Things quickly went from bad to worse this past quarter as we came to experience one of the worst markets in history, worthy of the bronze as the third worst out of twenty four bear markets since the great depression. For 2008 the S&P return was down 37.0%, the Nasdaq composite was down 40.5%, foreign markets were down about 43.5%. Volatility has been exceptional. From the peak of Oct 9, 2007 to the intraday low of Nov 21, 2008 bottom, the S&P lost more than half of its value and was down 53.5%. In the fixed income arena, treasuries gained nicely as we witnessed one of the most significant flight to quality ever, driving treasury yields to incredibly low levels. The rest of the fixed income market performed poorly.

We firmly believe that investors have overreacted to the housing bubble and the financial crisis, but overreaction at the extremes is typical as things tend to become driven by emotions. In addition to the fear, forced liquidations by institutional investors, mutual funds and hedge funds among others have contributed significantly to the market overshooting on the downside. Forced liquidations, certainly as part of the de-leveraging process have caused the indiscriminate selling of all types of assets, regardless of fundamentals. As a result, many valuation measures happen to be at or near record lows for stocks.

The recession is now a year old and the rate of contraction in economic activity is accelerating. Gross domestic product (GDP) will likely be down significantly in the current quarter and further contraction appears to lie ahead for the first half of 2009. This may be the longest and deepest recession of the postwar era. Lenders aren't lending, companies aren't hiring, consumers aren't spending, producers aren't producing and confidence is down. Despite all of this gloom, the seeds are being sown for some type of recovery in 2009, helped by unprecedented government intervention and by the normal healing process an economy undergoes as it shakes off the excesses. More importantly, we may be approaching a critical inflection point in the financial crisis as interest rates are now low enough and banks have had substantial injections of cash from the TARP that lending activity may pick up in the near term. The Federal Reserve has made it clear that it intends to keep interest rates low for some time. This recession which began in housing was followed by a credit crisis causing a drop in confidence and developing into a consumer led recession. This is different than the previous recession which started in the business sector. The point here is that entering this recession, many businesses were not dealing with excesses that typically precede a more traditional business led recession. This can provide some silver lining as companies that were already fairly lean with good balance sheets will probably get leaner and recover quicker from the slowdown. The weak companies may disappear, providing opportunities for the stronger players. Even tough we will see dismal earnings in the fourth quarter and probably first quarter of 2009, to the extent that some confidence can be restored, we could see a quick rebound in earnings.

With regard to the stock market, at this level, the downside risk is small relative to the upside potential. Cutting against the grain is hard, as it always has been and always will be. The best returns historically have occurred when it is most uncomfortable. The stock market is always forward looking as it discounts future value. It usually turns around about six months ahead of an economic recovery, a time when things are likely to be at their gloomiest. Case in point, despite the flurry of poor economic data over the past month or so, the S&P 500 has rallied a little over 20% off its low of November. Going forward we know from experience that just as there have been forced liquidations driving stocks to abnormally low levels, there is such a thing as forced buying on the upside as the market begins to move up and staying on the sidelines in cash earning very little becomes comparatively a costly proposition, particularly for those individuals who were unwisely cashing out near the bottom. The fact is that steep declines toward bottoms occur because more people are selling and cashing out near that bottom. At this juncture, the sheer amount of cash on the sidelines now exceeds the market capitalization of the entire US Stock market. The Federal Reserve through its policies is clearly intent on making staying in cash and low risk assets such as treasuries very unappealing. A shift in sentiment could lead to some very positive stock market action as investors now become more compelled than ever to seek higher returns which are essential to the achievement of their long term objectives.

I will leave you with this upbeat statistic: In the one year following the low point from each of the nine bear markets that have occurred since 1957, the S&P 500 stock index has experienced a double-digit return. The best of the nine produced a +58.3% return. The worst of the nine was up +23.2% (source: BTN Research).

We are thankful for the trust and confidence you have placed in us, and the opportunity to help you navigate these difficult times. From all of us, we wish you a happy new year in health and prosperity.