Keep the Faith Young Sisyphus

2Q 2010

In “normal” times, relatively small countries in southeastern Europe are not capable of holding hostage the world’s vast financial markets. After all, the market capitalization of publically traded Greek companies is only about $65 billion (1/4th that of Exxon Mobil Corporation (XOM)), and its Gross Domestic Product (GDP) represents less than 0.6% of the world’s total output. Despite this numerical insignificance, the sovereign-debt crisis that crystallized during the second quarter has seemingly restored the country’s level of influence to the days of Socrates and the birth of Western philosophy.

In all seriousness, however, it’s not solely the technical default in Greece that has caused global market participants to reevaluate there positions. With the public sector debts and social obligations of many prominent nations approaching unprecedented levels, parallels to the recent Greek tragedy are being drawn and worst case scenarios are being advanced into the here and now. Policy makers, who unfortunately lack consensus in terms of their economic approach, are attempting to respond with a variety of fiscal and monetary reforms that may prove politically hard to implement. While we certainly live in interesting times, described as the “new normal” by some industry professionals, we believe it’s more important than ever to maintain proper perspective. Positive outcomes should always be available for industrious companies and individuals committed to long-term objectives.

Turning now to the actual market summary, you will notice how the statements that follow reflect the challenges of a tough few months. After achieving new highs for year in late April, the S&P 500 Index declined by 15.7% to close out a volatile second quarter. Through the end of June, the benchmark for Large Cap U.S. stocks had fallen 6.7%. Domestic Mid & Small Cap companies lost value, but continued to outperform on a relative basis. Developed non-U.S. equity markets had very poor performance, and with few exceptions, ended the first half of 2010 with double-digit negative returns. After being the top-performing asset class in 2009, emerging markets continued to cool off in the second quarter, although returns there were generally better than in developed countries. Fixed income securities had good returns given the widespread derisking trade. Intermediate government securities and inflation-protected securities (TIPS) did particularly well.

According to Robert Shiller, Professor of Economics at Yale, the economy and markets are driven by stories and “right now the story is one of anger, frustration, disillusionment, and mistrust”. Given this appraisal, it should come as no surprise that investor sentiment is in abysmal shape. Readings for both individual and institutional investors have not been this bearish since March 2009. Mutual fund flows continue to favor bond purchases over stocks, despite relative valuations that are now fairly attractive by historical standards. While we’ve certainly heard many accounts and stories in recent months, we find encouragement in knowing that these behavioral indicators are frequently wrong at key turning points.

Finally, to explain our title, we must journey back to a lesson in Greek mythology. Sisyphus was a crafty king that betrayed Zeus and was thereby punished to an eternity of rolling a huge rock up a hill, only to have it roll back down each time. While the market’s recent gyrations may trigger a similar sensation, we ask that you keep the faith as we strive to remove the Sisyphean analogy from the ongoing investment process. We expect history and discipline to be powerful winds at our back.