"We don't think the world has ended."

With so much doom and gloom being published these days, it's refreshing to hear a respected leader of a global, blue-chip company make a positive statement. Doug Oberhelman, the chief executive officer of Caterpillar, met with analysts last week and painted a rather bright picture of the world economy, including the quote above.

Oberhelman went on to say that Caterpillar does not expect a double-dip recession because the world's central bankers are staying on top of the situation and the global economy is improving -- especially in the developing world. As the world's largest maker of construction and mining equipment, Caterpillar is considered a good indicator of worldwide economic health, according to Associated Press.

One question that many analysts and economists are struggling with is, "Can the world recover without the United States?" As the world's largest economy, there's an old saying that when our economy sneezes, the world catches a cold. Well, we've certainly done more than sneeze in the past three years. Optimists say that yes, the U.S. is still important in the world economy, but other countries, most notably China, India, and Brazil, can still prosper even if the U.S. is down for a few counts. They call this "decoupling."

Underscoring this idea of decoupling is the fact that China just passed Japan as the world's second largest economy, according to The New York Times. Forecasters are predicting that China will surpass the U.S. as the largest economy by as early as 2030.

Caterpillar, for one, thinks the world will continue recovering even if the U.S. is a bit weak. And the stunning growth of China makes that idea plausible.

YOU MAY NOT HAVE HEARD OF STANLEY DRUCKENMILLER, but he will be remembered as one of the most successful investors (speculators?) of all time. Since 1986, Druckenmiller has generated average annual returns of 30%, according to an August 18 article by Bloomberg. Incredibly, in 30 years of managing money, he's never had a losing year, according to Bloomberg.

Perhaps his most famous moment came in 1992 when he was working for famed investor George Soros. Together, they made a multi-billion dollar bet that the Bank of England would be forced to devalue the pound. Sure enough, that occurred and the duo made a $1 billion profit for their investors -- in a single day -- according to Forbes. Over the years, Druckenmiller did well personally, too, as Forbes magazine estimated his net worth at $3.5 billion in 2009.

When it comes to making money, Druckenmiller said, "It is not whether you are right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong."

Last week, Druckenmiller announced that he was retiring from managing client money.

The fact that he was retiring was not unusual, rather, as it was the reasons he gave for the retirement. According to The New York Times, Druckenmiller said, "I have had to recognize that competing in the markets over such a long timeframe imposes heavy personal costs." He went on to say, "While the joy of winning for clients is immense, for me the disappointment of each interim drawdown over the years has taken a cumulative toll that I cannot continue to sustain."

Two days after Druckenmiller announced his retirement, another famous investor, Paolo Pellegrini, said he was getting out of the business of managing other people's money. Pellegrini is famous for betting against risky mortgages and helping his former boss, John Paulson, score a $15 billion profit a few years back, according to The Wall Street Journal. This coup was chronicled in the bestselling book, The Greatest Trade Ever, by Gregory Zuckerman.

Why should you care that these two famous investors are exiting the business of managing other people's money? It's important because of the possible signal that it sends.

Back in August 1979, BusinessWeek magazine ran a cover story titled, "The Death of Equities." It concluded by saying, "The old attitude of buying solid stocks as a cornerstone for one's life savings and retirement has simply disappeared…The stock market is just not where the action's at." Exactly three years later -- in August 1982 -- the stock market took off on an 18-year bull run that was one of the greatest in history. That story, in hindsight, served as an early inverse indicator of the future direction of the market.

Could the disappearance of Druckenmiller and Pellegrini be a signal similar to the infamous BusinessWeek story?

A stretch, perhaps, and there's no way of knowing what the market will do until after it happens. But it's interesting to consider what non-traditional clues like this might mean.  Food for thought.

For your convenience the sources have been listed below:
http://news.yahoo.com/s/ap/20100819/ap_on_bi_ge/us_caterp...
http://www.nytimes.com/2010/08/16/business/global/16yuan.html
http://www.bloomberg.com/news/2010-08-18/druckenmiller-c...
http://www.forbes.com/lists/2009/54/rich-list-09_Stanley-Druc...
http://dealbook.blogs.nytimes.com/2010/08/18/druckenmiller-...
http://www.prudentwealth.com/quotes.htm
http://online.wsj.com/article/SB1000142405274870448840...
http://www.businessweek.com/investor/content/mar2009/pi2...
http://www.afterquotes.com/great/quotes/investing.htm

One week, the glass is half full, the next week, it is half empty.

Investor's lack of conviction was on full display last week as a scandal at Hewlett Packard, a change of heart from the Fed, a revenue miss from tech bellwether Cisco Systems, and an unexpected rise in weekly jobless claims led to a decline in global stock markets, according to Bloomberg.

