The third quarter of 2011 reflected significantly increased volatility. Toward the end of July, the S&P 500 dropped close to 20% in a two week time frame. It has since bounced up and down within a 10% range from the August lows. As of the end of September, the S&P 500 was down 8.7% for the year, the Dow was down 3.9% and foreign equities represented by the MSCI World Ex US Index were down 15.1%. The Barclay Aggregate Bond Index returned 6.65%, reflecting the continued strength in bond prices.

There are several issues holding the equity markets back. The fear of a second recessionary dip in the U.S., concerns over the state of the global economy, uncertainty with our budget issues and most significant at this time, the European debt crisis which has brought a level of uncertainty that is far more challenging to assess. The European Monetary Union is facing the ultimate test as it struggles with a lack of fiscal unity. Things probably would not have gotten this far if European leadership had dealt with the situation in Greece in a more concerted and decisive manner back in the spring of 2010. This is particularly true since Greece is a relatively small part of the European Union with its total outstanding debt totaling less than 1% of the assets of the European financial system. Without a commitment from the stronger countries, particularly Germany, confidence was eroded in a way that has made this a much bigger issue. The failing of European policymakers has turned this into a crisis of confidence thereby opening the door to contagion concerns, particularly among the weaker European countries such as Portugal, Italy, Ireland and Spain (PIIGS). The threat of an impending recession and increasing contagion risks in Europe may force more action from the European Central Bank (ECB) which thus far had distanced itself from the issue. Backed against a wall, it has now started injecting liquidity in the system. A Greek default would cause bond investors to flee Italian and Spanish government bonds requiring the ECB to pour billions to support their value. European banks own a lot of these bonds and the impact would be significant. The impact on U.S. banks of a default of Greece alone is relatively small, however the impact on U.S. banks relating to debt concerns from countries such as Italy in a contagion scenario is far greater. Much depends on Germany's willingness to prevent a Greek default as well as providing support to the weaker economies. As I write this, the German parliament just approved the expansion of the European Financial stability Facility bailout fund.

The outcome of all of this has been a global rush toward U.S. Treasuries, pushing yields to historically low levels. With regard to the possibility of a recession in the U.S., it is important to remember that no recession has ever occurred with the type of backdrop that we have. We have an aggressively accommodating Fed, a steep yield curve and no pattern of at least four consecutive months of negative leading economic indicator data. Some upbeat U.S. economic data was reported at the end of September showing that initial jobless claims fell by much more than anticipated and that the economy grew by more than initially reported in the second quarter with a revised number of 1.3% from the 1% previously reported. While still relatively weak, it is an improvement over the first quarter.

The market's reaction is an opportunity in U.S. equities. The excessive volatility is indicative that it is hard for investors to factor in the equity valuations the unknown potential impact of the debt woes from Europe. That is a near term event that is shaping confidence and perspective. Many U.S. companies have strong balance sheets and cash flows and over half of the companies in the S&P 500 are now paying dividend yields in excess of the ten year treasury yield. While dividends are not guaranteed, it seems that the trend lately has been toward raising dividends rather than cutting them. We can't say that this kind of volatility will not continue as investors increasingly remain tuned to global events in real time, but for the long term investor, U.S. stocks represent a good long term opportunity at these levels and as we know the best opportunities don't usually come about when everything is rosy but when there is fear and uncertainty in the world.

Thank you for your continued trust and confidence.