by Fred RuoppU.S. ECONOMY
Industrial output was up approximately 0.9% in March and housing starts rose about 7%, partly owing to better weather. Consumer prices rose 0.1% and retail sales were up an unexpectedly strong 1.1% due to auto sales.

GDP for the year should increase 3 to 4%. At the end of this year, unemployment will still be historically high, business and consumer confidence will remain fragile, but the direction appears up.

The eventual cost of the U.S. bailout of troubled banks, auto makers, etc., is estimated at $89 billion, down from earlier projections of more than $250 billion due to paybacks in cash and stock to the U.S.

INTERNATIONAL
The EU announced they were prepared to extend a $40 billion loan to Greece if needed. One-third of this amount may come from the IMF. From a German standpoint, the IMF is useful, because the anger of Greek labor unions and consumers could be deflected away from German exporters to the IMF. A default by Greece would have brought immediate pressure on Portugal, Spain, Italy and, subsequently, other EU members.

In March, China ran its first monthly trade deficit in six years, giving the Chinese some ammunition against revaluing the Yuan. Some contraction of the Chinese growth rate is possible, but it does not seem likely China will dip into recession. Other producing countries such as Brazil, Australia and India continue to show strong economic growth.

ENERGY
Crude oil is trading in the $80 to $85 a barrel area. As world economies continue to improve, demand is recovering. While substantial quantities of new crude are being discovered, it is almost all $80 lifting price in deep water areas off of Brazil, Ghana, Sierra Leone and the Gulf of Mexico. The tar sands of Canada also require $80 oil for newer expansions to proceed.

With natural gas having fallen to the $4.00/Mcf area due to the many new sources of shale oil in the U.S., this fuel is priced cheaply compared to its oil equivalent. Growing use is being made of natural gas in electric power generation and in vehicle use, which will over time eat into the oversupply.

FIXED INCOME MARKET
The 10-year U.S. Treasury continues to yield just under 4% as it has done for the better part of a year. The present level of government stimulus, coupled with the global increase in the monetary base of the industrialized economies, passage of the U.S. health care legislation, along with recently poor auction results, suggests upward pressure on interest rates for quite awhile.

The spread between corporates and U.S. Government issues still favors the former.

Municipal bonds, California included, continue to offer a good after-tax return. In spite of alarmist publicity, California is the largest seller of new issues to willing buyers. It is interesting to note the State is the largest seller of Build America Bonds, the relatively new taxable (to the investor) bonds. These bonds are very popular with foreign buyers.

EQUITY MARKET
With the DJIA in the 11,000 area, the market is reflecting financial stabilization of the U.S. economy and an improving economic environment. At this point, based on anticipated 2010 earnings growth of 25% to 30%, the market looks neither very expensive nor very cheap. Issue selection and sector selection will continue to allow above average capital appreciation prospects. Well-selected common stocks remain attractive.

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Fred Ruopp was named one of the Top 20 Value Managers in the country by Kipplinger’s.

by Fred Ruopp, Sr.

U.S. ECONOMY:

The course of the U.S. economy over 2009 has been one of slow recovery.  Stabilization of the banking and financial sectors in this country and abroad was the first and necessary step in rebuilding consumer and business confidence. Production, retail sales, inventories and employment have begun to show positive change. Production in the U.S. rose in December, for the sixth consecutive month, with output up 0.6%. The cost of living increased 0.1%, less than the median forecast by economists.  Consumer confidence measures continued slowly to the upside.  Intel – a bellwether for the economy – has reported very good earnings and outlook.

The net effect is that the economy is still slowly recovering but definitely moving upward.

INTERNATIONAL:

The U.S. dollar has largely stabilized for now against the yen and the Euro.  This partly reflects the stronger U.S. economy against a somewhat weaker performance for both Europe and Japan.  China continues to rush forward, showing more recently an 8% increase quarter over quarter. Observers predict it will accelerate to 16% in early 2010 if the government continues the present level of stimulus measures.

