But after further thought and consideration, buying high quality mega-cap stocks makes sense in our current economic environment for several reasons:

1. The cost of capital for top rated companies is substantially lower than for stocks with weaker ratings.  Borrowing rates for AAA companies are very low, approaching 3.5% for 5 year bonds; while BB rated companies are forced to borrow at 8% or more.  This affords quality companies the opportunity to acquire smaller and riskier firms at cheap prices.  This is a tremendous cost advantage that should last at least for a while.
2. Most mega-cap companies are broadly diversified internationally.  This affords them the opportunity to benefit from the worlds changing demographics and growth trends.
3. US mega-cap stocks are cheap for foreign investors. I believe that if the dollar turns, there will be a major push from foreign investors into the US equity market, with US high quality mega caps being a major beneficiary. 
4. Relative safe haven. If the market continues to retrench, the mega caps could be a relatively safe haven when compared to foreign stocks or US small cap stocks.  

A Very Rough Quarter

Since December 31st of 2007 the S&P 500 has declined by 9.4%.  This is on top of the 6.4% decline from the October 9th market high. This decline has been broad based with financial stocks being particularly punished.  As noted in the following table, the safe havens in the first quarter of 2008 were commodities, gold, US bonds and foreign bonds.

                            Index                                      Quarterly Return

                                     Dow Jones Industrial Index            -7.0%

                                     S&P 500                                             -9.4%

                                     NASDAQ                                          -14.1%

                                     Russell 2000                                    -9.9%

                                     MSCI World Index                             -8.7%

                                     Emerging Market Index                    -9.8%

                                     DJ Commodity Index                        +9.6%

                                     Gold                                                     +9.6%

                                     LB Aggregate Bond Index                +2.2%

                                     Money Market Funds                         +0.8%

As you may recall, our 2007 year-end comment was decidedly bearish and we generally positioned our clients according.  The key events that evolved through the 1st quarter were:

1. Continued write-offs in the financial sector among insurance companies, hedge funds, municipal bonds, banks and brokers culminating in the demise of Bear Stearns.   We believe that the write-off process is in full swing and should continue for another quarter or two.
2. De-leveraging at all levels in the financial sector.  Due to current mark-to-market accounting rules, firms are forced to write-off bad investments immediately.  This has resulted in a frenzy of write-downs, many of which should be partially recoverable over the next few years.   
3. The pace of sentiment change from bullish to bearish was quite dramatic.  With today’s new technologies and instant communications, investors can react instantly to changes in the market.  We believe that sentiment has moved too bearish too quickly and will likely rebound before the bear market reasserts itself.
4. Commodities and energy were the star performers of the quarter due to expected future demand from emerging markets and outright bullish speculation.  We continue to believe in the commodity rally but believe it is due to rest for a quarter or two before reasserting itself.
5. Little liquidity in real estate.  Buyers have disappeared as they address their own ability to borrow and wait for more opportunistic prices.  Sellers have moved from hope to fear.  There is a good chance that the prospective increases in the Federal Mortgage loan limits will start to re-liquefy the real estate market.  That would be a positive first step. 
6. The decline in the dollar continued.  It declined -6.4% against a basket of currencies in the 1st Quarter of 2008 and 13.3% over the past 12 months.  We expect that foreign central banks will start easing while the US Federal Reserve slows or stops its rate cuts.  This should result in a rally for the dollar from these levels.  In our opinion, the pendulum has swung too far, too fast. 
7. The interest rate credit spread between US treasuries and corporate bonds have significantly increased in sympathy with subprime mortgage delinquencies.  However, I believe this is due more to hedge fund and bank deleveraging than to actual credit losses.  Real credit exposures might not occur unless the economy truly slows down.

While the economy is slowing and is probably in negative territory, the media hype surrounding this market decline has been greatly exaggerated.  The core economy and employment remains resilient. The positive news is that the Federal Reserve, Congress and the Administration are reacting in a proactive manner.  There are several stimulative economic proposals in the works that should help re-liquefy the mortgage market and stimulate the economy.   In my opinion, the fear is out of proportion to the risks that we are facing.

Our Investment Strategy

We believe that the stock market has become overly worried.  Over the next ten years, the S&P 500 is likely to double in value. We believe that the market is due for either a bounce or bottom in the stock market and US dollar.  As stated earlier, we believe that our equity exposure should lean towards US large cap and quality stocks and credit exposure should be focused in bonds.  We believe that at some point in the next quarter there will be a substantial move out of money market funds and back into quality stocks as investors level of fear recedes.    

Our overall investment strategy is to be fully allocated in large-cap and mega-cap stocks and slightly underweight in small cap stocks and international stocks.  Our bond positions favor higher risk bonds where we are paid to take some risk.

We still believe that the economic slowdown is likely to last for several years.  The national “have- it-all-now” philosophy using borrowed money will ultimately have to be corrected at a federal level, municipal level and individual level.  Living on borrowed money ultimately leads to bankruptcy.  

Our overall investment strategy for 2008 is to remain patient and invested according to your Investment Policy Statement.   However we are likely to see a shift in the performance of asset classes as some previously leading sectors suffer and new leaders materialize.  Sector allocation and fund manager selection will be keys to performance in upcoming quarters.  I strongly believe that a diversified portfolio should continue to perform well over the long-term.  I remain optimistic that 2008 will be a successful year for investors.

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Scott P. Noyes, CFA®, CFP® is the President of Noyes Capital Management, LLC, an independent fee-only wealth management firm based in New Vernon, New Jersey. See www.Noyescapital.com.

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Noyes Capital Management, LLC (“Noyes Capital”) is a registered investment advisor with its principal place of business in the State of New Jersey.  Noyes Capital and its representatives are in compliance with the current registration requirements imposed upon registered investment advisors by those states in which Noyes Capital maintains clients.  Noyes Capital may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.

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