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Please find enclosed your reports for the first quarter of 2008. The offensive and defensive components of your accounts balanced each other well over the last three months. Occasionally our strategy – which is developed with the full year in mind – may trail the market, and we lagged slightly in the first quarter. However, we are confident that we are continuing to appropriately position your accounts, with both defensive components that help buffer against volatility and offensive components that take advantage of the opportunities presented by market conditions.
Portfolio Update
In January, we introduced defensive pieces to the portfolio. Ivy Asset Strategy is a multi-asset fund that is designed to provide positive absolute returns to the portfolio under a variety of different market conditions. Since its purchase it has performed well despite downward market trends. Goldman Sachs Government Income invests solely in government and government agency securities, the highest credit-quality bonds available. To fund these positions we sold two excellent funds, Artisan Mid Cap Value and Westcore Small Cap Value, which specialize in the two areas of the market that had become the most expensive. We also tactically held a higher position in cash in order to take advantage of investment opportunities.
In February and March, we undertook the process of individually rebalancing your accounts. This produces a temporarily higher than normal volume of trades, but is a very important part of risk management in your accounts, trimming positions that have grown overly large through organic growth and fully funding our current investment strategy.
Beginning in March we initiated positions in the Claymore/Bank of New York BRIC and PowerShares DB Agricultural Index as appropriate per account. We will continue to introduce these holdings to your accounts during April. We anticipate low economic growth in the US in 2008 and into 2009; following a sell-off in BRIC (Brazil, Russia, India, & China) stock markets over the last several months, there is now a relatively cheap opportunity for us to access the much higher growth rates in these countries. In a related theme, worldwide there is a 1.5-month supply of grain, while food consumption by growing middle classes in BRIC and other emerging countries is increasing rapidly. The DB (Deutsche Bank) Agriculture Index, particularly after a recent decline, provides access to wheat, corn, soybeans, and sugar, all of which are staples in short supply. Individually, each of these funds is a more volatile holding; however, within the context of the greater portfolio they are a risk management tool, providing access to assets with low or no correlation to the US stock market. Particularly in light of recent market activity, they also provide good upside return potential.
A defensive move taken in March was to move your cash sweep from Advisor Cash Reserves to the US Treasury Money Fund. For a short period of time we are comfortable with the tradeoff of somewhat lower yields of this fund in return for the ironclad guarantee of the US Treasury. There are a variety of securities that are legally permitted to be held by money market funds, as long as they are AAA-rated. Advisor Cash Reserves currently holds one security that was AAA-rated but has been downgraded. With extremely high likelihood this will have zero impact on the fund. However, cash is one area where we are not willing to accept even incredibly unlikely risks. While the fund managers are resolving the issue with the one holding we are using the US Treasury fund in your accounts instead.
Market Scorecard
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Investment Return:
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Equity markets both at home and overseas had negative returns. The S&P 500 w/ Dividends Reinvested returned -9.44% and the MSCI EAFE returned -9.53%. Government bonds, especially Treasuries, were positive for the quarter, and the Lehman Brothers Aggregate returned 2.17%.
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Overall Economy:
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GDP slowed to 0.6% in the fourth quarter of 2007. The definition of a recession is two consecutive quarters of negative growth; opinion remains mixed as to whether or not we are currently in a recession or in a period of very slow growth.
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Employment:
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Unemployment decreased to 4.8%, considered full employment.
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Interest Rates:
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The Federal Reserve cut interest rates three times in the first quarter from 4.25% to 2.25%.
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Inflation:
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Inflation decreased to 4.0%; excluding food and energy the inflation rate remained steady at 2.3%.
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Economic and Market Overview
There are multiple positive mile markers that we have passed coming to the close of the first quarter, and more that we see on the horizon:
- Buyout of Bear Stearns. It is normal that not all banks would weather the current financial environment triggered by the subprime mortgage crisis last July. We are finally at the turning point where strong banks are cheaply acquiring the assets of weaker banks, which is what history teaches us is the normal response to an industry-wide event. While there is some likelihood that one or two other banks may be bought out, the “first is the worst” and it is now behind us.
- Increased volume of existing home sales. Purchases of existing homes upticked in February. Home prices will likely continue to go down in 2008, but there are buyers at today’s prices. Rates on prime mortgages have come down over the last month. While this should not be interpreted as a turning point for housing prices, it is a positive sign that supply and demand are functioning properly in the residential real estate market, and that banks are willing to provide the financing for those transactions.
- Potentially strengthening dollar. We anticipate the dollar may strengthen against major world currencies at some point during 2008. A weak dollar has helped our export sector, but a strengthening dollar is helpful on the import side, and it is appropriate that this become more balanced. Importantly, most commodities – including oil – are traded in US dollars. A strengthening dollar permits easing on the cost of commodities. The Bank of England, which has cut rates very modestly, and the European Central Bank, which has not lowered rates at all, will likely need to make larger cuts, which would benefit the dollar.
- Interest rate cuts. The Federal Reserve continues to lower interest rates and provide liquidity to banks. This acts as a stimulus to financial markets. Typically there is a lag of around nine months from when interest rates are first cut to when they begin having a significant impact; rates were first cut at the end of last summer, which should prove positive for the second quarter. Easing inflation concerns permit The Fed to continue to be aggressive with monetary policy.
Financial markets tend to either overbuy or oversell news. The first quarter had a lot of, albeit predictable, bad news: Banks wrote down losses. Unemployment increased. Manufacturing slowed. Consumer sentiment waned. However, the magnitude of these changes is within reasonable bounds, and the market oversold on the bad news. Stocks are cheaper now then they were at the end of the bear market in 2002. This leads us to believe that in the remainder of 2008 there is ample opportunity for the market to react to good news.
So far this year, our allocations to growth stocks and international stocks have contributed to our slight underperformance. During a sell-off such as the one we had in January, the “winners” from 2007 were the first to be sold. Panic selling by nature ignores fundamentals, but there is still a strong fundamental case to be made for these sectors of the market, which is why we continue to hold them in your accounts.
Monitoring market conditions, challenging our ideas, and adjusting our strategy accordingly is all part of our ongoing process of managing your accounts. We are anticipating that 2008 will continue to be a volatile year, and feel we are taking advantage of the opportunities presented while also tactically taking defensive moves as is prudent. We currently feel that there are many good investment opportunities in the marketplace and expect that patience will be fruitful. We are, as always, at your service.
New Partners at Singer Xenos
We are pleased to formally announce that F. Scott Wells, CFP and Neil Sosler, MBA, CFP have been named partners of Singer Xenos. For many years both Scott and Neil have demonstrated their financial expertise in advising our clients, as well as sitting on the firm’s investment and management committees. Congratulations to both of them on this well deserved honor.
Singer Xenos Wealth Management
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