It is hard to believe the Chinese rate of increase in Gross National Product will be sustainable over any long period of time.

The Chinese banking system is stretched, having loaned on many capital and infrastructure projects. Some of these are redundant and may never be put to use.  Accordingly, China has begun to tighten capital constraints for its banks.  While their economy will almost certainly grow at above trend rates in the first quarter of 2010, inflation is responsive to market conditions and could begin to be a problem later this year.  Therefore, tightening by the banking system has begun.  An alternative would be to float the Yuan against the dollar, but this would not be China’s first resort.

ENERGY:

Crude oil has been trading in the $80 range, reflecting stabilization of world economic conditions and anticipation of growth in 2010.  Present inventories in the U.S. and abroad appear full and a bit on the high side, but looking forward a continued world wide economic recovery puts a floor under crude.  New oil supply discoveries, i.e., Canadian tar sands and deep-water off-shore areas of Brazil, Ghana, the Gulf of Mexico, and Sierra Leone all need $80 oil as a breakeven.  Accordingly, it is difficult to see how oil will sell much below $80 (except for brief periods of economic weakness and/or speculation).  It is more likely that economic recovery and a certain amount of attendant speculation will continue to slowly push the price of oil up.

Alternative energy sources, including solar and wind power, continue to become more competitive in price with fossil fuels.  The day will come when fossil fuels will be used primarily as chemical feedstock and not as fuel for transportation and electric generation.

FIXED INCOME:

The 10-year Treasury continues to offer a yield just under 4% as it has done since April of last year.  This is expected to prevail early into the New Year.  With the present level of government stimulus, as well as the global increase in the monetary base of the industrialized economies, containing inflation will be a challenge.  The Federal Reserve will favor growth and employment and will move slowly to increase rates.  U.S. bond yields continue to be supported worldwide by the perceived safety of U.S. credits, resulting in a very steep yield curve.  The spread between corporates and U.S. Government issues still favors corporates.  Municipal bonds (tax-free) continue to offer a good after-tax return.

EQUITY MARKET:

Stocks continued their strong 2009 performance through December.  While equity markets do not appear particularly cheap based on current earnings expectations, the pattern all year has been for reported earnings to outrun expectations.  We expect that to continue in early 2010.  Accordingly, well-selected stocks should continue to provide good long term profit possibilities.

by Fred Ruopp

U.S. ECONOMY

Signs that the business cycle may have reached its trough strengthened as inventories were again reduced in the second quarter at a yearly pace, estimated by JP Morgan, of $162 billion.  After 10 consecutive months of decline, replacement demand alone can be expected to support manufacturing activity ahead.  Just as importantly, U.S. worker productivity in the second quarter rose at an annual rate of 6.4%–the best quarterly figure since the country emerged from the last recession in 2003.  It should be noted that this gain resulted from hours worked declining by 7.6% against a drop in output of 1.7%.

Another tentative sign of stabilization and recovery can be found in the price action of base commodities which are a good measure of anticipated industrial demand.  For example, the price of copper has risen over 100% year-to-date.  After falling from a peak of $4.00 in 2008 to a trough of $1.40, it has now rebounded to about $2.80.

INTERNATIONAL

With increasing evidence of a bottoming of the U.S. economy and a slow recovery ahead, the dollar has gained some strength against the euro. This reflects the E.U. countries being behind the U.S. in dealing with their banking problems and their GDP growth revival.  Russia is recovering thanks to higher oil prices.  China and India continue to move ahead with China becoming aggressive on locking up mineral, oil and gas supplies around the world.  The latest such activity being a $17 billion bid for Repsol’s stake in YPF, its Argentine unit.  This would be the biggest overseas investment China has made to date.

China is working to build an international currency bloc with other Asian powers and perhaps such nations as Brazil.  The object would be to limit the use of the U.S. dollar as a world reserve currency.  Their holdings of more than a trillion dollars of U.S. Treasury bonds have them a bit nervous as to a fall in the dollar’s value.  Such a fall would also affect their profits as their product prices are denominated in dollars.

