Latest Quarterly Commentary from Q3 2009

Market Snapshot
The recent positive developments that have evolved have offset the negatives in the short-term. Earlier in the year, we posited that the Dow Jones Industrial Average would end up in a trading range between 7500-9500. Briefly the Dow traded to about 6350, and has now run up to over 10100. Earnings are coming in above estimates, due to massive cost cutting, and sustainability of earnings is becoming the next concern. Where is the top line growth? Can prices be justified at these levels without it? Some are calling this a “jobless recovery”, though people always talk this way on the way out of a recession. It is important to delineate between the stock market and the economy; they are, and always will be, two different things. While the markets have anticipated recovery, they are not perfect as a barometer of economic health. It is likely that this final quarter of the year will be met with more worry, yet investors continue to pile into equities. Chasing performance here, at these prices, especially by buying index ETF’s, could prove perilous. We continue to selectively make purchases in areas that appear undervalued and underappreciated for their earnings stability, necessity, and stable of products.

The New Normal
The price we pay for a company’s earnings was much lower than it would otherwise be during the recent market price adjustment. Now, we are entering an era of what some term “the new normal”. What does this mean? The “new normal” ostensibly means that the U.S. share of global GDP is declining; we have firmly established ourselves as the largest debtor nation, and our currency is under attack via stronger currency alternatives. On the bright side, emerging market economies are growing rapidly, have surpluses, and the consequent demand for minerals, commodities, and ingenuity (we’re pretty good in that department) remains strong.

Inflation Is A Monetary Phenomenon
We received great feedback of our Milton Friedman inflation piece in the last letter. To sum it up, Milton Friedman said it best: “Inflation is always and everywhere a monetary phenomenon”. MV=PQ is the equation, and it essentially breaks down into a simple explanation such as “the more money is printed or created by the government, the higher the price level (prices) will be”. In other words, inflation.

We believe that the Fed is engaging rather aggressively in reflation, whereby all asset classes are re-flated due to a commensurate newfound liquidity creation of dollars and Treasuries via debt monetization (i.e. using one credit card to pay off another). The Fed has recently assured us that they will “withdraw policy accommodation in a smooth and timely manner”, meaning the Fed will do everything in its power to control inflation by reducing the money supply as needed to stave off inflation. It must be noted that inflation by itself is not a foregone conclusion, as the Fed actually “could” succeed, which would of course result in dampened economic growth.

Re-flation of Assets
The economic debate has centered on deflation versus inflation. Based upon a fiat currency (our currency has been this way since we went off the gold standard), inflation is always preferable to deflation. Deflationary risks are to be avoided if at all possible, and by that measure we are likely to avoid it on a grand scale. Apparently the Fed agrees with us. By the way, gold has risen and is between $1,050 to $1,070/ounce.

When we're trying to figure out what's more likely in the future – inflation or deflation, we need to ask a few questions: 1) Would I willingly choose to be a creditor to the federal government, considering its soaring deficits, its $12 trillion in debt, its current economic policies, its endless entitlement programs, and the miniscule interest rates it pays on its debts? 2) Why is the largest creditor to the United States (China) going on an all-out commodity-based spending spree, all over the world? 3) Why, during two decades of soaring productivity and giant technological advances, has the purchasing power of the U.S. dollar continued to fall at an accelerating rate? For the deflationist camp to be right, the U.S. dollar would have to have a sustained increase in purchasing power, which hasn't happened since the creation of the Federal Reserve. To believe in deflation is to believe that government is here to help, that paper money (fiat) currency systems aren’t based on devaluation, that Santa Claus is real, or that Ben Bernanke actually is Santa Claus.

History As Prequel
On a historical basis, every major stock market peak of the 20th Century was followed by a crash in the U.S. dollar five years later. People who kept their savings in dollars saw the purchasing power of their savings shrink substantially. For example, four years after the peak of 1929, FDR closed the banks and made it illegal for private citizens to own gold. In January 1934—five years after the bubble—he devalued the dollar, crushing people’s savings. Commodity prices had triple-digit rises in the mid-1930s and speculators once again made a fortune. The same thing happened five years after the market peaked in the late 1960s. Five years later, Nixon took the dollar off the gold standard (this time for good). Commodity prices soared for the next ten years, with the price of gold reaching $850/oz by the time it was over. Fast forward—the stock market popped in March 2000, and five years later in the Spring of 2005, the bull market in commodities was on. Oil went from $40 to $140; gold went from $400 to $1000/oz. We just had another peak in the stock market in October 2007. Based upon this precedent, we could foresee a raging bull market in commodities (due to a falling US dollar value, big inflation, or both) somewhere between mid-2011 and the fall of 2012. This is the risk, and this is the opportunity.

