In recent weeks, global stock markets have declined to new lower levels on familiar news: a depression in the housing market, dysfunctional credit markets, ever-rising oil prices and rising unemployment. Interestingly, all global stock markets have now receded by at least 20%, giving stock investors little place to hide other than in the safety of higher than normal bond and cash balances.

As we have discussed for more than a year now, throughout history global economies have experienced recessions about every 7-9 years. Though the recent economic expansion lasted only 7 years, it was our belief in 2007 that, among other criteria, the pending housing crisis might curtail the length of the expansion and the risk of recession was heightened. As you know, this information, along with a tremendous amount of other research, lead us to more fully leverage our risk management tools, resulting in higher than normal bond and cash balances in your portfolios during this period.

Our work suggests that we are now firmly in a global recession. Recessionary periods typically last about 13 months and stock markets usually decline about 30%. Based on this and many other data points, it appears to us that this global recession is a little past its halfway point and that the stock market is probably about two thirds through its decline. It is quite possible that the economy and stock market may be on better footing by year end or the first quarter of 2009.

Given that global economies and stock markets may continue to face headwinds, we will continue to attend to the risk management of your stock portfolio through higher than average bond and cash balances, sector and industry weightings, and stop loss orders on the economically sensitive companies in your stock portfolio. Keep in mind that your portfolio may have exceptions to some of these risk management tools due to your specific circumstances, such as low cost basis stock positions.

In the short term, we would not be surprised to see stock markets advance and provide investors with a period of relief. However, the fourth quarter may further test investor’s patience and we will be wary of that possibility.

Most importantly, we want you to know that we are preparing for better days ahead and making lists of the great companies around the globe that we will be able to add to your portfolio as economies and markets revive. We continue to believe that recent inflationary fears will eventually abate and that the next global economic expansion will likely be stronger and longer in duration than past cycles. We look forward to this period and are relieved that it is not too long from now.

We hope you find these thoughts helpful. If you have any questions or would like to get together, we look forward to hearing form you.

Sincerely,

James E. Demmert
Managing Partner