What was great about 2010 is that it was not 2009. According to the Chinese calendar, 2010 was the year of the tiger. Statistically, at least in my book, 2010 should be titled The Year of the Scaredy-Cat. No great tiger in the stats, unless you look at how many people behaved as if they had grabbed a tiger’s tail and were fearful to let go. At the peak of this year $17 went into fixed and money market funds for every $1 that went into stock funds. There were few signs that people were being released by the seductress “irrational fear” that led them to the silliness of earning a guaranteed near 1% on money markets and negative returns after inflation.

Upon hearing our wealth management advice FIM Group's clients, however, were not seduced by the scaredy-cats. Rather, as long-term investors, they held firm that life will go on and took advantage of the big opportunities created by all the fear. Thankfully, most sellers of stock had already sold, so there was little for those scaredy-cats to do except buy once they realized that the tiger was a friendly sort and just wanted to be respected.

2011’s Worry List

We will stand firmly in the future and give forecasts in our next newsletter, but for now I need to explain a few things that would keep me awake at night if our portfolios were not structured to benefit from an unfolding of the malaise.

Municipal Bonds: There are 90,000 local governments in the U.S., and these utility districts, cities, schools, counties and states account for 15% of our workforce. The main sources of income for local governments are sales tax and property tax. Property values have dropped (and continue to drop) and so has consumer spending, thus affecting taxes. At the same time, governments are feeling the need to provide more services for unemployment, health care and social services. President Obama gave billions to help support state and local governments, which really only delayed the inevitable, namely layoffs, pension reform and fewer services. Will there be backlash? Will states and municipalities just say “No” to paying the interest on their (municipal) bonds, renegotiate their terms or just not pay them off at maturity? Pay the police and fire departments or pay the interest on bonds will be a decision that many weaker local governments will have to make. Most state and local governments can’t “legally” run defici
ts, so lawyers from coast to coast will be creating a new expense for municipalities as they try to ascertain their legal options. Cutting pensions, reducing salaries (and taking on the unions), declaring bankruptcy, shuttering health and welfare programs, shutting down prisons, outsourcing police and fire, and consolidating schools are some of the tough decisions that might come before defaulting on an interest payment on their municipal bonds.

FIM Group’s Investment Policy Response: For now, FIM Group’s portfolios will be light on municipal bonds; we will be sticking only to the highest-rated. Many municipalities will do fine through this newer, slower economy, but most will be faced with some tough choices. Rampant municipal bond weakness will be good for AAA government bonds from around the world. Long-term income investors might also turn to preferred and dividendpaying stocks to enjoy the 85% tax exemption on the dividends.

U.S. Dollar: Chairman Ben Bernanke sees “a downward pressure on the dollar as a reflection of perceived growth and return differentials that favor emerging markets and views efforts to resist currency movements as counterproductive to the goal of redistributing production from high to low utilization rate regions” (Source: JPMorgan). The U.S. Fed buying $600 billion treasury bonds, keeping interest rates low, and a U.S. government with spending plans un-influenced by any constraints will have an effect on our U.S. dollar, and most likely continued weakness into 2011.

FIM Group’s Investment Policy Response: Dollar weakness can have a good side – if you’re a (U.S.) exporter, you can be more competitive if you have highvalue added products (e.g., pharma, technology) or are in the service business (e.g., telecommunications, consulting). The U.S. is chock-full of such businesses, so owning them could be a great strategy if the price is right. Energy companies that own oil, gas and renewable energy, generating assets should benefit from U.S. dollar weakness as should select foodproducing companies and companies that have commodities like cement, nickel, copper, gold, silver and agricultural land. Also owning AAA high-quality sovereign bonds in stable, pragmatic and wellmanaged countries is a rational response to U.S. dollar weakness.

U.S. Political Leadership: We are spending more than we take in no matter whose budget you look at. As we approach April, we expect a lot of fear talk and posturing by Tea Party, Democrats and Republicans alike, as our elected officials need to “make sure the government doesn’t close down by voting to raise the debt ceiling.”

FIM Group’s Investment Policy Response: No big deal – markets that respond with weakness to our normal political “goofiness” will create a buying continued from page 1 opportunity. It should also be good for creating more U.S. dollar weakness opportunities. As Samuel Taylor Coleridge said, “In politics, what begins in fear usually ends in folly.”

North Korea (War): Will the problems in that hemisphere balloon into a major conflict that requires our mighty military’s involvement?

FIM Group’s Investment Policy Response: As this situation unfolds, the effect on the U.S. dollar should be neutral as it could make it a “safe” place for a while. The more the U.S. becomes involved, the larger the negative impact will be on our currency. Korea should be a non-market event. China will run the show – and be key to how the conflict is handled. Politically, South Korea is our ally, and we are politically tied to their defense.

The Drunk Brothers Euro: Greece gets 110 billion € to help keep its economy afloat; then Ireland, one of the (former) tigers of Europe, gets 85 billion € for liquidity purposes. And let’s remember Spain and Portugal that are messing with the euro’s stability. 2011 will be more of this mad attempt by the European community to hold it together.

FIM Group’s Investment Policy Response: Currency union without political union is a recipe for disaster. The euro is 11 years old, and it is going to be an ongoing pain in the fiscal, monetary and economic rear, especially for France and Germany. There is little incentive for weaker countries to do more than say they will “be good” and be fiscally conservative and economically responsible. This will cause significant volatility, but a good business holds its value regardless of its location or its “domicile” currency. So this euro noise will create headlines, but really it’s just noise that creates buying opportunities. FIM Group will avoid euro bonds and euro fixed investments. Bottom line: what is bad for the euro is good for other currencies. The volatility will create opportunities.

Worry lists create opportunity, and they are as normal as can be. The chart on the next page shows the cycle of market emotions. Perhaps it should be called the “Way of Worry.” I have rarely been as optimistic about the right environment for outstanding investment results as I see when I look forward to our new decade. Many investments are at near historic bargain prices. Investors still are reluctant to even nibble away at good, quality, well-managed, solid investments in income stocks, and other equity investments, and there are trillions of dollars sitting in money markets earning near “0” – all one needs to do is look to this chart to know we are closer to a trough of great opportunity than a peak.

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