While substantial problems remain in the U.S. and international banking and finance systems, the Fed and Treasury as well as foreign central banks have had a good deal of success in stabilizing the situation.

ENERGY

Crude oil again reached $73/barrel on an intraday basis and has pulled back to approximately $70.  This is normal profit-taking in a trend that still appears to be up.  Economic recoveries in the U.S., China, India and Brazil mean higher demand for oil and therefore the tendency will be for prices to work higher rather than lower.  In addition, alternative energy such as wind power and solar as well as the new deep water oil finds offshore Brazil and Ghana all need approximately $80 oil to be profitable.

FIXED INCOME

On August 12th, the Federal Reserve Open Market Committee issued a statement suggesting that “economic activity is leveling out.”  Despite this change from previous, more cautious assessments (for example June’s statement read: “economic activity is likely to remain weak for some time”), the Fed signaled that it would keep rates unchanged for “an extended period” in an effort to assure sufficient liquidity as we emerge from recession.  Few economists expect the Fed to raise rates at all before 2010 and many expect present rates to remain into 2011.

In another sign of confidence, the Fed signaled it would phase out its program to purchase up to $300 billion in U S Treasury securities. As these and other efforts to shore up the nation’s financial house are eased, market reactions will require close scrutiny to assess the pace and success of these efforts.

STOCK MARKET

From the March 6th low to the August 12th high, the Dow Jones Industrial Average rose 2,960 points or 46%.  While many solid companies enjoyed strong rebounds from over-sold conditions, much of the recent upside action has been concentrated in sectors that performed poorly during the sell-off, particularly securities of financial, housing-related and consumer discretionary companies.  With over-sold conditions now largely behind us, future gains can be expected to correlate more with long-term earnings prospects.  Therefore, well-selected equities will continue to do well.

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Fred Ruopp is the CEO of Chelsea Management Company and was named one of the Top 20 value-oriented managers in the U.S., according to Kiplinger’s. To learn more, click here.

by Fred Ruopp

Fred Ruopp, a veteran investor named one of the Top Value Managers in the country, a serious Catholic,  and founder of Chelsea Management, Fred Ruopp, Sr., provides a wealth of pithy insights on different economic sectors, beginning with national considerations.  His insights follow:

U.S. ECONOMY
While U.S. economic activity has not yet turned positive, clear signs of a rebound are emerging.  Industrial production figures suggest a bottom, the inventory cycle is turning, and both business and consumer confidence is improving.  It should be remembered that, just as unemployment was a lagging indicator at the beginning of this recession, improvement in this area could come well after the economy has returned to growth.

In a press release issued July 8th, IMF Chief Economist Olivier Blanchard, said, “The good news is that the forces pulling the economy down are decreasing in intensity.  The bad news is that the forces pulling the economy up are still weak. The balance is slowly shifting, and this leads us to predict that, while the world economy is still in recession, the recovery is coming.”

INTERNATIONAL
While substantial problems in the U.S. and world banking and finance systems continue, a greater feeling of resiliency and stability is currently felt through efforts of the Federal Reserve and Treasury.

Europe and other parts of the world which have similar problems are not as advanced in their resolution as is the U.S.  However, the Europeans have moved with alacrity on infrastructure loans and have a bigger social safety net, i.e., pensions, unemployment compensation, and health insurance that tend to mitigate the effect to a large extent on its citizens.  A substantial increase in IMF funding has been agreed to by the major industrial nations to help combat problems in non-U.S. and non-EU members.

Both Russia and China are attempting to convince others such as India and Brazil to limit the use of the U.S. dollar as a world reserve currency. They are concerned about the prospects for lower dollar value and what this will mean to the very substantial holdings they have already.  A lower dollar reduces, in effect, their profits as their product prices are in dollars.

