April, 2010
By Darren Nyce, CFA
Senior Research Analyst, Castle Investment Advisors®, LLC

Remember what it felt like the first time you rode on an intense roller coaster? Whether you got on board of your own volition or were dragged on by a friend or relative, the emotions were likely varied and powerful including apprehension, curiosity, anxiety, fear, and exhilaration, and for me that was just while I was in line. At some point during the ride after experiencing a variety of violent drops and turns you felt the ride slow down and while you felt like the most extreme portion was past, there was something inside you fostering a sneaking suspicion that something unexpected and a bit frightening was still to come.

This is similar to how we view the current economic environment. We have survived the drops of an intense recession and the violent twists of a credit crisis but are suspicious of what may be looming. It is possible we will ease on in to the station gather up our personal belongings and safely exit to our left (no political commentary intended), but it is also prudent to be prepared in case this ride is about to send us careening another time.

Re-capping some of the headlines from the beginning of 2010:

  • Healthcare bill passes
  • Economy improves
  • Unemployment remains high
  • Oil prices rise
  • Dollar strengthens
  • Rates held low
  • Greece’s debt problems
  • Inflation watch continues

Some of the economic areas that have improved are:

  • An upturn in manufacturing activity
    • The ISM manufacturing index hit its highest level since 2004
  • Stabilization of housing prices
    • Up 3% from May 2009, but still down 30% from May 2006
  • Auto sales improvement
    • From 9.1 million in annual sales in Feb. 2009 to 11.8 million in March 2010
  • Stock market performance
    • S&P 500 up 5.4% in the first quarter
  • GDP starts to rise
    • There has not been an official announcement regarding the end of the recession but seeing GDP (Gross Domestic Product) growth both on a quarter to quarter and on a year to year basis would certainly lead us to believe that the declaration will be coming soon. While we are glad to see the improvement, the growth is still well below the historical average of 3.3%.

Real GDP growth is always quoted at a quarterly annual rate. It measures how much the economy has grown over a three-month period. Quarterly growth rates are often volatile; consequently, economists also like to look at the year-over-year growth in GDP. The yearly changes tend to be more stable.

In regard to the jobs situation, unemployment, while off of its peak, is still very high at 9.7% and when you include the number of part time workers who would like to be full time as well as those who are so discouraged that they have given up looking, the underemployment rate is an alarming 16.9%.

When we take a look at the investing landscape that we have just described, we rejoice for the nice run that the market has experienced but are not compelled to declare this a launching point for a multi-year stint of double digit returns. While we have been impressed with the level of earnings that many bellwether companies have been able to produce, we are not convinced that a robust economic recovery is upon us, especially when we consider the following:

  • The previously mentioned employment situation
  • With a market P/E of around 18, we would not consider valuations cheap
  • Eventually, government stimulus will have to end as will accommodative interest rates
  • The gap between the growth in government spending and the growth in personal income is staggering and unsustainable (see graph below from a recent Wall Street Journal Article)

  • As noted in our last quarterly letter (which, if you missed it, can be found on www.castle3.com), people are coming out of an era of using too much debt and we expect that many will be either by choice, or by directive, spending less and saving more – this is called a de-leveraging environment.

It cannot be emphasized enough that no one can tell you what the market is going to do in the short term, so we do our best to position client portfolios in a manner that gives them the best chance to meet their personal goals given the long term trends as we see them.

Currently, that involves increasing positions in non-correlative securities (these are assets whose performance is designed to not mimic the overall stock market), inflation hedges such as commodities and currencies, income production with preferred stocks, and protection against higher interest rates with Floating Rate instruments. Our emphasis on the equity side is on stocks that pay dividends, primarily in the large cap space.

We hope you are having a terrific spring, and by all means, “Keep your arms and hands inside the car until the ride has come to a complete stop.”

The Castle Investment Advisors®, LLC Investment Team

Tax, legal, and estate planning advice contained in this article is general in nature. Always consult an attorney or tax professional regarding your specific legal or tax situation.
This article was prepared for informational purposes only and does not constitute an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information regarding products and services. It should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. 
Any strategy discussed herein may not be suitable for all investors. Before implementing any strategy, investors should confer with their financial advisor. No current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels.