Market Review & Outlook

R.W. Roge & Co.

Ron and Steven Roge

February 4, 2010

Market Review & Outlook

by RWR Investment Management Committee

We are very pleased with the performance of our portfolios in 2009. Our cautious balanced and middle of the road strategy paid off nicely. That strategy allowed us to recover much of the losses our portfolios experienced in 2008 and has us solidly back on the road to recovery.

Large-cap stocks, based on the S&P 500 Index, gained about 6% in the final quarter, and finished 2009 with a 26% gain. In both the quarter and the full year, growth sharply outpaced value, but between larger-caps and smaller-caps, returns were pretty similar. Mid-caps seemed to be the sweet spot of the market. This category posted fourth-quarter returns in line with the overall market, and full-year returns were just north of 40%. Small-caps posted gains of about 4% for the quarter and 27% for the year.

Overseas, the picture was even better. The MSCI EAFE index tacked on 2% in the fourth quarter to bring its full-year gain to 32%. This impressive return was mostly the result of strong equity returns in Asia, as the Chinese economy continued to grow at a substantial rate due to government stimulus programs.

On the domestic fixed-income side, returns varied widely in 2009. The Barclay’s Capital U.S. Aggregate Bond Index gained 6% for the year, but the longer maturity government bonds posted a mid single digit loss for the year, while Corporate bonds gained more than 10%.

Money Market funds continued to lag as the Federal Reserve has kept short-term interest rates artificially low. For the year, the average money market fund returned a measly 0.19%, failing to keep pace with inflation.

Commodities and commodity stocks performed strongly for the year. In particular, gold rose on concerns that the U.S. government will devalue the U.S. dollar by printing more money in an effort to stimulate the economy. Oil increased as well as it typically increases as the U.S. dollar retreats.

Outlook

We are cautiously optimistic about the future and we plan to continue to allocate capital where opportunity presents itself. We continue to worry about interest rates and inflation down the road.

As we look ahead over the next several years, we continue to believe that the weight of the evidence makes a strong case for a bumpy and slow road for economic recovery and the financial markets, despite the beginnings of our current economic recovery -- which until now has been stimulated mostly by government programs.

The Challenges

We continue to believe that we are in the midst of a major debt-driven transition in the economy. As a result risks will be elevated, resulting in continued economic headwinds, and have longer-term consequences due to the acceleration of the buildup of our public (government) debt.

Households are overextended with debt and are in the process of deleveraging. Despite the huge government stimulus, this deleveraging process will take years and possibly a decade to complete.

Consumer spending, which is over 70% of the economy, is very important to overall economic growth. The desire among households to reduce debt, along with high unemployment and low perceived job security, makes it very likely that consumption growth will remain low.

The U.S. Government’s actions in aggregate saved us from a 1930s-type depression. However, the resulting leap in the government deficit comes at a terrible time. This increase, coupled with a coming explosion of Social Security, Medicare, and Medicaid benefits to retiring baby boomers, means that the U.S. faces extremely challenging times in the coming years.

Given these challenges, there is also risk of policy mistakes as the Fed and the Treasury attempt to maneuver through the next few years. Unwinding of the stimulus at the right time and in the right way will be one of the big challenges.

The Opportunities

Among all of these concerns listed above, there are still many positives. As Americans we are a resilient, resourceful and entrepreneurial society. These traits have allowed us to work our way out of even more difficult situations, many times in the history of our nation. We tend to recover from the worst of times and turn them in to the best of times.

We are now experiencing the largest global governmental stimulus program ever to occur in peace time. Strong emerging-markets economies are feeding back into the global economy, which is a positive for exports and manufacturing. Corporate balance sheets, outside of financials, are in good shape and have the highest liquidity in 50 years. Inventories are low and a rebuilding cycle is beginning, which will support growth. And, the severity of the economic contraction and corporate cost cutting may mean that businesses will slowly but surely increase investment and hiring in the near future.

Outlook Summary

While we love being optimistic, we remain cautious about this economic recovery. We continue to believe that the weight of the evidence makes a strong case for a sustainable but slow economic recovery, with the risk of another recession at some point in the future, as the government and the Federal Reserve begin to remove the punch bowl. (See chart above.)

Portfolio Strategy

Looking forward over the next three to five years we believe higher returns can be captured by having a risk adjusted, flexible, globally balanced portfolio, which is rebalanced while patiently waiting for compelling opportunities to appear. When those opportunities appear, we will have the liquidity and flexibility to make tactical moves and capitalize on those opportunities.

Our investment strategy for the near future is to manage risk first and return second. We currently think it’s a fool’s game to try and chase any index (i.e. S&P 500 Index) given all of the unknown policy risks in the system today. Instead, we are focused on temporary investment strategies that we can change quickly when evidence appears to warrant such a change.

We are expecting interest rates to rise in the not to distant future. Therefore, we are focused on the shorter end of the yield curve, even though interest rates are very low at the short end. This will give us the ability to move up the yield curve to a higher interest rate when rates rise. At that point, we can lock in those higher rates for longer periods of time. Chasing yields in this environment is a very dangerous game that could lead to very big losses of principal.

While prices of assets continue to fall in the near term, we can anticipate deflation for now. However, as asset prices begin to bottom there is a very high probability that inflation will dominate over the longer term. Therefore, we have already begun investing in areas that can benefit from inflation, such as commodities, stocks, and Treasury Inflation Protected Securities (TIPS).

Another strategy is to be invested in high quality dividend paying stocks. Here we are getting paid while we wait for growth.

Since we are concerned about the long-term purchasing power of the dollar, investing in global and foreign securities provides a hedge against the dollar.

The U.S. Dollar will most likely be in a trading range for the next couple of quarters as the world’s economies work through the current financial crisis, and de-lever their balance sheets. This will inevitably mean that there will be opportunities in short-term asset allocation moves to add incremental value. Asset Allocation funds may be able to add this value to our portfolios through strategic investments in a wide variety of assets classes and the full credit spectrum.

Portfolio Strategy Summary

Our portfolio strategy for the near future is to manage risk first and return second. We continue to remain cautiously optimistic, taking a balanced and flexible, middle of the road approach. This allows us to remain liquid and nimble, so we can seize opportunities as they present themselves.

www.rwroge.com

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