural gas and cable industries. Another is a waste management firm that develops, constructs, owns and operates energy generating facilities. We believed these stocks to be undervalued at the time of purchase and anticipate clients will be well rewarded for owning these companies.