Portfolio Update - 02/28/09

By proceeding, I acknowledge that I have read and understood the Disclaimer, Performance Reporting Disclosure and Copyright Statements . Dear Clients, The following is my Performance Update and Outlook for February. All prices and returns are as of 2/28/09.

Administrative Note: Starting this month, I am going to post a concise summary of my performance with a few market notes by the first business day of the month. I will follow it up with a more in-depth piece which I will e-mail you as a .pdf document. It will include specific investments and trades as well as the information that I have normally included in my web updates. If you are not a client and you would like to receive a copy of our expanded monthly Performance Report, you can call our office or e-mail us to request one. For compliance reasons, we can not make it available for public dissemination if we include specific securities or trades. Our office number is 214.954.4300 ext. 1. To e-mail us, simply fill out the contact form on the upper right hand corner of this page.

PART I: INTRODUCTION

The market has undertaken a substantial beating over the past month. I haven’t even researched it yet, but I assume that the S&P 500 just experienced the worst January – February period ever, which is significant given that last year was the second worst year ever for the stock market. Since the S&P 500 peaked in October of 2007, it is down over 50% which means an investor who subscribes to the “Buy and Hope” school of investing will need to achieve a 100% return on his equity portfolio just to get back to even. For those investors whose financial advisors rebalance their accounts, they are going to be in for a heartbreaking revelation as they realize that the only way to significantly underperfrom in a bear market is to average down. (Rebalancing in a bear market is essentially the same thing as averaging down.)

PART II: ACCOUNT PERFORMANCE

Here is how my performance measured up to the averages as of February 28th of 2009:

1. We implement our Focus Portfolio inside of IRA accounts and margin accounts. Both strategies are invested in the same themes, but their performance varies significantly for many reasons. Primarily, in our margin accounts we are able to short-sell securities, we focus on tax efficiency and they are charged margin interest expense. The risk with short selling securities is substantial as it can result in losing more than a 100% of your initial investment. The performance dispersion of our margin accounts is greater than in our IRA accounts due to margin requirements, tax-loss selling and ability to borrow shares to sell short.

My monthly winning streak is over. After generating positive returns for three straight months, I gave a little back this month, but not nearly as much as equity and balanced portfolios did. We are still up for the year which is encouraging but I am discouraged by developments in the equity markets over the past few weeks. Despite the market falling below last November’s lows, the total number of individual securities hitting new lows has been fairly moderate. This is a result of the weakest sectors continuing to fall while stronger sectors begin to appreciate. This development is a sign of strength and normally is a prelude to a rally. As a market bottoms, the market is drug down by the weakest sectors – just as the market is pulled higher by the strongest sectors at the top of a bull market. Eventually the stronger sectors overpower the weaker ones and the market shoots higher. With this in mind, I started building some long exposure which has dragged down our portfolio over the past couple of weeks. Late last week, the market broke through a lot of technical support levels so I’m liquidating the majority of these positions and will look to possibly rebuild them at lower levels – or at least later in the month if I can become more comfortable with the technical strength of the market.

PART III: MARKET OUTLOOK

Technically, if the market isn’t poised to rally now, when will it ever rally? Despite the depressing newspaper headlines, the technical picture of the Dow now is one of being super-oversold. Investor sentiment is on the verge of being demoralized. The weakest kind of market is a severely oversold market that refuses to rally. Sad to say, that’s what we have now. - Richard Russell, Dow Theory Letters via www.investmentpostcards.com, 3/1/09 -

