• The first decade of the 21st century was punctuated by a market decline beginning in March 2000 and lasting all the way through October 2002. This devastating bear market cut almost 50% from most of the major indexes and about 65% off the internet heavy NASDAQ. It was very reminiscent of the '73/'74 stock market decline and it was thought that a bear market of this magnitude would only occur once every 30 or 40 years. Unfortunately, this was not the case. After a five-year upturn, the market began another decline in October of 2007. This decline took more than 50% from most of the major indexes and culminated on March 9, 2009 with the Dow reaching a low of 6547.05, along with the S&P 500 at 676.53. Although we believed that the market overreacted to the true economic situation, the fear that gripped the nation (world) as we entered 2009 simply carried us into a black hole.
• Just as things looked like they could only get worse, the markets turned around and for the last 10 months of the year produced gains almost every month, generating positive returns in the S&P 500, which finished the year at 1115.10 (up 26.46% for 2009 Standardsandpoor.com), the Dow which finished at 10428.05 (up 22.60% DJIndexes.com) and the NASDAQ which closed at 2269.15 (up 43.89% NASDAQ.com). As heady as those gains were, they really masked the spectacular rise from the March lows. Investors were feeling numb in March, but they were feeling much better at the end of the year.
• But what lies ahead? Arguments can be made for a long, slow, modest recovery, or for the "W" that has been predicted by many prognosticators. While we believe the former is the more likely scenario, by no means do we think it will be an easy path. Thus, we will keep our eye on events both in the U.S. and around the world, as even the smallest event could cause the markets to decline temporarily. For example, we need only look back a few weeks to the Dubai situation, which raised questions about banking credit and the emerging markets. Fortunately, calmer heads prevailed and the markets stabilized in a short period of time. Nonetheless, those headlines spooked investors, indicating the tenuous nature of the recovery. Please keep in mind, however, the Wall Street maxim: "The market climbs a wall of worry."
• Certainly, we have seen our share of bubbles over the past 10 years, beginning with the internet bubble of the late 1990s. This was followed by the real estate bubble of the mid to late 2000s, the oil bubble of 2008 and now one could argue the gold bubble that is beginning to form. Bubbles form as investors start believing that increasing prices will last forever. Ultimately those prices reach an unrealistic level, bursting the bubble. It is often the small investor who is caught at the tail end of a bubble, losing a significant amount of money. This is one of many reasons it is important for an investor to have a strategic asset allocation in place which helps provide a disciplined investment approach. However, blindly following a strategic asset allocation is not the answer either, as investors must apply good, common sense and look at valuations, having the courage to take advantage of situations where valuations are low and having the intelligence to sell when those valuations rise, in some cases absurdly high. Nothing goes straight up forever.
• Depending upon the economic measure used, one could again probably argue both sides of the economic equation. Let’s start with the one that is likely to get worse before it gets better--unemployment. We saw a downturn in the unemployment rate in November, along with an adjustment to fewer job losses for September and October, which was seen as positive. It is highly likely that the unemployment rate will go up to about 10.5% before it begins to fall on a regular basis. The unemployment numbers are a lagging indicator as to what is happening in the economy. As more people begin to look for jobs, the unemployment number will go up. What we ultimately need to see is not fewer job losses, but actual jobs added. We'll take anything we can get, but in order to simply absorb the new people looking for jobs, businesses will have to add 150,000 to 180,000 jobs every month. Perhaps with the numbers over the past several months, the tide has been stemmed, but it will take awhile for us to have sustained job creation. Why? There remains significant capacity with current employees. We are seeing a slight uptick in the average work week. Remember--a lot of people didn’t lose their jobs, but lost hours. These people will return to working a regular week before new hires are brought on board. Even then, companies are liable to staff with temporary employees initially, wanting to ensure that the economy is really turning around. As recently as mid December, Ben Bernanke, Chairman of the Federal Reserve Board, was talking about keeping interest rates low for an extended period of time, because of the continued risks in the economy.
• This leads to a conversation regarding all of the money Washington is spending in an attempt to reverse the tide and eventually stimulate the economy. By the estimate of the Congressional Budget Office (CBO is a non-partisan governmental entity), up to this point in time the stimulus has sustained somewhere between 600,000 and 1.6 million jobs. Given that range, it’s hard for them to be wrong. The fact is, it is very difficult to measure the effect on job preservation and job creation under the stimulus bill. Nonetheless, spending the money has probably been better for the economy than if they had done nothing--at least in the short run. As reported previously, the Troubled Assets Recovery Program (TARP) money is in large measure being returned to the government, and much of it remains unused--to the tune of about $200 billion. The TARP law regarding the use of this money was crafted narrowly, along with what would happen when it was repaid. The President and Congress, however, are looking for ways to create a loophole in the law. Of the $750 billion that was authorized under TARP, it is estimated that less than $50 billion will actually be spent by the government on a net/net basis. There have been plenty of headlines over the past six weeks concerning many of the companies that borrowed money from the government that are now repaying the money with interest. By law, this returned money is supposed to lower the national debt, not be "re-spent." Thus, the question Congress is now asking, “is there somehow we can authorize the spending of $200 billion or more for job creation?” By no means do we want to scoff at the amount of money represented by $200 billion, but the reality is it will be a drop in the bucket in job creation.
