Second Quarter, 2011 Economic and Market Commentary

There are at least a few major issues confronting continued economic growth and equity market expansion. The first would be the anemic pace of the U.S. recovery itself. Housing is commonly a key driver in any recovery and this is and will likely continue to be missing for some time. Further, over the next several quarters the employment picture is likely to weaken somewhat as public sector reductions are likely to exceed private sector gains. However, the retrenchments in both these areas of real estate and employment have been going on for a few years now and are accommodating some significant imbalances that existed prior to that time. As such, these adjustments, although painful at the micro level, will likely be helpful in maintaining more sustainable growth in the long run.

Another major concern is the debt ceiling stalemate of the U.S. government. Many fear a significant market disruption in the event certain agreements are not reached in time to avoid a default on some treasury issues. Although we would concede the potential short term market volatility due to the uncertainty surrounding default, we believe it is likely some type of accommodation will be reached. Further, even if the ceiling is not increased, we believe the fallout should be rather limited in effect. This is because the U.S. treasury would not be defaulting due to a real incapacity to pay its debt. Rather, this is more akin to a squabbling couple who have a mortgage payment due from a joint account requiring two signatures. They have the means to make the payment and sooner or later the system will force them to work it out although the ramifications of not making the payment in the interim are not pleasant.

Globally, the fate of Greece continues to unsettle investors around the world. Following a downgrading of Greek debt by Standard & Poor's in June amidst an impasse by Euro zone leaders regarding an additional bailout package, equity markets temporarily retreated. The pullback was short lived, however, as Greece quickly approved an austerity plan and optimism grew that an agreement could be reached among Euro zone leaders, banks and private investors regarding a new financial rescue package. This will no doubt continue to be one of the most closely followed stories in the third quarter, with the ultimate resolution and impact on the rest of the Euro zone likely to impact near term equity market returns across the world.

In the U.S., corporate profits remained strong despite an economy that continues to struggle to pick up steam. Many investors are skeptical that earnings can continue at its current pace in the face of such a weak economic recovery. This has kept equity valuations, based on historical P/E ratio averages, in check despite corporate earnings and profits that remain well above historical averages. In the meantime, corporate balance sheets remain flush with cash as many companies trimmed expenses during the downturn and then saw earnings quickly rebound. The eventual deployment of this cash, whether for hiring, research and development or mergers & acquisitions (M&A), would help to stimulate the economy without the aid of any further government involvement. Already we have seen M&A activity begin to pick up over the last couple of quarters.

These many considerations discussed above and the uncertainty they create, reiterate the need for a balanced approach in your investment policy. The adequacy of cash and fixed income exposure to meet short to intermediate term requirements will afford protection for the volatility likely to be seen in the equity markets over that period. By committing only funds not necessary for the longer term to stocks, you can withstand the short term volatility and gain a significant hedge to inflation and other risks within the portfolio. This can be seen in the earnings yield on the Standard & Poor's 500, which currently reflects a premium of two and a half times the yield on a ten year treasury. Over a period of several years this is likely to result in a premium return to equities over bond instruments.

The model growth component that we employ favors active over passive management for most asset classes. In order to gauge the performance of the managers utilized within the model growth component it is necessary to compare the returns of the model growth component to a weighted average benchmark return. The weighted average benchmark return is calculated by taking the returns of the indexes that mirror each asset class utilized in the model growth component by each asset class' respective weighting in the model growth component. This is a more meaningful and appropriate benchmark to use for a diversified portfolio; as opposed to just benchmarking against one index. The table that follows provides these returns and weightings:

Benchmark Sector


3 Month Return

12 Month Return

Large-capitalization Domestic

S&P 500



Mid-capitalization Domestic

S&P 400



Small-capitalization Domestic

Russell 2000



Micro-capitalization Domestic

MSC US Microcap



Developed International Markets




Emerging International Markets




Real Estate Investment Trust




Global Real Estate Investment Trust