In particular, the Federal Open Market Committee last week slightly changed its economic outlook by saying, "The pace of economic recovery is likely to be more modest in the near term than had been anticipated." To help the economy maintain momentum, the Fed announced that it will goose the economy a bit by reinvesting the principal payments it receives on its agency securities in longer-term Treasury securities and that it will roll over its maturing holdings of Treasury securities in new Treasury securities. Effectively, this means the Fed will not shrink its balance sheet for the time being.

Whether this move is good or bad for the economy is subject to debate. One camp says it will help keep interest rates low, which could be good for the economy. Another camp says it will help keep interest rates low, which could be bad for the economy at this stage of the economic recovery. That was not a misprint -- smart people are taking opposite views on whether low rates are good or bad for the economy. Kansas City Fed President Thomas Hoenig leads the dissenters. In a speech in Lincoln, NE last week, Hoenig said, "We need to get off of the emergency rate of zero, move rates up slowly and deliberately" and "We will repeat the cycle of severe recession and unemployment in a few short years by keeping rates too low for too long."

This tug-o-war between smart people makes for interesting reading (at least for us, anyway!)... but generates no clear trend in the market.

IF YOU HAD TO DESCRIBE THE STATE OF THE ECONOMY as an animal, which animal would you pick? This may sound like a silly question, but it is an actual question from a national survey released last month and sponsored by the Certified Financial Planner Board of Standards.

Some of the less common survey responses included cow, kangaroo, lamb, dinosaur, possum, rat, giraffe, hyena, and, not surprisingly, bull. Looking at this list makes us wonder… what attribute does a giraffe or a possum have that can be compared to the economy? Let us know what you think.

The most common responses were bear, snake, turtle, sloth, lion, pig, dog, and skunk.

Okay, have you picked your animal?

For discussion purposes, let's say that you picked a bear as your animal. Of course, a "bear" is also commonly used to describe a weak stock market. Now, here's the point. Often, investors get an idea in their mind -- e.g. this is a "bear" market -- and have a hard time changing their perception even in the face of new evidence that would suggest their perception is inaccurate. Psychologists call this "anchoring" and it has led many investors astray, according to Investopedia.

The key to overcoming anchoring is to keep an open mind, be willing to change, and utilize rigorous thinking.

So, no matter what animal you picked, whether it be bull, bear, turtle, sloth, or skunk, be alert to new information that may suggest that it's time to pick a new animal. As your advisor, we are mindful of the "anchoring" bias and we do our best to base our decisions on rigorous thinking and not on an outdated opinion.

For your convenience the sources have been listed below:
http://www.bloomberg.com/news/2010-08-14/u-s-stocks-dro...
http://federalreserve.gov/newsevents/press/monetary/20100810...
http://www.marketwatch.com/story/unusual-uncertainty-clouds-...
http://www.kansascityfed.org/speechbio/hoenigpdf/hoenig-linc...
http://www.cfp.net/downloads/CFPBoard_Public_Opinion_S...
http://www.investopedia.com/university/behavioral_finance/be...
http://www.selfhelpdaily.com/quotes-about-time/

Despite a disappointing jobs report, stocks still managed to post a solid gain last week. In fact, all three major U.S. indexes --the Dow Jones Industrial Average, the S&P 500, and the NASDAQ Composite --ended last week in positive territory for the year, according to CNBC.

Strong corporate earnings are helping to keep a floor under the market. Roughly 75% of the companies that have reported second quarter earnings beat Wall Street estimates, according to CNBC. Of course, one factor that helped corporate America post strong earnings was keeping a tight rein on employment costs. Unfortunately, what's good for corporate America may not always be good for "employment" America.

Bond yields continued to decline last week as the 2-year Treasury hit a record low of 0.50%. The 10-year Treasury yielded 2.82%, which is a 15-month low. Foreign country bonds are sporting low yields, too. The 10-year German Bund hit a record low yield of 2.51% last week, while the benchmark Japanese 10-year government bond yielded just 1.05% last week, according to Barron's.

Low yields suggest either slower economic growth ahead or little to no inflation, or both, according to Barron's. Low rates are generally good for businesses because it makes their cost of capital lower and makes it easier for them to reinvest for future growth. So far, the low rates appear to have helped stabilize the economy, but robust growth and reinvestment has yet to materialize, according to The New York Times.

Overall, the mixed economic data is helping keep the market stuck in a broad range.

"WE ARE IN A NEW NORMAL WORLD in which the distribution of outcomes is flatter and the tails are fatter," according to a July 2010 Global Perspective report from Richard Clarida of PIMCO. What in the world does that mean?

Clarida's words might sound like mumbo jumbo, but he actually makes a solid case that planning for "extreme" outcomes rather than "average" outcomes might be the appropriate investment strategy in the current climate.

