In the past hour while writing this letter, the Fed announced the implementation of another monetary strategy in an attempt to inject more cash into the economy.

Of course, the stated objective is to “spur economic growth”.  But, the operative question is: “Do we have a ‘money’ problem or something else?”  It is our belief that it is not a “money” problem plaguing us, but rather a “confidence” problem.

There are, of course, many factors which lead us to such a conclusion…to look at a few:

The markets continue to essentially churn sideways with no real confidence.

Over the past several months, the economic data has been very mixed giving us no real foundation for growth.

Large amounts of money flowing into treasuries, thus driving down yields.  In fact, the 10-year bond closed today at its lowest level ever.

The markets are trading at very low equity valuations and dividend yields are very high compared to historic levels.  Thus, we are seeing substantial long-term value but not real catalyst to attract buyers and thus drive the markets to higher levels.

Now…interestingly, corporate insiders have continued to buy up their own stock.  But… these insiders are typically early and are looking long-term.  We continue to agree with these insiders that the long-term economy capital markets have substantial potential.  But, the short-term is a bit cloudier.

As always, we continue to look for emerging trends and sectors which have potential upside growth.  At the end of the day we still have a 14 plus trillion dollar economy.  And… that’s a lot of commerce and potential opportunity for investors.

One year ago, we experienced a summer pullback in the equities market and a deceleration in the economy.  As fall 2010 was ushered in, we began to witness an up-turn in the markets.  This up-turn evolved into a strong rally, which lasted for almost nine months.  Fortunately, we were well positioned and realized some very nice profits.

We think there are a lot of comparisons between the summer of 2010 and 2011.  First, we see the same array of indicators lining up now as we saw a year ago.  Does that mean we will experience the same 4^th quarter results as 2010?  Obviously, we will not know that answer until early 2012, but there are a lot of “under the surface” positives that people are simply choosing not to see.

As we have often said, ultimately at the end of the day, markets are driven by one thing and that is corporate earnings.  At closer glance, we see many positives on the earnings front:

1. Second quarter earnings reports were very strong but, maybe more importantly, most companies have continued to hold their guidance.  That translates into the fact that these companies believe they can hit their 3^rd quarter projected earnings.

2. Corporate insiders have been buying a “ton” of their company’s stock.  The reason is obvious; they believe they can make money buying their own stock at these levels.

3. Additionally, most leading economic indicators are still pointing to positive growth for the remainder of 2011.

History tells us that, when markets suffer a shock and the technical picture is broken, time is needed for them to heal.  So while we fully expect to see more choppy waters in the short-term, we believe that a strong run by year end is
forthcoming.

With the headlines fixated on our country’s possible debt default, I want to focus on the markets regarding this matter.  Obviously, the prospects of a government shutdown and debt default can be frightening with unnerving propositions.  So, what would such a default really lead to, and what are the markets telling us?

In a worst case scenario, we “could” see ratings agencies such as Moody’s, S&P and Fitch downgrade U.S. debt.  Such downgrades would possibly be more damaging than the default itself as it would likely force increased selling pressure on all forms of U.S. debt, leading to higher interest rates and lower bond prices.  Additionally, because we’re in a slow economic recovery rising interest rates would slow our recovery further, as borrowing costs would go up for companies and individuals.

History does not give us many comparisons for our current dilemma.  But, it is worth remembering that we experienced government shutdowns in late 1995 and early 1996.  In those instances, the stock market performed quite will.   In fact, the Dow Jones was trading around 3800 in November 1994 and around 4900 at the time of shutdowns.

What we need to focus on is that the markets are a “discounting mechanism”.  In other words, much of the fear of a shutdown was already “baked into the cake” in 1995 as the markets had anticipated a shutdown and adjusted/discounted  accordingly.  Of course, the prior results do not guarantee a positive outcome, but it does serve as a helpful antidote.  What the markets cannot discount are occurrences and events which are truly unexpected and unanticipated.  The markets know this issue is looming and arguably, investors have already discounted accordingly.  Case in point, the S&P 500 is currently off about 5% from its highs and the markets have essentially gone sideways since January.  This is against a backdrop of improving corporate earnings, with much of this scenario is already built into the markets.

At the end of the day, the capital markets are signaling that America will not default on its obligations.  While our current situation itself is disconcerting, it should not have a very long lasting effect because corporate earnings, not politics, drive the capital markets.