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Quarterly Letter to Clients

April, 2011

Indices at quarter-end (March 31, 2011):

Dow Jones Industrials: 12,319.73 1Q'11 +6.41% YTD +6.41%

Standard & Poor's 500: 1,325.83 1Q'11 +5.42% YTD +5.42%

With all of the problems in the world today--a continuing war, earthquakes, tsunamis, revolutions in several middle-east countries, economic problems and budget ills in Europe and the U.S.--you would think that stocks would be under pressure. And the earthquake, tsunami and resulting nuclear disaster in Japan did break the market's uptrend. But even that calamity could do no more than slow the markets; surprisingly, in the weeks following that event, stocks bounced back smartly.

We have now had two full years of very solid gains in both equities and bonds.

To my eye, while stocks have certainly gotten extended, there are still many decent buys in equities. The same cannot be said for bonds, which continue, in my opinion, to be much too high.

I have said before (October of 2005) that there were good times to buy and good times to sell. The good times to buy are when fear rules the market, for whatever reason, and prices are low. The good times to sell are when optimism is high and prices are extended. But for the very large part, most of the time spent in the market is best spent simply watching and waiting. You tend to your garden, pull the weeds, add a little water and fertilizer, and you wait. Time and nature do all of the heavy lifting. This is just such a time.

Fear does not seem to be anywhere to be found in the markets today. But fear's counterpart, greed, does not seem to be having much of a party either. It appears that investors are looking at the markets in a measured manner; not willing to take on too much risk; requiring good earnings prospects and decent balance sheets before they will make an investment. Valuation measures like P/Es and price-to-book are at levels that are not unreasonable overall. The headiness, the rampant speculation, the urgency that has sometimes in the past driven moves such as we have seen these last two years, is no longer present. Investors have been chastened, and the mood today is cautious but positive. I feel that the "gambling" mentality has been largely removed from the markets: this is a good thing.

There have always been problems, emergencies, reasons not to buy, in every market. The voices that predicted imminent collapse a thousand or two thousand Dow points ago have now been largely relegated to background noise. They will undoubtedly be heard again when the next situation arises, be it an oil spill or a nuclear meltdown or a war. Do not let them distract you.

More important to the long-term investor is what is happening in the economy, and there the skies seem to be brightening. Venture capital and initial public offerings, related sectors which have been among the missing for much of the last couple of years, are waking up again. (Though even in those areas, typically the realm of "hot" money, the enthusiasm is muted.) Many, if not most, of the big banks have repaid their government bailout funds and have been cleared to pay dividends once again. Corporate earnings are growing. Balance sheets are strengthening. There is a palpable sense that the economy is moving in the right direction, even if stubborn problems remain in areas like housing and employment.

Thus it is that I feel correct in remaining fully invested. At Dow 12,000-plus stocks are certainly not the buy that they were at 6500. But that is not to say that there is no money to be made. As for fixed income, I continue, as I have for quite some time now, to stress shorter maturities in the expectation of gradually rising interest rates.

The market has shown us how very skittish a place it can be, so do not misunderstand me: I know better than to get too comfortable, too complacent. In this world you must always be vigilant. I remain so.

Jim Pappas