3rd Quarter 2011 Market Update Letter

WE DODGED THE THIRD QUARTER BULLET

As all of you know from our interim letters in July, August and September, cash largely has been our investment choice of necessity in this environment, and we have kept it in short dated US government securities.

“INVESTING IN AN UNCERTAIN WORLD”

Wild price swings slowly erode investors’ confidence in the marketplace. The proximate cause of this volatile market is neither the Euro zone crisis nor the ambiguity of our domestic growth trajectory although they both contribute. We believe, the erratic moves we have been seeing in the markets are made and exaggerated by intraday reweighting of leveraged ETF’s and by the disproportionate impact price momentum based high frequency trading strategies are causing.

For a myriad of reasons (Europe, lack of effective government policy, US economy, China slowdown, to name a few), we are forced to pursue a more defensive and conservative approach. We believe investors should wait to see whether policy makers (both here and in Europe) can be effective in formulating a coordinated and credible solution for Europe and at home before taking on more risk. The uncertainty caused by the lack of clarity (again both here and in Europe) and the extreme volatility, has kept us mostly on the sidelines.


Our best recommendation is to keep a cool head and avoid volatility. The opportunities will and are returning. Patience is our byword, and we continue to look for appropriate opportunities. In that regard, we are beginning to think that we are closer to the end than the beginning of this market fiasco. We think that the opportunities to gain safe, reasonable returns will return to the market (with much less volatility), and we plan to be positioned to take advantage of them

WHAT WE ARE DOING

In the near term, we believe that higher than normal cash positions are still warranted. We are focusing on investments in areas where the fundamentals remain healthy and potentially attractive. Given slowing global economic growth and significant uncertainty surrounding the European sovereign debt crises, we believe it is wise to take a conservative and defensive stance.

The lack of policy coordination and a unified front in Europe combined with increasingly stretched sovereign balance sheets in the developed world are proving to be significant challenges for the global economy. It also suggests politics may increasingly influence outcomes, financial markets, and the economic outlook. In our opinion, the effectiveness of policymakers should also be questioned. Fiscal and monetary stabilizers appear to have become less useful in a world which continues to lack confidence, and faces significant uncertainty in developed economies, where aggregate sovereign debt levels remain elevated, and where fiscal stimulus is becoming less viable.

The combination of political, economic and policy implementation risks all cause us to maintain a conservative defensive approach. We believe investing in a world of heightened uncertainty means maintaining higher cash balances than normal, focusing investments in areas with strong fundamentals and balance sheets, and staying defensive in non-cyclical sectors as well as in investments senior in the capital structure. When looking to increase risk, we will remain patient and continue to focus on select investments where fundamentals remain supportive; such as equity and debt in select multinational companies, corporate debt, high quality municipal bonds, and precious metals along with treasuries.

As the market fluctuates in the coming weeks and months - this cyclical phase has yet to become fully extended in our view - we will be working hard to seek out the appropriate investment vehicle. It sure feels good to know we have the dry powder on hand to do just that.

Please feel free to call us at any time if you have any questions.





Past performance is no guarantee of future results. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities, markets or issues mentioned. The information contained herein, while not guaranteed as to accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.

A Reality Check of the Markets - September 2011

September 1, 2011

Here are some thoughts as to what we believe this market seems to be reflecting.

1. Mighty Machines. Volatility*, up and down, in our opinion can be traced to the high frequency buy and sell programs being used in the markets. They have little or nothing to do with a stabilizing Europe or improving U. S. economic data (especially as neither are actually happening). These programs have little interest in last week’s prices or last month’s prices. They are machine based, and they are destroying the integrity of the market place. As such, we are very hesitant to “play in this sandbox” which is characterized by outside, (up or down) non fundamental moves in either direction.

2. “No Place to run, No place to hide”. The markets look broken. Something funny is going on. The markets seem to be trading on “hope”, speculation, and whatever else “stimulates” the market – but not on Reality. We should be seeing “FEAR.” We want FEAR. We want to buy securities when people are afraid of owning anything not when they think it is a gift from heaven, ie. cheap. Again, we don’t want to “play in this sandbox.” Suffice it to say that we are not yet ready to embrace a specific asset class other than cash.

3. Flashing Red. All of our indicators continue to flash Red. De-risking continues to be our mantra. In our opinion, “hope” is not an effective investment strategy. Even so, hope continues unabated in this market. We do not agree and will continue to remain on the sidelines. We expect a hard landing for the U. S. and European economies. The empirical evidence is overwhelming to us, and we recognize that a deterioration in financial and economic conditions (US and Europe) not to mention China is upon us. This does not mean that the U.S. and European economies cannot avoid a recession but to expect that outcome relies on the “hope that this time is different.”