History tells us that the average annualized total return on the S&P 500 between 1926 and 2009 was 9.9% and the standard deviation was 19.2, according to TD Ameritrade. Standard deviation is a measure of volatility and at 19. 2 (one standard deviation), it means that about 68% of the time, we would expect the S&P 500 annual return to be somewhere between a loss of 9.3% and a gain of 29.1%. At two standard deviations, it means that about 95% of the time, we would expect the S&P 500 to return somewhere between a loss of 28.5% and a gain of 48.3%. At three standard deviations, it means that about 99.7% of the time, we would expect the S&P 500 to return somewhere between a loss of 47.7% and gain of 67.5%.

Clarida is suggesting that, in the future, more of the returns in the financial markets will fall in the 2nd or 3rd standard deviation range (the "fat tail") instead of the 1 standard deviation range (the "hump"). If true, this means we could expect more volatility -- both positive and negative -- in the future.

The future could be more volatile due to such things as the unpredictable nature of government regulation and bailouts, sovereign debt levels, high-frequency trading, geopolitical flare-ups, social unrest, high unemployment, and medical or scientific breakthroughs.

Recent events such as the May 6 "Flash Crash," the 2008 financial crisis, the 2007-2009 bear market, and the 2008 spike and then collapse in oil prices, support Clarida's idea that we live in volatile times.

So, if we are temporarily living in a "fat tail" world, then it makes sense to plan accordingly. And, that's what we're trying to do on your behalf.

For your convenience the sources have been listed below:
www.cnbc.com/id/38596993
online.barrons.com/article/SB50001424052970204593404575...
online.barrons.com/article/SB50001424052970204078204575...
www.nytimes.com/2010/07/26/business/economy/26earnings.h...
www.pimco.com/Pages/TheMeanoftheNewNormalIsanObserv...
planning.tdameritrade.com/sites/client/tda/tdap/article.vm?siteC...
mathworld.wolfram.com/StandardDeviation.html
historicalreturns-sp500.blogspot.com/
thinkexist.com/quotation/take_calculated_risks-that_is_quite_...

"The economy is still struggling; too many Americans are still out of work; and the Nation's long-term fiscal trajectory is unsustainable, threatening future prosperity," according to the Mid-Session Review submitted by the White House last week.

This supplemental update of the annual budget contained a number of projections that are of interest to us. Here are a few:

• A projected federal deficit of $2.9 trillion over the next two fiscal years.
• Gross Domestic Product projected to grow 3.2% this year, 3.6% in 2011, and 4.2% in 2012.
• Unemployment projected to average 9.7% this year, 9.0% in 2011, and 8.1% in 2012. It is projected to stay above 6% until 2015.
• The consumer price index projected to rise 1.6% this year, 1.3% next year, and 1.8% in 2012.
• The 10-year Treasury projected to yield on average 3.5% in 2010, 4.0% in 2011, and 4.6% in 2012.

Projections like this are, of course, notoriously difficult to get right. So much can happen in a short period and throw off the best laid plans. But, looking at the projections at least gives us a place to start. Overall, the projections are a mixed bag. The deficit numbers are problematic. The GDP growth projection is good if we can hit it. The unemployment numbers are painful. The inflation outlook is stable and the Treasury yield is favorable for business growth.

If, by the end of 2012, the above numbers come to fruition, then we would likely avoid a double-dip recession and the economy would probably "muddle along." So far, corporate America is doing its part by showing really solid earnings for the second quarter. Companies such as Caterpillar, 3M, AT&T, and UPS notched solid quarters and suggest there is underlying strength in the economy, according to MarketWatch. In fact, of the 175 companies in the S&P 500 that have already reported their second quarter earnings, a whopping 78% have beaten analysts' estimates while only 12% missed, according to data from Thomson Reuters as reported by MarketWatch. Buoyed by good earnings and relief over the European bank stress tests, the S&P 500 rose a solid 3.6% last week.

Given all the volatility we've had over the past 2½ years, "muddle along" might not be so bad!

WHETHER AN INVESTOR LEANS BULLISH OR BEARISH, there is ample data to support either view. This situation may explain why Fed Chairman Ben Bernanke told Congress last week that the economic outlook was "unusually uncertain." For those investors who lean bullish, here are several supporting points courtesy of economist David Rosenberg as reported by Financial Times:

• Congress extended jobless benefits, which is one form of stimulus.
• Some Democrats are now in favor of delaying tax hikes.
• China is having some success slowing its property bubble without bursting it.
• Confidence is growing that the emerging markets may keep world growth positive even if more mature countries slow down.
• Eurozone debt and money markets have settled down after the problems with Greece sparked default fears.
• The European bank stress tests contained no major surprises and added clarity to the soundness of the banking system.
• Consumer credit delinquency rates in the U.S. are improving.
• Mortgage delinquencies in California, one of the hardest hit real estate markets, are at a three-year low.
• The BP oil spill is coming under control and is no longer each day's top headline.
• The passage of the financial regulation bill removed one more cloud of uncertainty.
• Corporate America is reporting solid earnings for the second quarter and their future outlook has been, on balance, positive.
• Fed Chairman Ben Bernanke indicated he'll keep using monetary policy to stimulate the economy and he'll get even more aggressive if need be.

