Our Quarterly Commentary
Information on this site is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Opportunities and Risks

We are always assessing opportunities and risks. Do asset-class fundamentals and valuations justify significant risk taking, risk aversion, or something in between? Our weighing of risk versus opportunity is driven by scenario analysis that combines fundamental and valuation analysis. Valuations have certainly been affected by the recovery in financial markets we have witnessed and participated in this year. Stocks are no longer undervalued unless one believes that earnings growth will be very strong over the next few years. We believe that is unlikely. Both fundamentals (such as the weakened consumer) and valuations are pushing us toward a more tempered view.

As we look ahead, we will continue to weigh our “new normal” subpar-growth scenarios more heavily than our optimistic return to “old normal” scenario. This is a critical debate among today’s investors. If we believed the recovery from this recession to be in the range of all the other post-WWII  recoveries, then we would expect much more upside from stocks. But if the housing and debt bust triggered a transition to an economic re-set at a lower level, then economic history clearly suggests a period of subpar growth and lower returns.

We know that no one has a crystal ball and there are experienced and very savvy investors on both sides of the argument. We periodically examine the evidence for a more aggressive growth scenario
as we attempt to understand what could make us wrong. Nevertheless, our view is that the weight of the evidence continues to be heavily skewed towards subpar economic and earnings growth over our five-year horizon even though, as noted above, there are factors that could fuel a better outcome. As we continue to process all the factors we’ve discussed here (as well as others), it will impact the degree of risk we take and the opportunities we pursue in the portfolios we manage.

Thoughts

As we look ahead, there are a few thoughts we’d like to leave you with.

First, we believe the last year underscores the appeal of tactical asset allocation. As we’ve stated before, great tactical opportunities come along only occasionally, but when they do, they can provide an opportunity for a performance advantage over the long run. During the last 12-18 months, our   tactical changes led us to move out of non-investment grade bonds and commodities into higher quality bonds. We also underweighted equities and overweighted cash. While certainly not a complete defense against the volatility experienced, these tactical moves provided some mitigation against the negative market movement. Additionally, the active tactical tax management trades we initiated, made during the worst of the market slide, will, in many taxable accounts, allow for minimal taxes to be incurred as both strategic and tactical rebalances are made in future periods.

Most recently we have made tactical allocations which have reduced investment grade bond allocations and increased foreign bond and high yield bond allocations. We believe these are appropriate moves in the high budget deficit and weakened dollar environment we find ourselves in.

Second, our approach to tactical allocation requires a multi-year time horizon. We will not always be rewarded quickly so patience is required—a critically important investment trait that is lacking among many investors.


Tarpley & Underwood Financial Advisors, LLC      Third Quarter 2009