The short-term technical picture for equities is a train wreck. For every indicator pointing towards a rally, there is another one saying it has no where to go but down. Furthermore, the market might have a very solid day from a technical perspective, like it did last Tuesday, only to have all of the strength wiped out the following couple of days. The intermediate term indicators are suggesting a rally should start at some point in the coming weeks. The problem is that it could begin from prices well below where they are today. In Q4 of last year, we saw just how far markets can fall in the span of a few weeks so just because a rally is coming soon, doesn’t mean that it cannot begin after another severe sell-off. The long-term technical and fundamental picture is still very bleak. I have a hard time believing the market has much further to fall, but I only get one vote so it really doesn’t matter what I believe. It is my job to decide what Mr. Market believes and right now he is suggesting that markets may fall much farther. Fundamentally, we need to resolve ourselves to the fact that a national banking crisis has historically led to a depression. In the 1870’s and 1930’s in the US as well as in the 1990’s in Japan and with Great Britain and Germany in the 1920’s, equity markets performed miserable as credit markets and ill-advised government actions took their toll on the economy for a decade. There are proven ways to resolve the current banking crisis, especially given the flexibility of our currency, but unfortunately our government is not pursuing any of them. Ultimately, we have two problems in the economy and credit markets. The primary problem is counter-party risk. The second problem is a cyclical, economic slow-down in consumer and business spending. The solution to the first issue is simply a combination of doing what JP Morgan did in 1907 and what Sweden did in the early 1992. In 1907, our banking system faced a similar fate is it does today with many of the same causal factors. JP Morgan called each and every NY banker into his office and they wiped out all the counterparty risk at once, closed down the smaller, insolvent banks and the larger, solvent banks took over the assets and liabilities of the insolvent ones. It is critical to wipe out as much counter party risk as possible at once. Of course, Morgan accomplished this in the days before spreadsheets, computers and such. But wiping out the counterparty risk is not sufficient today, because, the insolvent banks are the large banks therefore making it unfeasible for the solvent banks to take over the insolvent ones. Therefore, the government will need to nationalize the large, insolvent banks wiping out all the common and preferred share holders as Sweden did in the early 90’s. Once the counterparty risk is cleaned out of the system and the insolvent banks are nationalized, the government can gradually turn over assets and liabilities to the smaller, regional solvent banks who were not the primary cause of this entire mess. These actions would finally free up the credit markets. Once that happens, the Fed and the US government could take various actions to stimulate consumer and business spending and eventually it would get back on track. But until the counterparty risk is cleaned out and bad banks are removed from the system, the credit markets are stuck and the economy is likely going nowhere in real terms.

PART IV: FORWARD STRATEGY

I will update you on my forward strategy in the .pdf document that I will be sending you in the next couple of days.

PART V: CONCLUSION

Individual investors have liquated their long exposure in mass at the bottom of every bear market in the history of capital markets. Despite suffering through the second worst bear market on record, individual investors are still sticking by the “Buy and Hope” strategies promoted by their advisors. In January, Mutual funds experienced positive inflows according to James Investment Research. While there is a seasonality component to this development, as 401(k) plans see large deposits to meet matching requirements and advisors rebalance their clients’ accounts, mutual funds should not be seeing new inflows at bear market bottoms. This serves as a contrarian indicator suggesting equity markets may have much further to fall. I hope it is different this time but I sure as heck am not counting on it. Individual investors are failing to realize the impact of losses on an account. The percentage gains required to make up a percentage loss grows exponentially as losses deepen. The following is a break down of the required gains needed to make up for a specific loss:

Minimizing losses is critical in a bear market such as the one we are experiencing. Even though the 2000 bear market experienced similar losses in equities, bonds and real estate served as a reprieve. However, in this bear market, nothing except Treasuries and Gold have offered any sort of relief. Unfortunately for many investors, the losses from the last 17 months may never be recovered with the strategies that Wall Street firms have adopted. Despite prices being cut in half, the market is still expensive at a P/E of 18. Secular bear markets have historically not been resolved until the P/E ratio hits single digits. The next several years are going to be defined by valuation contraction which will drag down equity returns for some time. Generating significant gains over the next decade will be derived from two sources. First, as a result of hyperinflation due to currency devaluation where equity market returns maybe positive in nominal terms but not in real terms. Second, from alternative strategies that have been proven to be effective in past secular bear markets. I am seeking to capitalize on both of these themes which I feel will greatly increase the odds of achieving above average gains in the coming years. As always, if you have any questions or concerns regarding your account, please do not hesitate to call me at 214.954.4300, ext. 1. If you are not a client of the MAC and you’re at a point where you’ve come to question the strategy being implemented by your adviser, we’d appreciate the opportunity to visit with you about our unique approach to asset management. You can call our office or simply fill out the contact form on the top-right corner of this webpage.

All the best,

Matt McCracken