So, yes, there are reasons why the markets and the economy could do okay in the months to come. But, in this "unusually uncertain" time, it still makes sense to be "on guard."

For your convenience the sources have been listed below:
http://www.whitehouse.gov/omb/assets/fy2011_msr/11msr.pdf
http://www.reuters.com/article/idUSTRE66L0KW20100723
http://www.marketwatch.com/story/us-stocks-sprint-higher-o...
http://www.marketwatch.com/story/us-stocks-upbeat-on-earn...
http://federalreserve.gov/newsevents/testimony/bernanke20100...
http://ftalphaville.ft.com/blog/2010/07/23/296721/rosenbergs...
http://www.values.com/inspirational-quote/3688-Martin-Luth...

What is the most actively traded security on the planet?

The answer is the two-year Treasury note and its current yield is sending us a signal, according to Bloomberg, July 17. Last week, the yield on the two-year note fell for the seventh straight week and touched its lowest level ever. At just under 0.6%, it is now lower than during the peak of the financial crisis in the fall of 2008.

What does this signal?

In short, it suggests the economy is slowing down, inflation is not a threat, deflation is a possibility, and money-market rates will remain historically low, according to BusinessWeek, July 15, Barron's, July17, and Bloomberg, July 17. Here's a list of several economic reports released last week that help support this view:

• U.S. consumer sentiment tanked in early July, according to a survey by Reuters and the University of Michigan (MarketWatch, July 16).
• The consumer price index dropped for the third straight month in June, according to data from the Labor Department (Market Watch, July 16).
• Industrial production rose a modest 0.1% in June after having risen 1.2% in May, according to the Federal Reserve, July 15.
• Another report released by the Federal Reserve, June 22, said, "The economic outlook had softened somewhat and a number of members saw the risks to the outlook as having shifted to the downside."
• The dollar has posted significant declines recently against the euro and yen as traders position themselves for a potential slowdown in the U.S., according to Bloomberg, July 17.

While the data above points toward economic softness, second quarter corporate profits are coming in strong. Of the 48 companies in the S&P 500 index that have reported their earnings, 75% have topped analysts' estimates, including a blow-out quarter from Intel, according to Reuters, July 16.

The tug-of-war between soft economic data and strong corporate profits is helping keep the market stuck in a bouncy trading range.

HOW DO YOU SOLVE A PROBLEM LIKE JOBS? This question has a double meaning--jobs as in employment and Jobs as in Steve Jobs of Apple.

Chronically high unemployment in the U.S. is having a debilitating effect on our economy. We can point to many causes for this, but one that receives lots of press is the outsourcing of jobs overseas--and that's where Steve Jobs comes in.

Without getting into a political debate about the pros and cons of free trade, it turns out that in a little recognized fact, Apple is one of the biggest beneficiaries of outsourcing jobs overseas. We can't get enough iPods, iPhones, iPads, and Macs, but relatively few of the jobs created by our insatiable demand are sprouting on our shores.

According to Apple and BusinessWeek, as of September 26, 2009, Apple had about 37,000 full-time equivalent employees of which about 25,000 were based in the U.S. By contrast, Apple has subcontracted with a Chinese company called Foxconn that employs roughly 250,000 people who are devoted to building Apple products. Doing the math, for every one Apple employee working in the U.S., there are 10 Foxconn employees building Apple products in China. Knowing that costs are much lower in China (and that Apple products are in high demand), is it any surprise that Apple earned $3 billion in profit with a 42% gross margin in the first three months of this year?

Again, this is not meant to start a political debate about free trade or protectionism as there are many facets to this issue. It simply points out the intractable nature of high unemployment in the U.S., particularly in the manufacturing sector. Some people argue that free trade and capitalism are the best ways to grow jobs and profits. Others, notably former Intel chairman and chief executive officer Andrew Grove (Bloomberg, July 1), argue for protectionist measures to rebuild our domestic manufacturing base.

Ultimately, America needs to get its people back to work. The Apple example shows just how difficult that may be.

For your convenience the sources have been listed below:
http://www.bloomberg.com/news/2010-07-17/treasury-...
http://www.businessweek.com/news/2010-07-15/treasu...
http://online.barrons.com/article/SB5000142405297020...
http://www.marketwatch.com/story/us-july-consumer-sent...
http://www.marketwatch.com/story/us-consumer-prices-f...
http://federalreserve.gov/releases/g17/Current/default.htm
http://federalreserve.gov/newsevents/press/monetary/fomc...
http://www.bloomberg.com/news/2010-07-17/dollar-weak...
http://www.reuters.com/article/idUSTRE66F5VG20100716
http://phx.corporate-ir.net/phoenix.zhtml?c=107357&p=ir...
http://www.businessweek.com/magazine/content/10_28/...
http://www.businessweek.com/technology/content/jul20...
http://www.apple.com/pr/library/2010/04/20results.html
http://www.brainyquote.com/quotes/authors/s/steve_jo...

