• Bill Bullock

2009 Fourth Quarter

"So while the past decade was very tough, going forward I'm very confident that equities will not just survive, but prosper. I think that stocks will remain consistent with their historical role of building wealth over the long term and that diversified investments are the soundest method for investors to try to realize their goals." -

Chuck Royce, Royce Funds, Fourth Quarter 2009 Report.

2009 was a breath of fresh air in the stock and bond markets after some tumultuous times in late 2008. As you will recall we opened last year to a lot of uncertainty. Up until March 9, 2009, the stock market expressed this uncertainty with the Dow down as much as 53.8% from its all time high in October of 2007. I remember those days well. One forecast was by a commentator on a major cable news channel suggesting that the stock market was going to rally for a few months from the early March lows and then it was going to decline to nothing. That is right...nothing. Now if that is not a "sky is falling" type scenario, I don't know what is. Within a day or two of hearing that report, the market rallied and, boy, did it rally.


I would encourage you to review your performance reports that are enclosed. If you broke down the individual mutual fund returns, I think you would find that all of our funds met or beat their respective benchmarks - sometimes remarkably well - over the past 12 months except for two foreign funds: First Eagle Overseas and Artio International Equity II. Should we be concerned with these two funds' underperformance in 2009? No, not right now. If you were to stretch these two funds' returns over the past five, ten and fifteen year time periods, you would find that they have significantly outperformed their benchmarks on average. With cheap money following the hot emerging markets stocks, I am comforted to know that these two managers are not simply jumping on the China bandwagon. They are scouring for value among all foreign markets including Brazil, India and China - the so-called "BRIC" countries.


The last we heard of inflation for 2009 it was at a relatively low level of 2.72% versus 3.1% for the annual average. As the stimulus money continues to pour into the economy, we will need to keep our eyes on inflation. However, some of the mutual funds that we use to hedge against inflation have had such a boost this past year that I am beginning to think that maybe we should trim our exposure to these areas in the near term. In other words, the demand for the underlying Treasury Inflation Protected Securities (TIPS) has forced the prices up so high, so quickly, that it would be nearly impossible to continue this acceleration. For example PIMCO Real Return (D shares) was up 17.01% and Vanguard Inflation Protected Securities was up 10.80% in 2009. Obviously, inflation was extremely low for 2009, so one can only conclude that these returns were based on a perception that extreme inflation is right around the corner. I will continue to monitor this situation and may end up taking some profits in this area should I feel it is necessary.


Stock performance in 2010 will depend primarily on whether or not corporate earnings are able to meet and beat their expectations. Most analysts, I believe, would agree that the stock market is fairly valued at the present time. This means that the market is "neither too hot, nor is it too cold" to put it in layman's terms - it is right about where it should be based on past and projected corporate earnings numbers. Most of the mutual fund reports I have been reading claim that actively managed mutual funds should especially outshine the indexes in the near future based on their ability to find individual stocks that are undervalued compared to the overall stock market. As I mentioned above, our actively managed funds did a good job in 2009 and I expect these funds to continue this out performance for the foreseeable future. Nevertheless, we will continue to devote a 10-20% weighting to the S&P 500 and/or the total stock market to hedge our bets.


While we had a wonderful 2009, I realize that those of you who had more stocks than bonds at the market peak are probably short of the highs reached in your portfolio in 2007. As I have mentioned in previous letters, this process is going to take time.

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