ENERGY
Crude oil having touched $73/barrel on an intraday basis has had a pullback to $62.  This is part of normal profit taking and should be expected.  With economic recoveries apparently underway in China, India, Brazil and the U.S., it is likely that, over time, the price will work higher rather than lower.  This is aided not only by an end to shrinking demand, but also by attrition in new oil drilling activities owing to the low crude price in early 2009.

A 10% to 15% drop in drilling costs for oil and gas has been positive for earnings at the drilling companies.  These industries remain, of course, subject to swings in the basic commodity price.

FIXED INCOME
As world equity markets recovered in the 2nd quarter and investors started to consider the interest rate climate that a recovery might bring, interest rates rose in general with the benchmark 10-year U.S. Treasury Bond yield rising from around 3.40% to over 3.75%.  More recently, as equity markets have consolidated and economic indicators have pointed to a more muted rebound, rates have begun to return to previous levels with the 10-year Treasury bond presently yielding under 3.50%

We still favor selected corporate bonds, municipal bonds and U.S. Agencies for their safety and relative yield.

STOCK MARKET
After rebounding sharply from the lows of early March, equity markets appear to be entering a period of consolidation as participants digest recent corporate earnings and economic data.  With the Dow Jones Industrial Average now 1500 points above last winter’s low of about 6500, any consolidation that keeps the average above that level can be looked at as positive and provide good opportunities to add high quality long-term holdings.

by Fred Ruopp, Sr.

U.S. ECONOMY
Preliminary estimates of 2009 first quarter GDP suggest only a slight improvement from 2008’s fourth quarter (-6.1 vs. -6.3); however, the massive federal stimuli coming forward point to a possible leveling and then rebound in the quarters ahead.  Much of the last quarter’s contraction centered on decreases in exports (-30%) and a reduction in inventories held by domestic businesses (-2.79%).  Imports also declined as economic activity slowed worldwide.  Reductions in automobile output accounted for nearly one fourth of the overall contraction.

Meanwhile prices leveled, decreasing just 1% over the quarter after a sharp 3.9% decrease in the fourth quarter.  Similarly, personal consumption rose 2.2% after a 4.3% decrease in the fourth quarter.
Most importantly, real disposable personal income (adjusted for inflation and taxes) rose a very strong 6.2%, setting the stage for a rebound in consumer spending.

INTERNATIONAL
While the U.S. has substantial problems in the banking and finance area, the rest of the world has not been excluded from these problems.  Europe in particular, having made many loans to Eastern Europe and other less developed parts of the world, has banking problems.  Austria has, as an example, loaned twice its Gross National Product to Hungary.

There has been a difference in approach, with the U.S. directing $3.5 trillion of stimulus to the U.S. economy. Much lesser amounts are so directed by the European nations led by France and Germany. However, Europe has much broader social safety nets than the U.S. (unemployment compensation, medical care, family allowances) and this in part compensates for less stimulus spending.

Parts of East Asia, led by China and India, appear to be recovering faster from the worldwide downturn than the rest of the globe.  In India, the re-election of the Congress party has given the Indian stock market a 17% increase in just one day.  Recovery in these major Asian markets will have a beneficial effect on the U.S. and Europe as well.

ENERGY
Crude oil has extended its trading range to the upside having hit $60 several times in recent days.  It does appear November was a bottom and a turning point and that crude is working its way higher.  OPEC did not further cut production at its last meeting, but does have a meeting coming up May 28.  While there is no apparent present disposition for further OPEC cuts, price action of crude will determine what happens.

Substantially lower crude prices were felt throughout the alternative energy market with many projects (i.e., wind power, solar power, tar sands, etc.) put on hold or terminated. As the crude price has gradually moved up, some of these projects are coming back on line.  Because of a slow-down in alternative energy and substantial cutbacks in drilling for conventional crude and natural gas owing to lower prices, it is safe to assume that higher oil and natural gas prices lie ahead.

In addition, lower gas and oil well drilling has caused a 10%-15% drop in drilling costs.  This combination is obviously positive for the prices of oil, gas and drilling companies.

