October 31, 2009

The third quarter of 2009 saw continued stock market recovery, leading to a second entry in the record books. The period from market peak on October 9, 2007 to trough on March 9, 2009 proved to be the deepest stock market decline since the Great Depression. Now, the seven-month period ended September 30, 2009 has generated the largest seven-month market return since the 1930s, as measured by the S&P 500 Index. In spite of the market's record-breaking performance, we remain cautious, as the economic recovery appears weak.

Although far less ebullient than the stock market, the economy has shown some signs of improvement in recent months, as well. Corporate earnings have risen in some industries, although most of the earnings improvements are due to cost cutting rather than increased revenues. Consumers continue to save, pay down debt and forego major purchases. Businesses appear reluctant to increase payrolls and production while consumer spending remains subdued.

Officially, unemployment is near 10%. The actual rate, however, probably exceeds 15%, including the underemployed, who have settled for part-time work, and the long-term unemployed, who have stopped looking for work altogether. Companies aren't expected to create more jobs for at least another year, so unemployment may still go higher before it heads lower.

Despite large government deficits to fund government programs, inflation has not yet become a problem. Historically, however, government deficits that are not paid for by higher taxes and spending reductions lead to rising interest rates, inflation, or both. There is additional risk of currency devaluation in the foreign exchange market.

As stated last quarter, with the market rebounding, some investors may be tempted to increase their equity targets in an attempt to try to recapture last fall's losses. But at Towneley, we know that client circumstances, not the ebb and flow of the market, determine the appropriate level of equity exposure in one's portfolio. Here are our recommendations:

• Individuals: Evaluate your equity target in light of your age, health, employment status, time to retirement, spending patterns, and other needs and goals.
  
  
• Institutions: Base equity targets on changes in long-term organizational goals, revenue forecasts, anticipated expenses, and other factors relevant to the organization's plans.

We encourage you to maintain the discipline to base changes in your portfolio allocation on your needs, rather than on anticipated market movements.