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2010 First Quarter Review

Will Health Care Reform Derail the Economic Recovery?
More of the Same
In our Fourth Quarter Review, we again addressed why we believe the economic recovery is sustainable and would not be derailed by government deficits, at least in the near-term. As expected, we have continued to see steady improvement in most economic indicators, confirming our view. Most of the primary concerns persist including government spending, unemployment, and housing. Due to the surprise resurrection & passing of health care reform, many are now also asking, “Will health care reform kill our economy?”
1st Quarter Review
The S&P 500 gained more than 5% in the first quarter, despite a moderate pullback of around 7% from mid-January to mid-February (as we expected in our last letter). From its’ low in March, 2009, the S&P 500 is up about 75% as the market continues to recognize what we have been sharing with you over the past year. We can’t help but reflect on many of the common comments we heard in the first quarter of last year, such as:
“I don’t trust the market anymore.”
“There is no way we will recover from this.”
“Everyone is saying the market will drop further from here.”
“It makes no sense to be in the market at this point.”
It is easy to understand why people felt this way and very hard to ignore these emotions as we were suggesting. We have recently seen the damage caused by other investors or advisors following these emotions and are thankful we had the strength and wisdom to trust our rational, fundamental research. 
While the risk of a double-dip recession has receded further, concerns still abound, which have kept investors from becoming overly optimistic, leaving potential for further growth in the coming year. 
Let’s take a quick look at some recent news updates, then address a question many of you are asking. We have revised the following points to focus on more relevant economic data.
  • Manufacturing – Factory orders continue to grow, as the ISM Manufacturing Index is now up nine straight months to 60.4 in April. According to Mark Zandy, Chief Economist at Moody’s Analytics, “Manufacturing is leading the way for the economy.” How can this be?     *Institute for Supply Management
  • Inventories – One of the reasons we were so confident in the economic recovery last year was wholesale inventories, which bottomed at historic lows in December before starting to grow in January & February. However, sales have been rising for 11 months through February, creating considerable demand for continued growth in manufacturing and jobs.     * U.S. Commerce Department
  • Unemployment – As we suggested last quarter, job growth has resumed, with 162,000 jobs added in March. This makes the third month out of the last five to experience job growth. The unemployment rate is down to 9.7% and we expect this to continue to improve throughout the year. But due to the number of people still out of work, it will likely be at least 2-3 years before this number drops to 6%.     *Based on data from US Bureau of Labor & Statistics
  • Leading Indicators – an index of leading economic indicators rose 1.4% in March, now up for 12 straight months. This strongly suggests continued growth in the economy for the next 3-6 months.     *The Conference Board
  • Economy GDP growth for the fourth quarter of 2009 was 5.6% and initial results for the first quarter show continued growth of 3.2%. It is becoming increasingly difficult to deny the recession is over, but many are still trying. 
*U.S. Commerce Department – Bureau of Economic Analysis 
  • Healing in the Financial System – Healing has continued as many banks are reporting strong earnings, despite the continued high level of foreclosures. Many have also been writing-up the value of assets that were written-down last year, just as we expected. Full healing will still take several years, so we expect the Fed to keep short-term rates low for the next year or two, although increases are likely in the next quarter or two.
*Sources include the Bureau of Economic Analysis-,
  • Inflation – Inflation continues to be tame, as we expected, with the Consumer Price Index only rising .01% on average from January to March. If inflation becomes a serious issue, it won’t likely be for 2-3 years. Refer to our 2nd Qtr. 2009 Review for a more detailed discussion.    *U.S. Bureau of Labor Statistics
  • Housing – With foreclosures still at record highs (RealtyTrac Inc.) and home construction still abysmally low (U.S. Commerce Department), many are still pessimistic on housing. However, according to Case-Shiller, home prices nationwide have stabilized and are rising, although there are still pockets of extreme weakness. Home sales have also increased more than expected (National Association of Realtors), probably due to government incentives. Altogether, we expect continued stabilization and recovery in housing, but at a very slow rate.
Will healthcare reform kill our economy?
After appearing to die a slow and painful death last year, healthcare reform was revived and passed using some legislative tricks, despite evidence it was not supported by a significant majority of Americans, nor did most members of congress read the bill.
Is reform needed in our healthcare system? Absolutely!
Will this bill solve the problems with the current system? Probably not!
While there will undoubtedly be several revisions before much of the bill is enacted, we believe this bill will likely lead to higher costs, limited & lower quality care, and shortages of medical personnel. It is simple economics.
However, there will also be many “winners” as a result. Hospitals and pharmaceutical & medical device companies will likely come out on top as demand will rise and there will be fewer “charity” cases for hospitals. 
While we hope we are wrong, we believe most Americans will come out “losers” due to higher taxes, higher insurance costs, and lower quality care. But we do not believe the overall economic implications are as bad as many fear. While any resulting tax increases will certainly put a damper on economic growth, the rest of the health care issues will simply lead to shifts in economic activity, but not economic destruction. Businesses and consumers will adjust, as we always do. 
Thank you very much for the confidence and trust you have placed in us! We are honored and take the responsibility very seriously. If you can think of any way we can serve you better, please let us know. 
Have a wonderful spring! 
Kind Regards,

Darren T. Munn, CFA

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