*In the four week period ending August 19th the S&P 500 declined 16.5%. Last week the S&P 500 recouped 4.7% of that amount.

Sailors are always complaining about no wind or praying for more wind. But the critical element in making forward progress is continuously adjusting and trimming your sails. This is exactly what we are continuously working on doing.

4. Our Mood. We remain fearful of economic and political event risks as it continues

to cast a pall over all risk asset markets. We still think we are trading in a minefield of data points, and the data points are all, without exception, flashing red. We know that many of you are itching to get reinvested, but, unfortunately we fear we are still in for a fairly tumultuous period in the near term. This is the time to be patient and extra careful. Patience should bring rewards and, in the interim keep our anxiety and risk levels low. We have had the luxury of sleeping well these last several months, and most investors cannot say that. Keep in mind that cash is an asset class like any other asset class. At this time of dysfunctional markets, it is the most appropriate asset class to be in, in our opinion, especially given the risk level we are prepared to accept. It is that judgment that our clients pay us for.

We want to repeat what we said in our last letter. For most of our clients, the money they have invested with us represents a significant portion of their investable assets. It is our opinion that this is not a time for taking on significant risks. It is a time for reflection without the burden of volatility and the fear of a significant loss. At this moment, we feel that the risks far outweigh the rewards in the markets and there will be plenty of time and opportunity to capture market appreciation. Be assured that we will be there to participate when we believe that the investment climate has the potential to properly reward our participation.

Past performance is no guarantee of future results. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities, markets or issues mentioned. The information contained herein, while not guaranteed as to accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.

2nd Quarter Interim Quarterly Update July 26, 2011

July 26, 2011


SOME THOUGHTS ON THE MARKET AND OUR INVESTMENT POSTURE

Mohamed El-Erian, the CEO of Pimco, someone we greatly respect, expressed our thinking perfectly in the Barron’s of July 25th. He said, “There are some key principles investors should think about. First, they should be able to navigate volatility, because the danger of volatility is it forces you to do the wrong thing at the wrong time. Second, I'd be careful about return expectations. Governments have borrowed returns from the future. [Fed chief] Ben Bernanke said the objective of QE2 was to push asset values up to make people feel richer. The Fed succeeded in asset-price inflation but the transmission mechanism to higher spending hasn't materialized. Third, the tail risks are much bigger: The loss of triple-A status, the possibility of a disorderly default in Europe, of China not being able to manage its success. An investor has to ask, 'Can I afford such a tail?' If the answer is 'No,' they should hedge the tail or look again at asset allocation. And don't underestimate the value of cash; in a volatile world both good and bad assets are impacted, and the higher the probability of being able to buy good assets at really cheap levels. You don't want to be fully invested today.” (emphasis added)

Here at L & S we are not confident that we can predict the future, but we can identify risk when we see it. Today the risk levels exceed our alert metrics to a greater proportion than anytime since late 2008 and early 2009. The Wall Street Journal ran an article this past Saturday talking about “neon swans.” A black swan event is unthinkably rare, immensely important, and as unpredictable in advance as they are inevitable in hindsight. WSJ defined the neon swan event as “unthinkably rare, immensely important and blindingly obvious.”

NEON SIGNS FLASHING RED

Our economic investment metrics continue to flash “caution” and/or “danger.” This does not mean we will stay on the sidelines forever.

We are going through a tumultuous post-bubble healing period. It is not the end of the world. We will endure and will come to the other side of the mountain whenever the next secular bull market in equities begins. We believe that this is not a time to be adding risk, cyclicality, or beta to a portfolio but rather a time to preserve and protect. Cash is our investment choice of necessity.

We believe that anyone making prognostications in this atmosphere is guessing. There are so many variables that can go wrong or right. In this type of atmosphere, we prefer to be on the sidelines in cash.

For most of you, the money you have invested with us represents a significant portion of your investable assets. It is our opinion that this is not a time for taking on significant risks. It is a time for reflection without the burden of volatility and the fear of a significant loss. At this moment, we feel that the risks far outweigh rewards in the markets and that there will be plenty of time and opportunity to capture market appreciation. Be assured that we will be there to participate when we believe that the investment climate has the potential to properly reward our participation.

Please feel free to call us at any time if you have any questions.


Past performance is no guarantee of future results. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities, markets or issues mentioned. The information contained herein, while not guaranteed as to accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.

2nd Quarter 2011 Market Update Letter

July, 2011


“I don’t want to make the wrong mistake” Yogi Berra

Yogi frequently captures the essence of our thinking about issues that are difficult to get your head around. So it is with the cross currents of today’s financial markets. Because we are laser focused on Risk Management, we want to avoid the wrong mistake. Consequently, your account is presently invested virtually entirely in cash.

