In light of the stock market volatility over the last several months, we felt it is important to share with you our thoughts. While we reduced stock exposure in November 2007 and January 2008 in our FLEX Portfolios, we still believe there is a considerable amount of “favorable news” for investors to consider. Our investment work suggests that a lower risk buying opportunity for stocks lies ahead.

We can visualize our detailed study of the stock market indicators as a four-legged stool. Currently, three of the four legs are very sturdy. Only price (trend of the market) is weak and recently violated some very important support levels, which we honored via the recent trades. Listed below are some components to our investment work. We hope this summary helps you better understand our portfolio allocations and why we still believe the stock market offers attractive total return potential.

• The monetary environment remains favorable, especially given the Federal Reserve’s 75 basis point cut in short-term interest rates on January 22, 2008 and an additional 50 basis point cut on January 30, 2008. Currently, the Fed Funds rate stands at 3.0%. The decrease in short-term interest rates will likely provide added stimulus for both business and consumers and should make stocks more attractive.
  
  
  
  The chart above shows money market assets in relation to the total value of the stock market as measured by the Wilshire 5000 Stock Index (chart 1). Currently, money market holdings represent at least 21% of the total stock market value. The last time we saw this mountain of cash (high liquidity) was in 1982 and near the end of the bear market of 2000-2002. In 1982 it made sense for investors to capitalize on high double-digit CD rates. From 2000-2002, fear drove many investors into money market funds even though yields were low single digit. The peak of the flight to money market which occurred in 2002 was right before a powerful 2003 - 2007 bull market began. Liquidity remains abundant and investors will likely look to move some of this liquidity to stocks for the attractive total return potential.
  
  
• Valuation is attractive. Our work supports that stocks are the best-valued asset compared with bonds, real estate, and commodities. In relation to treasury bonds, the S&P 500 Stock Index is undervalued by roughly 46% as of February 28, 2008 (chart 2). Additionally, the S&P 500 forward P/E ratio shows that stocks are fairly priced with a forward P/E ratio of 14.8 times earnings.
  
  
  
  
• Investor psychology is currently consistent with rising prices, not a severe bear market decline. Warren Buffet has stated that successful investors are greedy when others are fearful and fearful when others are greedy. Fear appears to be overriding the good fundamentals. History has shown that once the nervous investors finish selling, fear gives way to fundamentals and the market can resume its upward path.
  
  
  
  The Total Short Ratio is one of the effective tools we have to gauge investor psychology (chart 3). The current high reading points to excessive shorting, extreme pessimism, high liquidity, potential demand, and thus a potentially good buying opportunity.
  
  
• The absolute level of supply of stock is currently favorable. When we see stock being retired at a high rate, due to corporate acquisitions, stock buybacks and companies going private it is generally a bullish sign as it reduces the supply of stock and increases liquidity (chart 4). The lack of net new stock issuance suggests the supply side of the stock market supply/demand equation is favorable.
  
  
  
  
  
• The trend of the market is the only area of our work that has recently weakened. Because trend makes up a substantial portion of our investment process, we must honor the weakness in price and make some slight adjustments to some of our actively managed portfolios. The chart below shows the long-term bull market which started in 2002. Only until recently has the continuation of the trend come under pressure (chart 5).
  
  
  
  
  
• Lastly, the current stock market volatility is consistent with the typical Presidential election year cycle (chart 6). While Presidential election years, on average, have supported attractive returns, it is not unusual to experience some choppy market action until investors become more certain as to the potential outcome.
  
  
  
  

Our investment work suggests a below average weighting to stocks in our managed portfolios is warranted. We anticipate redeploying the money market proceeds to the stock market sometime later this year. In the meantime, our allocation to money market and investment grade bonds will likely add value until the stock market resumes its upward climb.

Stay tuned.

Member: Investment Adviser Association