Global stock markets rallied sharply during the second quarter as the intensity of the economic crisis lessened and investors’ appetite for riskier assets improved. Of particular note was the ability of the U.S.’s largest banks to sell nearly $90 billion of new common stock to private investors as part of their recapitalization plans. This marks another step in the recovery of the banking sector, which we continue to believe is a prerequisite for a sustained recovery in the broad stock market indices.

Similarly, most sectors of the fixed income market showed continued improvement. The
notable exception was the Treasury sector, which weakened in the face of heavy
government borrowing and diminished investor interest. Issuance of new corporate debt was
robust, enabling issuers to fortify their balance sheets and investors to obtain attractive yields.

As we enter the second half of the year, our portfolio strategy is being influenced by several broad themes. First, as encouraged as we are by the markets’ improvement, we
remind ourselves that the challenges in the real economy remain daunting. Specifically, we worry that rising unemployment could impede the nascent recovery in banks and that the staggering increase in public debt portends rising taxes.

Second, we anticipate that the economic recovery, once it gets underway, will be modest. This view is based on our belief that consumer spending – a significant component of global
economic activity – will remain subdued as households work down their debt levels and replenish their savings.

Third, we are preparing our clients’ portfolios for a more inflationary world. In the short term, rising unemployment and excess global manufacturing capacity should keep rising prices in check. Long term, a combination of expansionary monetary policies and global population growth makes rising prices a near certainty.

Our portfolio tactics are severalfold: For fixed income allocations, we continue to favor investment-grade corporate and municipal bonds. We have generally kept the maturities of these investments in the short-to-intermediate-term range, largely as a precaution against rising rates. We continue to deemphasize nominal Treasuries, despite their recent sell-off, in favor of Treasury Inflation-Protected Securities, more commonly known by their acronym, TIPS.

We continue to dollar-cost average into stock positions. As the recent rally demonstrated, extreme-return days (up or down) tend to cluster, making successful market timing very difficult. Consequently, we believe that the best way to respond to this situation is to invest at regular intervals over time, adjusting the size of the increments as appropriate. While today’s prices may not be rock bottom, they do provide a margin of safety for those
who can be patient.

In terms of real assets, we continue to favor commodities over commercial real estate. Our exposure to the latter asset class is confined to a handful of investments that several of our
international managers have made. For the time being, this level of exposure strikes us as adequate.

Finally, it has been widely reported that actively-managed mutual funds have outperformed their index-fund peers since the market lows of early March. This has certainly proven to be the case with our own list of approved funds. While short-term performance is not and has never been our goal, we hope that the rebound these funds have exhibited provides some sense of the magnitude of opportunity that remains as we move through this market cycle.

(c) Chess Financial

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