As we have communicated many times in the past, we consider cash to be an asset class. At this moment, holding a large cash position enables us (and hopefully you) to sleep soundly. Our present thoughts are that the risks of our being invested far outweigh the potential rewards. You are paying us for our judgment and to attempt to preserve your assets and at this moment, in our view, cash is a safe place to be.

In our first quarter letter, we said that we are constantly hearing from the talking heads and politicians that alternatively the world is ending or everything is going to be just fine. We feel the answer lies somewhere in the middle so our job is to be alert to how the markets discern the risks we face. The volatility of the markets recently indicates to us that the market is discerning considerable risk but not great rewards. For the balance of the year, our focus will be on the overall performance of our economy and the world economy and attempting to select the right vehicles to maximize return and minimize risk in this environment. At the same time, we want to be alert to any direction that the market chooses to take.

As an example of the extremes, consider the following: High yield bonds and many other investment vehicles have once again gone from being weeds to flowers - from pariahs to market darlings - and it has happened in a startlingly short period of time. As is so often the case, things that investors wouldn’t touch in the depths of the crisis in late 2008 now
strike them as good buys at twice the price. The swing of this pendulum recurs regularly in the financial markets and creates some of the greatest opportunities to lose or gain. We consider our job to be being alert to those appropriate opportunities.

The economist John Kenneth Galbraith described investors thought on history this way:

Contributing to…euphoria are two further factors little noted in our time or in past times. The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. In further consequence, when the same or closely similar circumstances occur again, sometimes only in a few years, they are hailed by a new, often youthful, and always supremely self-confident generation as a brilliantly innovative discovery in the financial and larger economic world. There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.

When the markets get cooking, the lessons of the past are frequently dismissed. Investors have moved towards being overly risk tolerant rather than risk averse. It appears that investor’s tolerance of risk is out of synch with our tolerance of risk. Consider some of the data points we watch. Interest rates, debt markets, treasuries, corporate debt, munis, derivative markets, CDs, libor spreads, 10 year T bond, 30 year T bond, yield curve, junk market, commodity prices (copper, oil, grains), precious metals (gold, etc.), fed policy, China, and emerging markets.

Warren Buffett is quoted saying “The less prudence with which others conduct their affairs, the greater prudence with which we should conduct our own affairs.” These thoughts bring us to our present portfolio construction. At this particular moment we see very little reason to take risk and a great deal of reason to be ultra cautious. Investors are being forced toward pro-risk behavior because of the paucity of returns in the safer, low-risk portion of the risk/return curve. But that is for this moment and will likely change in the future when we hope to take advantage of the opportunities that could potentially arise. The markets are open every day and the ability to reinvest is virtually instantaneous these days.

Our focus has been on this question - should you worry more about losing money or about missing opportunities? We believe the answer is easy. The macro uncertainties that we see indicate to us that we are not likely to see a dynamic economy or a meaningful trend in market environment in the near future.

Our role as portfolio managers is to gauge the risk and reward and to try to select appropriate investment vehicles in the construction of a portfolio. Our role is not to be dogmatic and to recognize that there is always a price that incorporates value in the market and in individual securities. Too many investors find comfort in the momentum of rising stock prices and too many investors are frightened by the value of market drops. We prefer to be opportunistic investors. Our job for you is to try to make the best possible risk adjusted judgments, preserve capital, and get the fair risk adjusted return.

“We would rather accept the risk of lost opportunity than risk of loss of capital”

Our path remains disciplined. Here is our plan. In our Growth and Income and Income portfolios, when we feel the time is appropriate to reinvest, we will continue to focus on investment vehicles, including MLPs, potentially capable of producing stable income, and will try to capture some growth from select holdings. In our growth portfolios we will continue to look for those sectors and specific equities that we feel will yield the most appropriate risk adjusted returns. We will remain ready to reenter the market while seeking to avoid market extremes, in an effort to protect capital.



Past performance is no guarantee of future results. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities, markets or issues mentioned. The information contained herein, while not guaranteed as to accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.

First Quarter 2011 Market Update Letter

First Quarter 2011 Market Update Letter

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to Heaven, we were all going direct the other way- in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only”

Tale of Two Cities by Charles Dickens

We are constantly hearing from the talking heads and politicians that alternatively the world is ending or every thing is going to be just fine. We feel the answer lies somewhere in the middle so our job is to be alert to how the markets discern the risks we face. The markets continued to be volatile as we moved through the first quarter; although, its direction was up. Our focus, as always, continues to be on risk management and, to the extent possible, the avoidance of market extremes. For the balance of the year, our focus will be on the overall performance of our economy and the world economy and attempting to select the right vehicles to maximize return and minimize risk in this environment. At the same time, we want to try to take advantage of any direction that the market chooses to take.