Wall Street investors are sure a fickle crowd these days.

After dropping 16% between April 23 and July 2, the S&P 500 recouped one-third of that loss last week and rose 5.4%, according to Bloomberg, July 10. Stocks rose on news that U.S. retail sales grew at the fastest pace in four years in June and a bullish report from the IMF projected an upwardly revised global economic growth rate of 4.6% in 2010, according to CNBC, July 8. Rising optimism that second quarter earnings reports might be better than expected also supported stock prices last week, according to MarketWatch, July 7.

Although the market jumped dramatically, has much changed in the past week? Maybe, maybe not.

Wall Street observers have a tidy tendency to explain every movement in the market with an explanation that seems, on the surface, to be reasonable. Last week's bullish reports on retail sales, world economic growth, and some earnings pre-announcements all seem like logical explanations for the big rise in the market. However, between April 23 and July 2, when the market dropped 16%, we were reading reports that retail sales were weak, economic growth was slowing, and we might be heading for a double-dip recession. Now, a week later, the economy seems to have turned a corner, right?

In reality, the truth is probably somewhere in between. The economy may not have been as bad as the 16% market swoon suggested and it may not be as good as last week's 5.4% pop suggests, either.

It's good to know what market observers are ascribing to the market's weekly moves, but as financial advisors, we have to filter their tidy explanations with a dose of skepticism.

DOES THE LARGE U.S. BUDGET DEFICIT MATTER? Below is a chart of our annual budget surplus/deficit for the past few years.

Source: Office of Management and Budget

Notice how our budget deficit has soared over the past three years as the recession took its toll. Surprisingly, it was just nine years ago that we ran a budget surplus of $128 billion. On a cumulative basis, the national debt is $13.2 trillion, according to the Treasury Department. So, should we be concerned that our annual deficit and national debt are rising dramatically?

Without meaning to be glib, deficits don't matter until they do. Just ask Greece.

Currently, financial markets are relatively unconcerned about our debt level. Investors' lack of concern shows up in the fact that interest rates on government bonds are near historic lows and the spread between interest rates on inflation-protected Treasury bonds and regular bonds is a mild 2.3%, according to MSN, July 9. If investors were concerned about our debt level, they'd send interest rates skyrocketing (as happened in Greece) and inflation might rear its head if the government cranked up the printing press to monetize our debt.

Investors are not alarmed at our large debt level because they still have confidence that our country will weather the storm. However, investors could lose confidence if, for example, we experience some new shock or a "failed" Treasury auction. If that happens, confidence could dissipate rather quickly and throw our economy into disarray.

Nobody knows if this will happen or not, but we continue to monitor interest rates and inflation expectations as early indicators to help determine if confidence is slipping.

For your convenience the sources have been listed below:
http://www.bloomberg.com/news/2010-07-10/stocks-in-u-s-rise...
http://www.cnbc.com/id/38146840
http://www.marketwatch.com/story/us-stocks-gain-at-open-led-b...
http://www.reuters.com/article/idUSTRE64B53W20100512
http://www.treasurydirect.gov/NP/BPDLogin?application=np
http://www.gpoaccess.gov/usbudget/fy11/pdf/hist.pdf
http://articles.moneycentral.msn.com/Investing/Extra/3-big-my...

Data as of 3/12/10

2nd Qtr

Y-T-D

1-Year

3-Year

5-Year

10-Year

Standard & Poor's 500
(Domestic Stocks)

-11.9%

-7.6%

12.1%

-11.8%

-2.9%

-3.4%

DJ Global ex US
(Foreign Stocks)

-12.6

-11.2

9.2

-12.7

1.3

0.0

10-year Treasury Note
(Yield Only)

3.8

N/A

3.5

5.0

3.9

6.0

Gold
(per ounce)

11.5

12.7

33.1

24.1

23.3

15.8

DJ-UBS Commodity Index

-4.8

-9.7

2.6

-9.5

-3.8

1.8

DJ Equity All REIT TR Index

-4.1

5.4

53.6

-8.8

0.4

10.2

STOCK MARKET RALLY FALTERS ON "MACRO" ISSUES

The stock market rally that began in March 2009 came to an abrupt halt in the second quarter. Despite excellent first quarter corporate earnings in the U.S., investors fretted about larger issues that could overwhelm the economy in the months ahead. These "macro" issues include unsustainable government debt levels in numerous countries, the unwinding of stimulus spending, possible deflation, persistently high unemployment, financial regulation, and a government-orchestrated economic slowdown in China, according to The Wall Street Journal, June 30. These concerns helped send the S&P 500 index to an 11.9% decline in the quarter.

Second Quarter Country Returns Based on the Dow Jones Global Indexes
Ranked by U.S. Dollar Performance

Winners

Other Notables

Source: Dow Jones Indexes

ECONOMY SLOWS DOWN

A variety of economic reports over the past few weeks suggest the economy is slowing down. For example, home sales dropped, consumer confidence slumped, manufacturing growth cooled off, and new claims for unemployment insurance remained high, according to Bloomberg, July 3. However, let's not get too carried away. A slowdown does not necessarily mean we are headed for another recession.

Today's weak economy puts policymakers in a tough spot. Normally, fiscal and monetary stimulus is enough to jumpstart growth. Unfortunately, we've shot those two rockets and we still haven't reached escape velocity. If the economy rolls over from here, the question becomes, "Where do we find a third rocket?" According to Tony Crescenzi, strategist and portfolio manager at Pimco, CNBC.com, June 7, our third rocket might consist of time, devaluations, and debt restructurings. If fired, this third rocket could be painful for many Americans.

INTEREST RATES DIVERGE BASED ON RISK PERCEPTION

As the stock market declined, yields on U.S. government securities declined, too, as investors fled to the perceived safety of our government paper. During the quarter, the yield on the 10-year note declined from 3.8% to 3.0%, according to data from Yahoo! Finance. This decline in yield occurred even though the government issued more than $300 billion in new debt during the quarter, according to The Wall Street Journal, July 1. It was a different story in the corporate bond arena. Yields on investment-grade corporate bonds and high-yield corporate (junk) bonds rose as investors began pricing in added economic risk. In a sign of growing risk aversion, the spread between yields on corporate bonds and government bonds rose significantly, as investors required a higher yield to hold the potentially riskier corporate bonds.

THE DOLLAR REMAINS POPULAR

Some naysayers think the dollar's days are numbered, but that countdown had yet to begin in the second quarter. The dollar index, a measure of the dollar's strength compared to a trade-weighted basket of six other currencies, rose a solid 5.9% in the second quarter, according to MarketWatch, June 30. Two major trends are apparently tugging at the dollar and in any given week, one trend seems to outweigh the other. The euro zone debt crisis helped spark a flight to the U.S. dollar and was a major reason why the dollar jumped sharply in the second quarter. However, toward the end of the quarter, disappointing economic numbers out of the U.S. and new austerity measures in the euro zone led some investors to rethink their dollar-haven strategy.

SUMMARY

The recovery from the recession hit a rough patch in the second quarter as several economic indicators turned soft and the stock market turned south. It's too soon to tell if this is the start of a new leg down or simply a pause that refreshes. Either way, we continue to do our best to help you reach your goals.

For your convenience the sources have been listed below:
online.wsj.com/article/SB1000142405274870433460457533924...
noir.bloomberg.com/apps/news?pid=20601087&sid=aiFsUt6_88...
finance.yahoo.com/news/So-what-exactly-is-a-apf-718644427.ht...
www.cnbc.com/id/37555786/?Crescenzi_The_Keynesian_Endpo...
online.wsj.com/article/SB1000142405274870361510457532929...
www.contrarianvalueinvesting.com/2008/07/26/4-david-dreman-q...
www.marketwatch.com/story/dollar-slips-ecb-funding-results-boo...

Can world governments "cut" their way to prosperity?

It's no secret that many countries are incurring large--and unsustainable--budget deficits. What's interesting is the approach each country is taking to try to lower their deficits to a manageable level. Britain, Japan, Germany, and Greece, for example, are focused on cutting government spending, according to Bloomberg, June 22. Conversely, the U.S., while concerned about government spending, seems more focused on keeping the stimulus spending alive and raising taxes until (hopefully) the economy can catch fire and grow on its own.

Who's right?

According to Harvard University professor Alberto Alesina, "There have been mountains of evidence in which cutting government spending has been associated with increases in growth, but people still don't quite get it." In addition, a study by Ben Broadbent and Kevin Daly of Goldman Sachs Group, Inc. as reported by Bloomberg on June 22, "discovered that reducing expenditures by 1 percentage point a year boosted average annual growth by 0.6 percentage point. Raising the ratio of taxes to GDP by the same margin cut growth by an average 0.9 percentage point." And, from a stock market perspective, the same report said, "The equity markets of the countries that sliced spending beat those of other advanced nations by 64% during a three-year period."

Like many things related to finance and economics, we won't know "who's right" until time passes and the market delivers its verdict. Between now and then, expect the vigorous debate on spending cuts versus stimulus spending to continue among academics, investors, and world leaders.

