The Second Quarter ended in disappointing fashion as the market lost momentum following the March lows.  Despite the lack of follow through, we maintain that the technical bottom for the market occurred with the Bear Stearns announcement.  Similar to the 2002 market, several technical re‐tests of market lows should be expected.  Also, as we mentioned previously, a technical bottom is not equivalent to fundamental improvement ‐‐ i.e., we anticipate the period of balance sheet repair for financial institutions to be quite extended.  The de‐leveraging of the financial markets could require several more years.  The entire banking system needs to be recapitalized, and the uncertainty associated with that process will continue to hinder the market’s progress.  Further, we believe that a new system of controls and regulations will emerge.  Policymakers want solutions to prevent future financial upheavals and to avoid the “moral hazard” embedded in the current system.

While the First Quarter witnessed a dramatic sell off among almost all asset classes, the market was dichotomous during the Second – i.e., commodities appreciated to historic highs while consumer and credit‐related sectors exhibited profound weakness.  In our view, this bifurcation has applied enormous pressures on the economy and has effectively put central bankers in a bind.  On one hand, they need to maintain sufficient liquidity in the system to facilitate a healing process among the banks.  On the other, they must remain vigilant with respect to preserving price stability.  This tension will continue to be reflected in heightened volatility – a characteristic of the market which should not abate until there is fundamental resolution to the credit/housing crisis.

We believe the extremely rapid rises in oil, grains, fertilizer, and coal prices have reached a critical juncture – commodity price inflation has eclipsed the point at which most economies can absorb further increases.  While the developed world frets primarily about an energy crisis, the developing world is tackling a more painful food crisis.  Many nations have begun to implement policy responses, and we believe these corrective measures are good for the long term health of the markets.  We further believe high prices will eventually temper demand for most commodities, lower prices in the near term, and
encourage much needed investment in long term solutions.  In the US, we are doubtful that the average consumer can withstand the overwhelming pressures on income, and we anticipate energy and food costs will “crowd out” spending in other discretionary areas.  Behavioral adjustments have begun to accelerate, with conservation efforts growing in earnest, and we view this trend as favorable long term.

Despite the backdrop of uncertainty, we believe there are areas of fundamental strength during this period of transition.  We urge clients to remain positioned for an eventual recovery, and we remind clients of the powerful 40% moves by the stock market indices following the March 2003 lows.  We also remain confident of our investment themes:  a) global infrastructure build out; b) long term demand for commodities, especially agriculture and energy; and c) economic strength outside the US, particularly parts of Asia and Brazil.  We also believe yield spreads in certain sectors of the bond market have become compelling.  We appreciate that recent market activity is unnerving; please do not hesitate to contact us.  We look forward to discussing our views with you.