End of Quantitative Easing (“QE”): Perception vs. Reality

We are not particularly worried about how the markets will react to the end of QE. It might not be good – even if you believe the impact from QE has been limited. However, we do not think it will be as bad as many fear and we are careful not to use the period post QE1 as the benchmark given that it also corresponded with a flare-up in European sovereign debt concerns. We think the economy can (for now) stand on its own without the need for extraordinary liquidity measures, and if growth data holds then markets will remain supported even if there is a negative sentiment impact.

There are a number of problems with assessing a post QE world for risk assets. Not only is it difficult to determine/disentangle what the impact has been on risk assets and the economy, but also how investors will react over the coming months: will they move pre emptively to de-risk? Will they take profits from equities? How will growth data hold? Will the world still be confronted with $120/bbl oil? The end of QE will not occur in a vacuum.

Our best guess? At a minimum, it removes a backstop for risk assets. We are not bullish on growth, rather our view is that growth is not at risk of collapsing as the Fed unwinds its balance sheet. Over the medium term, we worry about the structural issues which are pushing the government to get fairly serious about addressing its fiscal position (or else money printing might unfortunately prove the only solution) However, for now we think if growth data holds then markets will remain supported even if there is a negative sentiment impact.

We would make the following points:

• Positive correlation between Fed purchase and equities is not a causation: We think the measure of QE’s success is whether the recovery becomes self-sustaining – we think it is, with an improving labor market the key, going forward. It seems obvious that the correlation between equities and Fed purchases of asset backed securities and US Treasuries since the start of QE has been positive. But, the Fed was also expanding its balance sheet through the financial crisis and the correlation with equities was negative during this period. The correlation with Leading Economic Indicators (i.e. ISM) has also been positive and while it has been more volatile, so has the correlation with indicators such as payrolls. The point we are making is that correlations with Fed purchases and selected economic indicators are all positive – but correlation is not causation.

• Consensus growth estimates for the US rising: We are not the first to admit that the US recovery might not look great. There is enough ammunition for the bears to use to discredit the success of QE. Credit creation remains weak, the housing market is once again deteriorating and income growth has been non-existent (a wage-less and job-less recovery). But equally, we can point towards a significant rebound in manufacturing, strong Purchasing Managers Indexes, improving labor market and an equity market which has doubled over the same period. We know that US is still not in great shape and that a multi-trillion dollar expansion in the Fed’s balance sheet should have done more. But growth looks a little more like the “old” than the “new” normal at least for the next two years if consensus economics forecasts are to be believed (2.9% in 2011 and 3.3% in 2012).

• Policy normalization likely to correspond with a small correction: Our biggest concern is that there will be a sentiment impact on markets as QE unwinds. We are already seeing higher bond yields and a flatter yield curve as the market anticipates the next phase of policy normalization. But for all the rhetoric around market impacts, we are yet to see signs of sector rotation of significant outflows. For markets, a simple analogy could be historic performance around rate hikes which has traditionally corresponded with a period of indigestion, and a small correction.

• QE unwinding unlikely to be the sole catalyst for market correction: Overall, we think it is unlikely that QE will be the catalyst for a correction in markets on its own. We remain more concerned that it may correspond with a peak in growth data momentum, still elevated oil prices and a weakening earnings backdrop. Irrespective of whether QE has been the key driver of the rally in equities or not, the strongest performers have been the risk on trades – small caps (back above their 2008 high), commodities and value over growth (the former dominated by Financials).

To that end, we believe that it makes sense to be long high quality, defensive, dividend yielding and dividend growth stocks, together with ongoing exposure to oil, food stocks, mining services (drillers) and the precious metals.

In the face of all of the above headwinds, uncertainties, geopolitical concerns, and a failing to lead government (aka politics as usual) the market continues to move generally higher. Our path will remain disciplined. We will continue to focus on stable income producing vehicles and MLPs and will try to capture some growth from select holdings. We continue to be cautious and maintain what we consider to be positions in dividend paying stocks, with some protection in the form of precious metals, material stocks, and energy stocks if inflation and/or deflation becomes a real factor. We will remain ready to exit the market to avoid market extremes if we deem it necessary to protect capital.


Past performance is no guarantee of future results. The information contained herein is based on internal research derived from various sources and does not purport to be statements of all material facts relating to the securities mentioned. The information contained herein, while not guaranteed as to accuracy or completeness, has been obtained from sources we believe to be reliable. Opinions expressed herein are subject to change without notice.

The performance of DJIA and S & P 500 may be shown as a general market indicator only and should not be considered an appropriate benchmark for individual account performance; the management style for client accounts may utilize positions and strategies, such as covered calls, that are not reflected in the index. Indexes are calculated on a total return basis with dividends reinvested and are not available for direct investment.