ARE THE FINANCIAL MARKETS "NORMALLY DISTRIBUTED" and should you even care? Consider this. The average height of an American male is 69.4 inches, according to the National Center for Health Statistics, October 22, 2008. If we randomly chose 1,000 American males and calculated their average height, we would likely come up with a number close to 69.4 inches. Now, in an un-random fashion, let's assume we found an 8-foot tall man--who is clearly an extreme outlier--and we have him join the previous group of 1,000. By recalculating the data, we now find the average height of this group of 1,001 men jumps by a very underwhelming 0.03 inches. In other words, adding an extremely tall outlier to this group of average height men had very little effect on the overall average height of the group. Without getting too technical and assuming "tall outliers" are just as likely to be found as "short outliers," we can say the height of men follows a "bell curve" or a normal distribution.

By contrast, let's consider the average net worth of American households. According to the Federal Reserve, February 2009, the average American family had a net worth of $556,300 in 2007. Like above, if we randomly chose 1,000 families, this group would probably have an average net worth near $556,300. However, for fun, let's add Warren Buffett--and his $40 billion net worth--to the group. Recalculating the data, we find the average net worth of this group of 1,001 Americans jumps to $40.5 million! Clearly, adding an extreme outlier to this sample dramatically changed the average of the sample.

As it relates to the financial markets, do you think their distribution of returns looks more like the average height of American men (where an extreme outlier doesn't really affect the average) or the average net worth of American households (where an extreme outlier could have an extreme impact)? If you think the returns in financial markets look like the average height of American men, but it turns out they behave more like the average net worth of American households, you could lose a lot of money. In fact, much of modern portfolio theory is based on the assumption that financial markets follow a normal distribution, i.e., they look like the average height of American men. Unfortunately, experience suggests otherwise.

Warren Buffett-type outliers such as the October 1987 stock market crash, the 2000-2002 bursting of the internet bubble, the 2007-2009 bear market, the 2008 credit crisis, and last month's "flash crash," suggest that the financial markets are subject to large outliers that can significantly affect your financial well-being. Knowing that, we do our best to try to limit the damage to your portfolio if one of these outliers occurs during your investing lifetime.

For your convenience the sources have been listed below:
www.bloomberg.com/news/2010-06-21/cameron-bets-on-prosperity...
noir.bloomberg.com/apps/news?pid=20601087&sid=aMCa3QIjXm6k
www.cdc.gov/nchs/data/nhsr/nhsr010.pdf
www.safehaven.com/article/17241/whats-the-point-of-macro
www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf
www.forbes.com/lists/2009/54/rich-list-09_Warren-Buffett_C0R3.html

A hypothetical Doctor of Investments might say we are in an "EKG market."

We've experienced a series of headlines that have sent the market on a yo-yo ride since we dropped the New Year's ball in Times Square six months ago. Here are a few of the eye-raising events that have kept investors on an emotional rollercoaster:

• The S&P 500 index rose 15.2% between February 8 and April 23, according to data from Yahoo! Finance. Unfortunately, investor sentiment quickly turned and the index declined 13.7% between April 23 and June 7, according to data from Yahoo! Finance.
• On May 6, the "flash crash" sent the Dow Jones Industrial Average to an intra-day loss of nearly 1,000 points before making a massive recovery to end the day down "only" 348 points, according to Portfolio.com. At one point during the day, the Dow dropped 481 points in 6 minutes and then jumped 502 points just 10 minutes later.
• An April 20 explosion on a drilling rig sent as much as 60,000 barrels of oil a day flowing into the Gulf of Mexico making it the worst oil spill in American history, according to The New York Times on June 18.
• A sovereign debt crisis in Europe sent shivers through world markets and led the European Union to unveil a nearly $1 trillion loan package designed to backstop weak countries from defaulting, according to The Wall Street Journal on May 10.
• Gold prices hit an all-time high of $1,258 per ounce on June 18, "fueled by sovereign risk in the euro zone, historically low interest rates, and concern over the stability of paper currencies," according to CNBC on June 18.

Pop quiz time. After all these headline-grabbing events, in percentage terms, how much do you think the S&P 500 index has gone up or down since the end of last year? Brace yourself. The index has risen a whopping 0.2% between December 31, 2009 and last Friday.

The up-down EKG between the bulls and the bears has, like the U.S. versus Slovenia in the World Cup, ended in a draw. However, unlike the U.S. versus Slovenia, we still have six months left in this year to see who wins the yearly "Investment Cup."

HELEN REDDY PROCLAIMED, "I am woman, hear me roar. In numbers too big to ignore," back in the early 1970s. Today, those words are coming true in education, the workplace, and on Wall Street.

In an article titled, "The End of Men" in the July/August 2010 issue of Atlantic Magazine, author Hanna Rosin reported some little known statistics about how far women have come in today's society. How many of these were you aware of?