FIXED INCOME
Money supply continues to expand while risk-averse investors favor U.S. Treasury securities.  Treasury Bills carry yields near zero, the 10-year 3.10%, while the 30-year offers 4.10%.  These rates reflect a rapid increase since year-end but they are quite low by historical standards.  The Government is issuing larger amounts of debt which,
unless there are unusual liquidity concerns, will ultimately lead to much greater inflation.  The question for investors then becomes one of timing and sector when committing funds.

In summary, even though yields are expected to work upward, investors should avoid U.S.
Treasuries in general and buy corporates, high yielding agencies and consider municipals.

STOCK MARKET
Equity markets continued to build on the rebound begun in early March, rising a further 11% (as measured by the Dow Jones Industrial Average) between the end of the first quarter and May 15.  With this recent rebound, equity markets have largely erased the January to March losses and now stand near breakeven for the year.  As credit market activity has returned to something closer to normal (for example, the closely watched London Interbank Rate has returned to historical trend levels), and consumer confidence has risen, equity market participants have become less fearful, thereby allowing valuations to return to more reasonable levels.  Whether these recent gains can be sustained will depend largely on continued restoration of fundamental economic activities.  Some well-selected equities will continue to do well in the years ahead.

by Fred Ruopp

U.S. ECONOMY
Recent economic indicators have been coming in at better than expected levels over the past month.  After falling at a 4% rate since the summer of 2008, consumer spending is expected to rise slightly in the first quarter of 2009.  The University of Michigan Consumer Sentiment Index is expected to climb again in April after bottoming in November.  After revising January durable goods orders downward, February orders showed surprising strength.  At the same time, inventories continue to drop sharply, suggesting the need to increase production as businesses restock goods for sale.

It remains to be seen just how much of this recent strength is the result of short-term fiscal stimulus and tax refunds, and to what extent it can be sustained over the coming months.

INTERNATIONAL
The recent G-20 meeting to coordinate worldwide monetary and fiscal stimulation efforts had mixed results.  It was agreed to add $1 trillion to the IMF reserves to help bail out third-world countries.  Direct additional stimulus was refused by many European nations led by France and Germany.  However, these nations all have much broader social safety nets than the U.S. (unemployment compensation, medical care, etc.) and this partly compensates for less direct stimulus spending.

Adding to the existing Treasury and Fed stimulus packages such as TARP is the new Treasury initiative referred to as PIPP.  This would create public and private partnerships in which five designated purchasers (Goldman Sachs, Pimco, etc.) would team with the Treasury and make bids on packages of toxic assets from major banks.  One difficulty perhaps is that should the assets subsequently decline in value, the Treasury (i.e., the taxpayer) would pay the difference whereas if the assets appreciate in value the private investors would receive most of the benefit.  It is a question as to whether public opinion will allow this particular formulation to stand.

China and India at this point continue to report positive GDP growth numbers, albeit much smaller than a year ago.  If these continue, it will make a return to growth come more quickly for the U.S. and Europe.

ENERGY
Crude oil has traded recently between the low 30’s and the upper 50 dollar range.  It appears the $30.50 bottom of November was a turning point and that crude is on its way upwards.  OPEC, which did not further cut output at its last meeting, stands ready to make additional cuts if necessary.

The effects of lower crude prices are felt throughout the alternative energy market with many wind-power and solar-power projects being put on hold or terminated.  Substantial additional capacity in the Canadian tar sands has also been put on hold and shale oil in the Western U.S. looks less probable than it did at higher prices.  As the oil price moves up, some of these projects will be coming back on line.  We have, however, laid the base for higher oil prices.

FIXED INCOME
Despite the growing need for public and private debt issuance and continuation of monetary expansion, we expect U.S. Treasury yields to remain relatively low this year because of the perceived safety.  Agency bonds, because of the government backing and a more favorable yield, are better for accounts desiring to maximize yield.  Corporate debt, carefully selected for the quality of earnings, should be accumulated.

