Orion Capital Management Investment Outlook — April 2009

Dear Investors, Even after a ferocious three-week rally in March that sent the broad market indexes up more than 20% off their lows, the S&P 500 Index was still in negative territory for the year through March 31 with a loss of 11.7%. But after global stock markets moved together in near lock-step (in a downward direction) during the height of the financial crisis in late 2008, some international markets are beginning to veer off in their own directions. This separation of markets indicates a reduced level of fear and more discrimination among investors, though the global economy does not yet appear to be set up for a near-term recovery. So far in 2009, both China (up 4%) and Brazil (up 11%) have bucked the global trend and risen. Given the dour economic backdrop coupled with active U.S. government buying of Treasuries, the yield on the 10-year Treasury note has sunk to 2.7%, which for all intents and purposes is a generational low and a harbinger of slow economic times ahead. The main drivers for equities in April will be corporate earnings reports, which have now begun in earnest. Expectations are being ratcheted lower in a hurry. Analysts expect first quarter operating earnings for S&P 500 companies to be down 36% from a year ago, whereas just three months ago the consensus called for a 13% decline. Although investors are expecting earnings to be pretty bad for the first quarter, they will be listening closely to company managements discussing the outlook for the balance of 2009. Investors face a big challenge in divining the true earnings power of companies that are facing a still-deepening downturn. Earnings achieved in the last few years–in a world of very high consumer spending and lax, cheap credit–are of limited use in trying to predict future earnings in this new world. Washington remains the main player in the market and the economy today–not Wall Street. Treasury Secretary Geithner will reveal the results of the bank “stress tests” this month, and if some loose-lipped government analysts working on these tests are to be believed, the results may be a relief for investors. The government’s $787 billion stimulus will begin to impact the economy in the second quarter, and the Fed’s active purchases of Treasuries appear to be helping to keep long term interest rates low. Finally, the Treasury’s PPIP (Public-Private Investment Program) is designed to provide up to $1 trillion in capital to assist private investors in buying so called “toxic assets” from the banks. These government actions, in concert, should provide significant help for the economy. But they will not be able to fully counteract the spending contraction and deleveraging that has to occur as the U.S. economy right-sizes itself after years of profligacy. While it is widely agreed that government help for the economy is necessary to head off an even deeper downturn, it does come with consequences that will become apparent in coming years. First, higher taxes to pay for today’s ballooning government spending commitments are likely. Second, the amount of money being pumped into the economy by the Federal Reserve will probably lead to inflation down the road and a decline in the value of the dollar. For the moment, however, those are long-term concerns that are outweighed by the need to get our economy started again. All in all, March turned out to be a relief after a dismal January and February. Gleeful bulls will even say that the bottom has been reached and that now, with stocks up more than 20% off their recent lows, we are in a new bull market. While we have certainly experienced a lot of pain and a deep, long recession is increasingly baked into economic projections, I believe any celebration is premature. The financial markets have, however, done considerable healing from their state of fragility in October and November. The main problem is that the former engine of the global economy-the U.S. consumer-is out of the picture for the foreseeable future and there does not appear to be anyone or anything else ready to lead the way. With the U.S. so much bigger than other economies, and with its consumers accounting for a very large percentage of GDP (about 70%), it would take an improbably massive increase in the spending of consumers around the rest of the world to make up for just a small drop in spending by U.S. consumers. And Americans are certainly spending less as the unemployment rate nears 9%. The national savings rate was negative in 2005 and 2006, but as of this February it has risen all the way to 4.2%. When you consider that the average national savings rate from 1980 until the mid-1990s was about 8%, it is clear that consumers still have lots of room to further restrain their spending. Economist John Maynard Keynes propounded this “paradox of thrift” which states that in tough times people save more money, but that while the act of saving is good for an individual family, it is detrimental to an economy. Investors are advised to buckle in and keep their resolve. It will take us time, but we will work our way out of this economic hole. As usual, I welcome your comments and feedback. Best Regards, Peter About Orion Capital Management LLC Founded in Coronado, California in 2002, Orion Capital Management LLC is an independent investment firm that manages assets for a broad spectrum of clients. The firm’s customized portfolio management services are grounded in independent investment research and objective judgment. Peter C. Thoms, CFA, Founder & Portfolio Manager 1330 Orange Avenue, Suite 302 | Coronado, CA 92118 Tel: (619) 435.1707 Fax: (619) 435.1706 Email: [email protected] Web: www.orioncapitalmgmt.com