• Continuing to run deficits that approach $1.4 trillion is absurd, and the creation of that much money will eventually have to work its way into the worldwide economy. This will most likely lead to higher interest rates and inflation in the U.S.  Early last year many people were predicting raging inflation by early 2010, and it simply has not manifested itself just yet. Much of the reason for this lack of inflation is due to the fact that oil is selling at around half of the high that it reached 18 months ago. As oil prices stabilize, some of the masking of this deflationary event will be lifted and we should begin to see some of the underlying inflation. Even then, at least in the early stages, much of the inflation will be commodity driven. History has shown that lasting inflation generally does not occur until inflation finds it way into wages. With over 10% of the population still unemployed, it's a pretty safe bet that inflation won't manifest in wages any time soon. With this many people out of work and those who are working being very careful with their spending, there is no huge demand for many goods and services. The classic definition of inflation is too much money chasing too few goods. Yes, there has been a lot of money created, but it has not gotten into the hands of the American consumer, which arguably generates 65% to 70% of our economy. Yes, there are relatively few goods and services as inventories have been reduced, but the demand needed to chase these fewer goods has simply not shown up. That having been said, increased demand should eventually occur. When it does, it will likely happen quickly as people will want to "reward" themselves for having been so frugal for so long.
• But what if the events of the past couple of years have created a major shift in attitude? Perhaps the "free spending" spirit previously pervasive in the U.S. with available easy credit going all the way back to the '70s and the ferocious consumption of the Baby Boomers will slacken. Perhaps Americans will become more practical in what and how goods and services are purchased. If this change persists and becomes a major shift in the psychology of the American consumer, it is entirely possible that the expected U.S. inflation will shift to other places around the world where there is a lot of money chasing too few goods. This, conversely, could strengthen the dollar as the U.S. investors return to being net savers rather than spenders. Yes, it might be hard to believe that this could actually happen, but think back to the '20s and the free spending ways of Americans at all levels, which lead up to the crash of the market in 1929 and then the Great Depression during the '30s. A major shift occurred. Back then, people were buying stocks by borrowing 90¢ on margin and only putting up 10¢. Within a very brief period of time, few investors trusted the stock market and found bank accounts, with the enhancement of FDIC insurance, as a primary way to save and invest. The influences of those times affected an entire generation or two. Is it possible this could happen again? If it does, it means that inflation might be held down for an extended period of time, notwithstanding the creation of money in the U.S.
• Talking about all of the immediate issues directly in front of us and the hoped for recovery from the recession somehow seems more important than looking out long-term, but as financial planners, it's hard to refrain from thinking about the future. A lot has been written, and perhaps even more has been said about the deficit. What a deficit leads to is national debt and that debt continues to grow at astronomical proportions. Historically over the past 50 years, the United States’ average debt has been 37% of GDP. It now stands at about 53%. One of the single largest costs to the government today is the interest on this national debt, and interest rates are at historically low rates. What part of the credit crisis of the past two years doesn't our government understand? The Democrats and Republicans are going to have to develop a totally bi-partisan approach to solving this issue and that process needs to begin now! You can't just pass a law and make it "go away." It has to start in small parts and build over time, with real penalties if Congress and the President don’t fix the problem. It's wonderful that the President says he "will cut the deficit in half over the next five years," but how will he do this? Even if he succeeds, it won't solve the problem of the debt, which must begin to be repaid. Politics aside, we find the proposal by the Democrats to take the repaid TARP funds and use that money for anything other than a reduction of debt to be a major error. It is just this lack of fiscal discipline that Congress and America’s citizens must avoid. Look at the American consumer…they get it…they are paying down their debt. They are sacrificing the things they might want to buy today in order to secure their long-term financial future. The Republicans are also very much at fault for the increase in the national debt, as the Bush Administration was anything but fiscally conservative. The Democrats can no longer point to the Bush Administration’s deficit, because the deficit projected for Obama's '09-10 fiscal year is expected to be close to $1.5 trillion.
• The answer to all of this is easy to discern, but difficult to implement. It is a combination of decreased spending and increased taxes--neither of which is an intelligent thing to do given the current economic environment. In fact, one could argue that President Bush lost an opportunity to do just that during his Presidency when the economy was doing well. Nonetheless, by 2011 and 2012 at the latest, we will have to demand leadership from our elected officials. Just as we have done in our personal lives for the past few years, we will all have to sacrifice even more. Further, America has got to get away from the "entitlement mentality" currently in place at so many levels.