We continue to advocated state, county and municipal tax-exempt bonds as the yields are attractive on a relative and historic basis for those able to enjoy the tax-free interest.   Investment-grade credits, even during the depression, experienced a low default rate, below 2.5% on average.  The few defaults were in lower, non-investment grade special assessment districts and special-purpose issues.  It is likely conditions will be somewhat more volatile this time – but not unmanageable.

STOCK MARKET
With frozen credit markets slowly thawing and the effects of recently passed, worldwide stimuli suggesting the worst may be behind us, equity markets staged a strong rally through March.  Whether this rally was a reaction to the over-sold price levels reached in February or based more on the prospects for an economic rebound in 2009 remains unclear.  Should corporate earnings and consumer activity stabilize and improve from here, present values are quite reasonable, particularly for those with an intermediate to long-term viewpoint.

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Fred Ruopp was named one of the Top Value Managers in the country by Kiplingers.  He is founder and CEO of Chelsea Management Company, which manages just over 1 billion dollars for a small number of clients including individuals, insurance companies, charitable foundations, endowment funds, religious organizations and employee benefit plans.

by Fred Ruopp, Sr.

U.S. ECONOMY
With prospects unclear for when a rebound in consumer activity may materialize, corporations are working hard to recalibrate their future plans while strengthening their balance sheets through tighter cash management and de-leveraging.  Until such time as the stimulus efforts of the U. S. Treasury bear fruit, such financially conservative behavior is warranted and can be expected to continue.

Some indicators are starting to suggest stabilization in world trade.  For example, the rates for overseas shipping (as measured by the bellwether Baltic Dry Index) have begun to rebound as energy prices have held recent lows.  Tight credit conditions are also easing up slightly.  All these indicators require close monitoring to see if the rebound can be sustained.

INTERNATIONAL
The U.S. and European banking systems have now for the most part been stabilized. The rest of the world, i.e., Asia, Africa, etc., have also made efforts and look at this point to be successful in stabilizations.  This is the first step and now bank loans need to be more readily available.

The new Treasury initiative announced by Secretary Geithner hopefully will accomplish much of this for the U.S. through his combination of private sales of toxic debt, underwriting of bank assets and encouragement of bank lending.  Other central banks in the world may follow.

Later this year, as corporate earnings continue to decline, some loans which now appear sound or marginal will have difficulties, particularly in areas such as mortgage loans, auto loans, credit card loans, etc.

The dollar may have stabilized recently after rising against the Euro and the Pound, perhaps reflecting confidence in the new administration.

ENERGY
Crude oil has ranged in recent months between $33 and $50 a barrel and is now at approximately $40.  We believe the correction, from the $147 level of June, is now largely behind us.

Currently, the continuing declining demand for crude is being met in part by OPEC with two production cuts and a third one being talked about.  These cuts appear to have been moderately successful, but will not fully be felt until closer to mid-year.  In addition, OPEC countries have delayed more than thirty drilling projects as have nations and oil companies in other parts of the world.  Additional capacity in the Canadian Tar Sands has also been put on hold and wind and solar projects are increasingly being put on hold owing to the low competitive price of crude.  It seems reasonable to expect a balance to be reached by mid-year and for the oil price to advance beyond that point.

FIXED INCOME
Investors continue to seek safety by focusing on U.S. government-sponsored issues.  Despite the looming debt issues and associated monetary expansion, we expect Treasury yields to remain relatively low this year until such point as employment numbers improve.  Agency bonds offer better value than U.S. Treasuries on a yield basis.  Corporate debt, when carefully selected for quality, should gradually be accumulated.

We continue to look favorably upon state, county and municipal tax-exempt bonds as the yields are attractive on a relative and historic basis.  Investment-grade credits, even during the depression, experienced a low default rate, below 2.5% on average.  Most defaults were in lower, non-investment grade special assessment districts and special-purpose issues. Within a few years, each default was made complete with no reduction of principal.  The structure of the municipal market has changed dramatically since then, but general obligation bonds remain as the first draw on taxpayer funds.

