US Equity Income & Capital Appreciation Strategies
Is the Recession Nearing an End?

What a quarter! The second quarter of 2009 closed with both the Dow Jones and S&P 500 indices up 12% and 16% and for the year -1.9% and +3.2%, respectively. Financials, basic materials and technology sectors led the quarter, as they did in March.

As economic surveys and data were released over the quarter, we saw the economy slowly recede from its disastrous fourth quarter 2008 Gross Domestic Product (GDP) drop of 6.3%. Some statistics give indications that the recession is abating as captured by the following quarter-end 2009 snapshot of the economy:

Another important economic indicator showing improvement is the Chicago Fed’s National Activity Index, a weighted average of 85 monthly indicators of economic activity drawn from five broad categories: i) output and income, ii) employment, unemployment and hours, iii) personal consumption, housing starts and sales, iv) manufacturing, and v) inventories and orders. This number has risen for the last four months. Typically this Index bottoms two to three months before the end of a recession.

Based on these and other statistics, economists are now looking for the real GDP to turn positive in the latter half of 2009 with a possibility that the third quarter will be slightly positive. However, many questions remain concerning the economy’s vitality in the beginning of 2010 as the initial effects of the stimulus package start to wear off. Our read on this is that the recovery will not be as vigorous as previous economic upturns — meaning, the rebound will not be V-shaped. A long litany of ongoing economic challenges will impact the GDP growth rate or may even cause another pullback (W-shaped recovery). These problems include a lack of disposable personal income, higher savings rate, higher mortgage rates, higher gasoline prices, heavy consumer debt, diminished housing equity, labor market pressures, inventory cycle, Fed’s monetary policy, and the slowing of the government stimulus package. But for now, the positives still outweigh the negatives, and the equities market is reflecting that the worst may be behind us. Thus we believe that the pending recovery for 2010 will be slower than previous economic recoveries and will be selective across economic sectors.

Our earnings expectations for the S&P 500 are more cautious than the consensus for 2009 and 2010. For that reason we will continue to be conservative and selective for the foreseeable future, preferring to be underweighted in most economic sectors and overweighted only in energy. Although oil prices are above our expectation on a short term basis, we remain bullish long term. We continue to believe that until investment in oil production is significantly increased there will be serious supply shortages during the next few years as the world economy picks up.

For Oakwood’s Equity Income portfolios we continue to be conservative, preferring to invest in high quality companies and maintain an above-average cash position. We increased our technology weighting, buying a provider of relational database management systems used in network-based client/server computing. In addition we purchased a leading supplier of virus protection, help-desk, network security, and encryption software. To offset these purchases we sold a provider of computerized payroll-accounting services, since we prefer companies with higher growth potential. In the Consumer Discretionary sector we purchased a company that operates a chain of retail building supply/home improvement stores, as we believe the home repair market will improve next year. We also purchased a company in Consumer Staples that specializes in technology-based agricultural product solutions for growers.

We are generally more aggressive in Oakwood’s Capital Appreciation portfolios where we increased our weighting in technology by purchasing a company that develops and supplies custom-designed user interface products and solutions that enable interaction with various mobile computing, communications, entertainment, and other electronic devices. We also purchased a company that makes electronic design automation software for the global electronics industry. In addition we sold one energy company to add to another we already owned, believing that it has better reserves and the potential to grow those reserves at a faster pace.