• All this could be coupled with an overhaul of our current tax system. We must open our minds to many alternatives. None will be perfect, but the present tax system is broken. One example is a Value Added Tax (VAT), which American does not have. It's too simplistic to call it a national sales tax, and the only way this could ever be implemented is with total reform of the current income tax laws. We are not suggesting that taxes be increased as much as we are suggesting that taxes need to be placed on those who consume rather than save. This is exactly what a value-added tax does. There are many issues that need to be resolved with a value-added tax, including its regressive nature. That is to say, people with less money pay a greater percentage of their income in taxes unless certain items, like food, are exempted. Of course, this leads to another battle as to what else should be exempted, and could also lead to manufacturers reclassifying their goods in order to avoid the tax. We will save that discussion for another day. All we are saying now is that we need to elect real leaders to Congress; those who are critical thinkers. We need people who will attack the long-term issues, not pass a $447 billion spending bill, such as Congress did a couple of weeks ago, containing thousands of earmarks--big/bigger government is not the answer. Practical solutions and efficiency are needed.
• No discussion on the economy would be complete without reflecting on interest rates. For the past year, the Federal Reserve Board has held interest rates essentially at zero percent. The "official" word is a floating rate between 0% and 0.25%. At the recent December meeting, the Federal Reserve maintained this same stance. Bernanke made it clear that the Federal Reserve Board would keep interest rates at these historically low levels for the "foreseeable future," which most have defined as sometime during the summer of 2010. These short-term rates are set by the Federal Reserve, but long-term rates are set by the marketplace. The Ten Year Treasury began the year at an unbelievably low 2.1% and finished the year in the mid to high 3% range. This was really not a rise in true interest rates, but rather more about some fear being driven from the markets over the past 12 months. A major advantage to keeping interest rates low is lower mortgage rates, which are needed to continue to help the housing market. In 2010, foreclosures are anticipated to be 1.9 million homes, up 200,000 from 2009. We have several thoughts regarding interest rates: First, since we believe it is possible for the economy to grow faster than is anticipated, albeit not robustly, it is possible that we will see the Federal Reserve move more quickly on short-term rates than is currently anticipated - especially if the fourth quarter of 2009 and the first quarter of 2010 show better than expected GDP and job numbers. We can’t keep these types of low interest rates forever. Regardless of when the Federal Reserve begins to raise interest rates in 2010, they will raise them. The markets will actually begin to predict this ahead of any move based on the Federal Reserve rate, and will also set long-term rates. As long as interest rates don’t have a lot of upward volatility but rather have reasonable increases, this should be a good sign, as it will mean that the U.S. economy is improving, along with the global economy.
• Any discussion concerning interest rates must also address the dollar. Throughout the last half of 2009, the dollar continued to weaken against most foreign currencies. This is not too surprising because as investors' fear subsided, the safety of the dollar was no longer required. Capital started to flow to other areas around the world where there was greater risk and potentially greater return. The weakening dollar made American goods and services less expensive, which resulted in the narrowing of the trade deficit, not only because of fewer imports due to lower consumer demand, but also because of greater exports. Regardless of all the rhetoric concerning the dollar, it continues to remain a force in money circles. During the Dubai incident, we saw money running to the U.S. seeking safety. As interest rates rise, it will have a dampening effect on the fall of the dollar, and thus it is anticipated that the dollar will not likely come under severe pressure in the coming year. It is likely that it will strengthen in the early part of the year and then move downward a little as the year progresses.
• How will you know that the economy is improving before anyone else? Watch for subtle signs, i.e., restaurants reporting increased sales, as casual dining becomes a small reward for being frugal; watch for automobile sales to improve month over month, not just from a comparison to the prior year; watch for foreclosures to moderate and/or home purchases to accelerate; watch for small businesses getting loans and beginning to hire new employees; watch for your own feelings getting better about your portfolio and your willingness to do some discretionary spending. It will be the little things behind the headlines which will be the early signs--it won't be the big numbers in the headlines which actually will be confirmation of the more subtle indicators.
• So where does all of this leave us? At the end of the day, if the equity market provides a return of 8% to 10%, we should consider it a successful market year. This would put the market at its long-term average return, but more importantly, it is a reasonable amount of growth that doesn’t introduce a great deal of excess. Volatility is not over and it will take patience to deal with some of the big swings that are likely to continue as day-to-day events unfold. We are in much better shape today than we were 12 months ago and while by no means out of the woods, we are much closer to that goal which seemed so distant just a year ago.