STOCK MARKET
The market continues to digest the recent poor economic data in a resilient way.  After making a deep low at about 7550 in November, the Dow Jones Industrial Average has worked its way back to 8000 while market volatility has fallen by almost half as measured by the CBOE Volatility Index.
There are now many high quality companies, with strong balance sheets and cash flows, whose shares offer values not seen in many years.  In the months ahead, we look for these shares to lead any rebound.

by Fred Ruopp, Sr.

U.S. ECONOMY
An economy characterized by constrained credit and a retrenching consumer continues to weigh on growth.  Although GDP growth was positive into the third quarter, much of this could be attributed to the tax rebates of the spring.  It is noteworthy that even with this stimulus adding 10.5% in annualized disposable income growth in the second quarter, real spending grew at less than 1%.

Meanwhile, no sign of a bottom in housing prices has emerged as weak incomes (ex government stimulus) and the limited availability of mortgages hold prices down.  Not until these two factors reverse can we begin to clear out the inventory of unsold homes and see prices stabilize and climb.

INTERNATIONAL
The dollar continues to gain against the Euro and the Pound – currently selling in the 1.45 to 1 area against the Euro.  The dollar is also gaining against the Japanese yen.  Some emerging market currencies, notably China’s, are continuing to gain against the dollar.  With worldwide materials demand coming off somewhat, material-oriented economies such as Brazil find for the first time in some while that the dollar is gaining against their local currencies.  While it is clear that the U.S., Europe and Japanese economies are currently cooling off somewhat, it is not at all clear whether this will extend to China.  China, now that the Olympics are over, is making great efforts to re-stimulate her economy and most particularly in the areas around the Olympic cities which had been shut down in the interest of clean air.

ENERGY
Crude oil is settling back after having for the first time in history passed $100 a barrel only in April, and vaulting to $147 in July.  With slower-paced U.S., European and Japanese economies and perhaps some slower pace in the emerging world led by China and India as well, world demand has come down somewhat.

Crude oil and natural gas, unlike other materials, are in short supply relative to average worldwide demand at this point in time.  There is additional land for planting grain crops, there are more trees to be cut for lumber, and there are substantial amounts of copper ore in the world.  But oil is increasingly found only in places like deep water drilling offshore Brazil, Ghana, the Gulf of Mexico and the Canadian tar sands where average recovery cost is now in the $70 to $80 a barrel area.  This means that should the price of crude world-wide fall to or below $80, many planned additions to the world oil supply to replace oil which is being pumped everyday will necessarily be suspended, thereby reducing world supply.

In addition, the OPEC nations have announced a cut back in production of 500,000 barrels a day.  All the OPEC countries have had big spending programs and some countries like Dubai and Abu Dhabi have strung themselves out on enormous infrastructure building programs.  Most of OPEC cannot afford to have oil go back to the $50 – $60 a barrel level and therefore strenuous efforts will be made in terms of reducing output if necessary.

For some weeks now, hedge fund operators and other speculators who came late to the purchase of energy stocks and commodities are now liquidating those hastily bought holdings.  This has put short-term pressure on the price of energy stocks and commodities and that may continue for some weeks.  We would think at some point in the next month or two such forced liquidations would be behind us and prices will return to values based on underlying economic fundamentals.

In any event, were oil to sell at $80 a barrel, the oil, natural gas and oil service companies would still be enormously profitable.  Prices of these stocks are at or below where they were when oil was selling at $80 to $90 earlier this year.  Accordingly, we believe adequate representation in the energy sector is a viable long-term position for long-term capital gains production.

FIXED INCOME
U.S. Treasury yields continue to move lower as investors around the world once again look to dollar-denominated prime issues for safety, this in spite of some concern about monetary inflation.

