Stock prices have advanced almost 30% in the past 8 weeks. However, stock indexes still remain negative for the year and more than 40% off their highs reached in 2007. Is this the beginning of a new bull market? Or another bear market rally that will eventually take us to new lows?

The recent advance is very similar to the occasional fits of strength markets have shown throughout this bear market. Unfortunately, each of these past advances have led to market indexes declining to new lows and disappointed investors. However, our research is indicating that the economic backdrop (the most important ingredient for stock prices) is finally beginning to change for the better. Most importantly, a number of our leading indicators for the economy have begun to turn upward for the first time in two years. This signals that the worst of the economic recession may now be behind us.

In the short run, our stock market indicators suggest that the market’s recent (and significant) strength is unlikely to last much longer. Market indexes have simply come too far, too fast. However, our work also suggests that a correction in stock prices from these levels should be less dramatic than those of the past 18 months. Most importantly, we believe that a correction in global stock markets will hold above the lows of early March. Given these circumstances, we will continue to purchase stock for you into market weakness, endeavoring to pay the best prices possible.

As you know, we began our process of purchasing shares of great companies that we felt were undervalued in late autumn of last year. Though markets went lower after some of those purchases, your investments have performed well. This was a great reminder that picking market bottoms is very difficult and that stock purchases should be done in phases – not all at once. Now that the economic backdrop is becoming even more constructive, we will continue our purchases into market weakness and most likely at a faster pace. Keep in mind that we will continue to use our risk management tools to mitigate downside risk. This includes monitoring your overall allocation to stocks and bonds, managing your exposure to the global economic sectors and industries, as well as employing stop loss orders on those companies that would be vulnerable to a deepening recession.

Keep in mind that a healing global economy will lead to higher stock prices as well as higher interest rates. This should allow us to become more active in our bond purchases as we will be able to “lock in” higher interest rates in your bond positions.

Over the next few months, stock prices will likely experience a normal correction – we would not be surprised if it was on the heels of bad news about the economy, employment or the banking industry. However, this next correction should provide and excellent opportunity for us to re-invest for the long term.

We hope this note finds you well. If you have any questions, please feel free to contact us at your earliest convenience.

Sincerely,

James E. Demmert
Managing Partner