We encourage you to visit with us if you feel that your risk tolerance level has changed so we can jointly determine if we should make changes in your asset allocation. It is important to prevent knee jerk reactions to events and to examine your long-term goals and objectives. Since many investors have a risk tolerance level higher than the risk they need to take to accomplish their goals and objectives, it is often better to address the risk budget of a portfolio. In other words, how much risk do you need to take versus how much risk you are willing to take in order to achieve your goals? Please don't hesitate to call us if you would like to discuss any of these matters. We look forward to 2010 as a year when confidence continues to return to the marketplace. We wish each and everyone the happiest and healthiest New Year.

Somerset's Wealth Management Team is pleased to provide this reprint with permission from ProVise Management Group, LLC, a SEC Registered Investment Advisor

PROVISE BULLETS ©

The Wealth Management Bullets are provided for your general interest. You should not act upon anything in the Bullets without speaking first with a Somerset representative to ensure that the action is suitable to your overall investment program. If you require additional information or have any questions regarding anything contained herein, please do not hesitate to contact us.

ProVise Management Group, LLC, is a SEC registered investment advisor, and is not affiliated in any way with Somerset. Clients of Somerset should not rely on any of the information contained herein without discussing it with their investment, tax or legal advisor. ProVise explicitly disclaims any responsibility for action taken by either Somerset or any of its clients.

ProVise Management Group, LLC, a SEC Registered Investment Advisor, and Somerset CPAs, P.C., an Indiana Registered Investment Advisor and Transamerica Financial Advisors, Inc., an independent broker dealer, are not affiliated.

*Registered Representatives with and Securities offered through
Transamerica Financial Advisors, Inc.,
member FINRA, SIPC

The S&P 500 and the Dow Jones are unmanaged indexes of common stocks and are frequently used as a general measure of market performance. An investor cannot invest in the S&P 500 or Dow Jones directly. Past performance is no guarantee of future results.

SOMERSET CPAs, P.C.
3925 River Crossing Parkway • Third Floor • P.O. Box 40368
Indianapolis, Indiana 46240-0368    
317.472.2200 • 800.469.7206 • FAX 317.208.1200

To unsubscribe from our e-mail communications, please click here and type "Unsubscribe" in the message subject.

PRIVACY AND REGULATORY NOTICE: The information in this email may be privileged and confidential. It is intended only for those named in this email.

Copying and distribution of this communication by parties other than the above addressee is strictly prohibited without prior consent.

This document and attachments are not intended or written to be used, and cannot be used, for the purpose of avoiding tax penalties that may be imposed on the taxpayer.

If you receive this email in error, please notify the sender immediately. Thank you, Somerset CPAs, P.C.

LD 35329-1/10