The government’s move to stem a large portion of the credit melt down by taking control of Fannie Mae and Freddie Mac is welcomed.  The two organizations have been placed in conservatorship backed up by government guarantee of their debt financing.  The stockholders will in all likelihood not fair so well as most of the equity has evaporated.

We continue to employ a risk-averse strategy consisting of U. S. government agency bonds offering about 4% for a 5-year maturity, or U.S. corporate bonds yielding a bit more.  The tax-exempt municipal market continues to offer value to investors paying the full tax rate.  As of this moment the ratings remain solid.

STOCK MARKET
Equity market declines have begun to broaden out beyond the housing, financial and consumer discretionary sectors as estimates of corporate earnings in general are cut.  It is worth noting that year-to-September 18, 2008 Wall Street has outperformed most global equity indices (London FTSE -22%, Hang Seng -34%, Nikkei -24%) in terms of both local and common currencies.  This suggests that the U.S. is probably further along in de-leveraging economic excesses and also reflects more reasonable valuations.

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U.S. ECONOMY
As the nation’s housing bubble continues to deflate, the general economy remains reasonably robust. U. S. GNP figures for the second quarter showed growth of 3.4%, well above most economic estimates, as consumers and a newly growing export trade (due at least partially to a weaker dollar) pushed growth ahead.

To date, the recent difficulties encountered by home builders, hedge funds, and particularly sub-prime mortgage lenders remain confined to those sectors. Reining in overleveraged borrowers and the institutions that lend to them, and thereby cooling housing prices, should all be viewed as crucial long-term objectives to enable strong, sustainable growth. The Federal Reserve now must work to ensure that these objectives are achieved without putting undue stress on other sectors of the economy.

INTERNATIONAL
International markets have largely mirrored the recent volatility in U.S. markets while the dollar seems to have found a short term level at around 1.375 to the Euro. Continued strong international economic growth has increased demand for U.S. exports and keeps commodity prices high.

ENERGY
With crude oil above $70 a barrel, the long-term upward trend of prices continues. Gasoline prices are down as refinery capacity is being more fully utilized in the US.

Short-term trading by hedge funds and others currently gives above average volatility to crude oil prices. For the longer term, however, the upward trend of crude prices continues based on fundamentals. Supply and demand are finely balanced.

FIXED INCOME
U.S. Treasuries have rallied from 5.06% to 4.75% on the ten-year bond. High-yield bonds have sold off sharply – spreads have widened 428 basis points, the highest since May 2005.

We are in a process of re-pricing risk after a number of years of loose lending standards. Thus, we recommend staying in the higher quality bond market with bias to lengthen maturities. The yield curve is exhibiting a more normal upward slope.

STOCK MARKET
Stocks had substantially risen through July 13 reaching 14,000 on the DJIA. From July 13 through early August the market was off approximately 6.5%. To a large extent this represents the systole and diastole of the market, periods of gain and loss alternating, even though the basic trend is still up. Much current market sentiment revolves around sub-prime mortgages and the pressure this has brought on higher-rated loans including private equity loans for corporate takeovers. These credit areas will take possibly a year or two to work out.

Should the economy in the face of credit weakness slow further, the Federal Reserve will likely feel its hand forced and begin rate reductions to revive consumer spending and mortgage lending. Although the resolution of underlying problems will take time to work out, markets will anticipate this and refocus on growing corporate earnings.

In recent years, the market has been through a period of unusually low volatility. We have not had as much as a 10% market correction in almost four years. At the onset of the Iraq war, the market fell 10.5% between 1/20/2003 and 2/7/2003. Within a matter of months the market regained this lost ground. In a more unusual instance, in 1987 the market fell 41% between 8/25/87 and 10/20/87. Within three months a substantial part of the loss was recovered, and by the end of the next year the market had gone on to new highs.

In sum, for the short term there may be additional market volatility, but the prospect of good corporate earnings growth and relatively low inflation will continue to drive well-selected securities upward over the intermediate and longer term.