In recent weeks, financial markets have continued to be volatile but have not declined much further than the levels achieved six weeks ago. This highly volatile trading range is reminiscent of past market bottoms. However, only time and hindsight will tell if a bottom is truly forming. Therefore, we will continue to employ a carefully paced strategy of investing new capital. Keep in mind that stock market bottoms usually take months – not weeks – to form, providing plenty of time for confirmation. On a fundamental basis, many indicators suggest that the bulk of the stock market decline that started a year ago is now behind us. For example, the 55 percent decline in stock prices has caused the dividend yield on the S&P 500 stock index to now be greater than the yield on 10-Year Treasuries – a highly unusual circumstance and one that has only occurred at the end phase of past bear markets.

The current recession may be worse than many on record and may last longer than average length. Stock prices typically begin their recovery in the middle of recessions – about where we are now. However, given that this recession may be worse than most, it is very important that government officials fight it with extraordinary measures. For example, last night US officials made the bold decision to inject $20 billion into Citigroup and assume significant risk of some troubled mortgage assets. In return, the US government will receive $29 billion of Citigroup preferred stock. We believe that this type of extraordinary concession is necessary to support the economy during this period. Though General Motors may not be fit to survive over the long run, they too should not be allowed to fail in the short term, during this fragile economic period. Allowing this to occur would increase the risk of an even more prolonged recession and severe economic damage.

After carefully reviewing a number of Mr. Obama's preliminary initiatives, it appears that he and his growing number of appointees also feel that the current economic crisis should be fought with extraordinary measures. This includes delaying any increase in tax rates (a reversal from his campaign promise) and actually reducing tax rates for the middle class. In addition, there are a number of very significant economic stimulus plans on the table to do whatever is necessary to revive the economy.

Financial markets are fragile, but can revive from these levels if current and future government officials recognize the seriousness of the current state of affairs and use extraordinary measures to resolve them. We are encouraged by these recent extraordinary actions and hopeful that these and other efforts will continue to be enacted. Anything less may put the global economy and financial markets at greater risk.

If our thesis that the worst is over for financial markets is correct, expect continued volatility and a trading range similar to the past six weeks. Though this type of volatility can create investor anxiety, it is an important step in the recovery process.

Happy Thanksgiving from all of us – we hope you are doing well. Please let us know if you have any questions or thoughts.

Sincerely,

James E. Demmert
Managing Partner