As I write this month’s letter, I am watching the market rise above the 12,000 (Dow Jones) mark.  This rally is a result of a European debt bailout by the European Union, the international monetary fund, and of all people, China.  In fact, the market is on course for the largest monthly point gain in the history of the Dow Jones Industrial Average.

That said, what does all this mean to us as asset managers?  That question is perhaps best answered in an assessment of both short and long term perspectives:

On the short term:

The need for a European bailout was the result of major sovereign debt issues across the continent.  The default issues started with Greece, but the bigger fear was that a Greek default would spread to countries like Italy, Spain and Portugal.  None of these countries individually is a major driver, but the ripple effect could be devastating.

This current market rally, while well received, may also be an oversold bounce before we go lower, so we’re being patient in this area.  It’s not that we don’t appreciate the rally; we simply need more evidence it’s sustainable.

We are still not seeing consistent job creation.  Of course, this continues to be the primary catalyst for full recovery.  As discussed in last month’s letter the primary reason for lack of job creation is lack of confidence in the political direction of our country.

On the long term:

Corporate earnings are good and corporations are flush with high amounts of cash.

Consumers have much stronger balance sheets than in recent times.

While consumers have retrenched and become more fiscally responsible, their spending continues to keep our economy afloat.  They have, however, curtailed spending on luxury goods, autos and housing.

Even at the panic lows of 1998, stocks were about twice as expensive as they are now.  The markets are at very reasonable long term valuations, which should eventually be a strong catalyst for growth.

On a personal note…  We as Americans have the great privilege and freedom of celebrating in a few weeks, The Feast of Thanksgiving Day.  On behalf of our entire Delta Team, please accept my very best wishes for a day filled with thankfulness.

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.

Our global expansion appears to be slowing, which is the result of an enormous array of factors.  While the slowdown is a bit disconcerting, it is not a surprise.  Economies and markets typically “stair-step” higher and, at this point, we are on a plateau.  That said, we saw a similar scenario last summer and it will not surprise us to see the economy reinvigorate again this fall in much the same fashion as 2010.  Thus, we feel this resilient market could head higher over the next 12-18 months.

Money is always looking for perceived opportunity and value.  While the U.S. economy has certainly slowed and faces headwinds, the commerce of the United States still leads the world in perceived opportunity and value.

Consider:

In May the U.S. added only 54,000 new jobs.  It was  some 100,000 fewer than the 150,000 expected.  But we did not lose 150,000 jobs and we are not expecting to lose another 150,000 or 200,000 this month.  Even at this slow pace in January 2012, 1.5 million people who were unemployed in January 2011 will have jobs.  This means higher consumer spending and  higher demand for housing.

Housing continues to be soft.  But, with that weakness, it is by definition a much smaller percentage of GDP.  So, the drag to future GDP growth, even with persistent weak housing, will not be as much of a negative impact as it was in 2008 and 2009.

As monies continue to chase perceived opportunity, those monies will invariably flow into the markets.  Even though as redicted, the market has recently flattened out, we expect to see a higher market by the end of 2011, and thus end the year with some nice gains.

The markets ran up to start the year, but now appear to be losing a bit of steam.  Earnings have been strong and, to this point, the economy has been improving.  However, in our most recent economic reports, we are seeing the economy flatten.  We saw a similar scenario last summer.  It’s our hope and belief that we will reemerge from this correction with once again an accelerating economy going into the end of 2011.

Additionally, we believe one of the sectors that offers a lot of value from these levels is the financial services group.  We have begun to build positions in the group and feel that this is a space that can make us strong long-term profits.  Our desire is to build our positions over a few months to relieve any short-term market volatility.  We are positive on this sector for several reasons:

 Financial services companies are most profitable when we are experiencing a steep yield curve, as we are today.  Interest rates are very low, from a historical standpoint, but the spread between short rates and long rates is wide.  Remember, banks borrow short and lend long and low rates give these companies a quasi-free source of capital. 

About 40% of the S&P 500 is comprised of companies that work in a financial services capacity.  We find it hard to believe the markets will do well without this sector participating.  Our bet is they will begin to lead. 

Banks and financial services companies are once again loaning, which is a huge positive.  In fact, the Federal Reserve recently made note of this in one of their meetings. 

 In the end, we are probably a bit “early to the party” in our financial services investments.  However, as we have seen with other groups like gold, the lion’s share of the gains are typically made by being early, not late.