• As of earlier this year, women now outnumber men in the U.S. workforce for the first time ever.
• Even though women outnumber men in the workforce, three-quarters of the jobs lost in this recession were lost by men.
• Thirteen of the 15 job categories projected to grow the fastest over the next decade are staffed primarily by women.
• Women now hold more than 50% of managerial and professional jobs, according to the Bureau of Labor Statistics.
• According to Rosin, women now earn 60% of master's degrees, about 60% of all bachelor's degrees, about half of all law and medical degrees, and 42% of all MBAs.
• A 2008 study by researchers at Columbia Business School and the University of Maryland looked at the top 1,500 U.S. companies from 1992 to 2006 and discovered that firms that had women in top positions performed better.

The rising level of women's educational attainment and workplace prominence will have a profound impact on the business and investment spheres in the years to come. As part of our "find a trend and throw yourself in front of it" philosophy, we will continue to monitor this long-term trend and the ensuing investment implications.

For your convenience the sources have been listed below:
www.portfolio.com/business-news/2010/05/06/nowhere-to-hide-as...
topics.nytimes.com/top/reference/timestopics/subjects/o/oil_spills/gul...
online.wsj.com/article/SB100014240527487036747045752338912...
www.cnbc.com/id/37768097
soccernet.espn.go.com/world-cup/story/_/id/5304289/ce/us/fifa-ax-u...
www.theatlantic.com/magazine/archive/2010/07/the-end-of-men/8135
en.wikipedia.org/wiki/I_Am_Woman
nces.ed.gov/programs/digest/d09/tables/dt09_268.asp
thinkexist.com/quotation/i_shut_my_eyes_in_order_to_see/218611.html

The U.S. stock market just entered its first correction of 10% since the March 2009 bear market low, according to Barron's magazine. In the paraphrased words of economist Michael Darda as reported by Barron's, are we experiencing an aftershock of the 2008 market crisis or are we having a relapse?

Catalysts for this recent correction are varied. China is clamping down on its easy money policy. Several European countries are in the midst of a liquidity/solvency problem. In the U.S., jobless claims unexpectedly rose last week and the Conference Board reported a surprising drop in its index of leading economic indicators. Both reports raised concerns that the economic rebound in the U.S. may be losing some strength, according to Bloomberg.

The case for optimism is also in plain sight. U.S. News and World Report says two new surveys out last week suggest, "We might be on the verge of experiencing the Great Shopping Comeback of 2010." Higher consumer spending could propel the economy and create jobs. In corporate America, first quarter earnings for the S&P 500 companies grew 55% from a year earlier and 77% of them beat their Wall Street estimate, according to Bloomberg. And, according to Federal Reserve Bank of New York President William Dudley as reported by Bloomberg, "The U.S. economy is recovering and we are now seeing the first signs of significant employment growth."

Economist Darda answered his own question and said we're simply having an aftershock, not a relapse. Even if he turns out to be correct, aftershocks could still generate some "scary headlines" in the near future. As always, we do our best to stay on top of these types of evolving situations.

"History provides a crucial insight regarding market crises: They are inevitable, painful, and ultimately surmountable."  --Shelby M.C. Davis, legendary investor

It's been said that we can count on death and taxes. We should also add "market crises" to the list. It seems like the market is always either in a crisis, recovering from a crisis, or anticipating the next crisis. According to a January 2010 Morningstar article, we've experienced numerous "crises" over the past four decades including the following:

• In the 1970s, we had stagflation, oil shocks, high inflation, and a stock market that dropped 44% in 2 years.
• In the 1980s, we had the collapse of Drexel Burnham Lambert and the stock market crash of October 1987, which sent the Dow Jones Industrial Average down more than 20% in one day.
• In the 1990s, we had the savings and loan crisis, the bailout of hedge fund Long Term Capital Management, and the Asian financial crisis.
• In the 2000s, we had two bear markets, the subprime mortgage meltdown, and the financial crisis of 2008-2009.

But, guess what? Despite these market crises, the Dow Jones Industrial Average rose from 800 at the beginning of 1970 to 10,193 at the end of last week, according to data from Yahoo! Finance. That's nearly a 13-fold increase.

It's easy for investors to let the events of the day or the "crisis du jour" cloud their thinking. However, successful investors take a wider view and realize that crises happen, crises get resolved, and while they can sometime be scary, they should not lead you to panic mode.

For your convenience the sources have been listed below:
online.barrons.com/article/SB127448088917195067.html
online.barrons.com/article/SB127448158833995199.html
www.bloomberg.com/apps/news?pid=20601010&sid=a5ewXALKTwQM
www.usnews.com/money/blogs/alpha-consumer/2010/05/19/6-signs-consume...
www.bloomberg.com/apps/news?pid=20601087&sid=ah8ddjsPcxj8&pos=7
www.bloomberg.com/apps/news?pid=20601087&sid=as1apsOPz4NQ&pos=3
news.morningstar.com/articlenet/article.aspx?postId=2764770#page=0&part=2