Enclosed please find your reports for the second quarter of 2007.  Both your equity and bond returns are outpacing their benchmarks by very healthy margins. Your portfolios, positioned to take advantage of a trend favoring larger, growth-oriented stocks, handily outperformed the S&P 500. Periods of sloppy trading, caused by mixed economic data, provided significant pockets of opportunity for our managers. Likewise, performance volatility in bond markets caused by changing interest rate forecasts provided ample occasion for our bond managers to add value, and your fixed income portfolios had a strong quarter, easily outperforming the Lehman Brothers Aggregate Bond Index. 

Economic and Market Overview

We’ve been answering two great questions from clients this quarter: “Should I be concerned about equity markets reaching new highs?” and, “Will a slower US economy trigger economic slowdowns in China and the rest of the world?” We’re happy to report that the fundamentals underlying domestic equity markets are strong, and the evolution of global equity markets should serve to significantly dampen the possible knock-on effect of a slower US economy.

Equity markets have been hovering around highs last seen at the apex of the tech bubble frenzy, but there’s a fundamentally critical difference between then and now: reasonable price. A commonly quoted statistic within financial circles is P/E (price to earnings), or what price an investor is willing to pay for the future profit-generating potential of a company. For companies in the S&P 500 this has been in the neighborhood of 19x over the last 20 years, but in the late ‘90’s the average spiked near double that – with some companies trading at prices well over 100x earnings! Today, the average P/E is running a bit below the historical average, and more importantly, the range of prices is also sensible, with no one segment of the market trading at implausible prices. So, how can it be that prices are reasonable, when market indicators are hitting record highs? In short, prices of company stocks have increased in line with their earnings, which have gone up as both domestic and overseas economies have grown.

Domestically we are in the midst of a maturing economic cycle, and forecasts for GDP growth in the US for 2007 and 2008 are modest. In the past, a slower US economy has triggered downturns in emerging markets like China, which historically have been heavily dependent on US demand for manufacturing and resources. There are several indicators that point to a mitigation of this effect. In the ‘90’s, 30¢ of every dollar of global GDP growth came from the US; today, the US represents only 15¢. Also, bear in mind that exports now only constitute 12% of China’s economy, and the US represents only a fifth of that. Emerging markets, formerly the beneficiary of strong US economic growth, are now in effect returning the favor, and they’re doing so primarily with increased local demand from their own growing middle classes.

There are a couple of important ways that we’ve been positioning portfolios to benefit from current market characteristics. We’re emphasizing managers that own companies with a high and growing percentage of sales coming from overseas. Such companies effectively cheaply import foreign growth, leading to robust sales and often experience earnings surprises that cause a pop in price. We’re also bullish on our foreign bond managers, who manage currency exposure and have a wealth of experience in the fast growing international, and particularly emerging, bond markets.

Singer Xenos Wealth Management