In the first quarter of 2009, the benchmark S&P 500 stock index fell 11.7% to 798, as the breadth and depth of the economic crisis became apparent to an increased number of investors. On March 10th, however, a powerful rally began that has taken the market up 17.9% from a closing low on the S&P 500 of 676 on March 9th. It is too soon to tell whether or not the March 9th low is in fact the bottom of this bear market. The market has taken massive damage, and it should come as no surprise that it was prone to experiencing a substantial rally at some point, as it has throughout this decline, most recently as this past November and December. What we are looking for is sustained trading above the peak of the last bear market rally, which was 935 on the S&P 500 reached on January 6th of this year. All previous rallies have failed to trade above previous rally highs, and if this rally were able to do so, we would begin to believe that the low was in fact reached on March 9th. The interest rate on the benchmark Ten-year Treasury note rose from 2.24% at the end of 2008 to 2.69% on March 31st, as global deflationary worries subsided. The Federal Reserve began purchasing $300 billion in long-term Treasuries in March, in a bid to keep increases in long-term yields in check. Given their efforts and the overall weak state of the economy, we believe they will succeed in keeping long-term rates low at least for the next several quarters.

Apart from the short-term technical dynamics of the market, we maintain our previously stated belief that the US Government will ultimately succeed in halting the significant economic decline we are experiencing. The exact timing of this is unknowable, but its eventuality is inescapable. To us, the more interesting question is what comes after the recession has ended? What will the economy look like? Who will be the winners and losers? Given what we know now, it is difficult to say. The Obama administration has been sending out mixed signals. In speeches, the President acknowledges that our economy had become overly reliant on borrowing and finance, and that we must move to a more balanced, self-sufficient economy. Yet at the same time, the Treasury, Federal Reserve, and FDIC are steering literally trillions of dollars into the financial sector this year alone, while only budgeting a few hundred billion or so into recapitalizing the industrial base over the next ten years. To wit, the administration has taken a much harder line in dealing with the struggling automotive industry than it has with Wall Street banks. This bears close watching.

At any rate, over the long-term, attempting to rebuild the “globalized,” finance based American economy that existed prior to this recession is destined to fail. This economy was ultimately based on the ability of US consumers to borrow and spend, and this ability has reached an irreversible state of long-term decline with maxed out credit cards, underwater mortgages, and stagnant wages. The globalization/finance based model required ever increasing asset prices for foreigners to lend against in order to sell us their goods and services. Asset prices have collapsed, and this model is broken. The economy of the future must be based on Americans building things besides houses and shopping malls, and then not borrowing heavily against them, as was the case up until 2007. It will take many years for housing prices to recover, home equity to be regenerated, and consumer debt to be paid down. No matter what anybody in business or government tells you, there is no quick fix for this.

To position our clients for this environment, we are focused on investing in companies that manufacture the goods and produce the sorts of services that will be required in a more balanced, self-sufficient American economy. Essentially, we are underweighting the financial, residential construction, and retail oriented sectors that became overgrown during the bubble years. Their heyday is in the past. Our investments should continue to outperform by capturing the share of GDP those three sectors will have to surrender moving forward. For the remainder of the year, our predicted range on the S&P 500 is 600 to 1000.