In a reflationary period it is quite possible for all types of assets to go up in value, and then based upon this 2011/2012 time frame, commodities and stocks could decouple in favor of commodities and commodity-related enterprises.

Earnings Season
Earnings season is again upon us, and earnings have exceeded expectations 74% of the time thus far. Many companies are reporting strong earnings based on massive cost-cutting maneuvers in the last 12 months, and now some are beginning to question the future sustainability of these earnings streams, since top-line growth looks weak. Earnings of multinationals that repatriate their foreign earnings back into U.S.$ are enjoying higher profits since currency translation is favorable.

Positioning Globally for Any Environment
The sectors we like most are commodity-related equities, including oil, coal, mining, agriculture, metals; we also like select healthcare, medical device, and biotech companies as well as a few select technology names that exhibit reasonable valuations (Growth At a Reasonable Price, GARP). The reasoning for our commodities-related/oil/metals bent is many-fold: 1) they are needed , (2) they appear undervalued and are economically sensitive; if they drop due to a double-dip recession it shouldn’t be disastrous due to their inherent value, and if the market goes up, they go up too, (3) commodities are priced in US$, so if the dollar goes down, it takes more US$ to buy them, meaning the producers of these commodities will have higher earnings, (4) during inflationary periods they tend to hold up the best, (5) if we experience a currency devaluation for whatever reason (and inflation is but another means of achieving this), see #1-4. So we are adding positions that can withstand gale force winds based on macroeconomics and/or deliver strong earnings.

Mortgages
If you have not done so, take advantage of still-historically low 30 year fixed mortgage rates. Recently the 30 year fixed mortgage dipped to about a 60-year low. It’s still cheap money, and it should be considered a very temporary “gift” from the Fed. This is simply unsustainable and will desist at some unknown point in the future (probably when the data starts to look better). Take advantage of this, especially if you currently hold an adjustable rate mortgage.

Fixed Income Commentary
Corporate bonds, both investment grade and high yield, look relatively attractive. In fact over the last several months investment grade paper had a positive after-tax spread relative to Treasuries, and high yield paper had a positive tax-equivalent yield over municipal debt. We seek to find debt issues with shorter maturities.

Treasury securities with longer maturities should be avoided, though Treasury Inflation Protection Securities (TIPS) could offer some additional protection in case of inflation.

CA Municipal Bonds
CA is not likely to default on its General Obligation bonds, and if it did, it would roil the entire country’s municipal bond market. Expect more IOU’s from the State of CA, followed by either a budget deal or more downgrades. The problems are big, but as a great politician once said: “the answers aren’t easy, but they are simple.”

Website
We’ve made some changes to the website, including a “Typical Client” tab which has helped with your referrals to us. Additionally, under the “Frequently Asked Questions” (FAQ) tab, we have put sub-tabs of regulatory information, as well as an “Account Access” tab which takes Clients to Schwab’s sign-in page. www.accimi.net

401k
After a monster run in the stock market, this is a great time to email or fax your latest statement from your 401k plan. We are happy to assist you in re-balancing your asset allocation for your long term goals. Fax is 650-745-7347.

Succession Planning
This is a big deal with the SEC, and it’s a big deal to us. Over the last two years we’ve been doing due diligence on a few different other Advisory firms, and may at some point elect to engage in a Succession Planning arrangement, Joint Venture, or some other arrangement that provides our Clients with a robust Succession Plan, additional Client service resources, additional Research capabilities, and additional Portfolio Management resources.

Thank you for your continued business and referrals
This has been a crazy year for all of us as investors. Please know that we are here to answer your questions, to go over your portfolio positioning in the context of your retirement plans, and to provide a sense of perspective in this market. Investing is a long term endeavor. Though risks remain, patience will be rewarded.

The “Referrals” tab on the website is designed to provide basic contact info to us for follow-up reasons; as you know, our style of follow-up is not aggressive, but it is consistent. www.accimi.net/referrals.html