US Equity Income & Capital Appreciation Strategies
Positioning for the Turn

The first quarter of 2009 closed with both the Dow Jones and S&P 500 indices down -12.4% and -11.0% respectively. US equity market indices did enjoy a nice bounce in March led by the financials sector up 18.6% and the basic materials sector up 13.6%.

The market has responded positively to Treasury Secretary Geithner’s latest private/public investment plan to address toxic assets plaguing the banking system. In addition the Federal Reserve has further eased interest rates by moving to purchase $300 billion of Treasuries and $750 billion of agency mortgage-backed securities. Deployment of these programs set off a significant bond and equity market rally and a US dollar sell-off. Also driving favorable market reaction was the indication that both the Fed and the Administration are working collectively to address concern about the economic outlook and the risk of sustained deflation.

Economic announcements of the last quarter spurred us to revise our GDP expectations. Four key factors have changed. They are:

• global recession – worsening
• energy prices - higher
• interest rates - lower, and
• US dollar - weaker.

The first two are negative; the latter two are positive. The bottom line is that the US economy faces stiff headwinds this year, but 2010 looks somewhat better given recent policy moves. We are now looking for GDP to decline 3 to 4% this year, and recover to 1.5 to 3% next year.

Implications for the stock market

We believe that while news and the economy will continue to drive occasional market recoveries; for now, these remain bear market rallies. Sometime toward the end of this year, or in the first part of next year, we could begin to see the start of a new bull market as fundamentals improve. Positive triggers may include improvement in the housing industry, savings rates approaching the 10% level, and/or increased liquidity in the banking system.

While we have been exceedingly cautious in the market over the past year, our strategy during this quarter was to increase weighting in financials by adding one to two banks. Our action was in part predicated on our anticipation that the suspension of mark-to-market accounting would ultimately benefit banks. Our recently purchased banks are in the large-cap category and are generally considered to be well managed and well capitalized. This important sector currently offers attractive prices and valuations not seen in the past 20 years. We also added a large-cap diversified precious metals firm for the basic materials sector. Traditionally, when you come out of a bear market, your best performing sectors are financials, followed by consumer discretionary and basic materials sectors. We are currently slightly over-weighted in financials and about equal-weighted to the market in basic materials.

Why gold? Why energy?

We were bullish on gold before the Fed’s latest balance sheet maneuvers and we remain so. Bullion is a traditional hedge against financial, economic, and geopolitical uncertainty. We believe it is an appropriate addition given world events and uncertain times.

We continue to be optimistic on energy and thus remain slightly overweighted in this sector. Oil prices have moved up above the $50 level, but may trade between $42 - $55 for awhile. We like the energy sector’s long-term fundamentals, especially as world economies pick up. Over the last few years growth in demand for energy outstripped the growth of supply. This led to diminished excess capacity and higher prices. The oil industry simply had not anticipated the strong growth in global demand. Prices dropped substantially due to the worldwide recession. Now, due to OPEC cutting back on supply and the oil industry substantially cutting capital expenditures, we anticipate that over the next three-to-five years we will revert to the predicament where demand again outstrips supply.