Orion Capital Management LLC–Investment Outlook July 2009

Dear Investors, In the second quarter, stocks around the world soared to their best collective gains in a single quarter since 2003. The S&P 500, after having been down by as much as 25% in early 2009, ended the first half of the year back in positive territory—up 1.8% year-to-date. Much of the gains, however, were just making up for the steady decline into March, which marked 12-year lows for the market. In any case, stocks appear to be indicating that the financial Armageddon scenario that seemed plausible last October is now off the table. For now, markets are merely facing a grinding recession that many economists think will end later this year. Reflecting the increased risk appetite of investors, the yield on the ten-year U.S. Treasury note climbed 82 basis points during the quarter from 2.7% to 3.52% as investors moved out of safe government debt into riskier realms. In the early 1990s, while on a cross-country move from Florida to California, I had trouble coaxing my fully-laden Honda Civic through some of the higher elevations of the Sierra Nevada mountains. I was dismayed that as I stomped on the gas pedal my car would barely respond except for emitting a high-pitched wheezing noise as it bucked and pitched. I was forced to drive up the highway’s steeper sections on the shoulder at ten miles an hour while other cars zipped by me. As I reflect on that memory, I can’t help but think of its parallels with the state of the U.S. economy. If the economy were my old Honda, then the car-load of stuff I was carrying could be thought of as the piles of debt we carry at the national, state and personal levels while my mostly ineffective flooring of the gas pedal could represent our government’s pull-out-the-stops fiscal and monetary policy. The U.S. economy continues to wheeze heavily but, in my opinion, is beginning to sprout just a few “green shoots.” The Federal Reserve’s interest rate policy of keeping short-term rates from 0% to 0.25% is as aggressive as possible and the $787 billion fiscal stimulus package is also very large relative to the $14 trillion U.S. economy. But these two measures have yet to stoke a decisive economic recovery. Why? First, even though short-term rates are near zero, banks have recently become more selective about which loans they extend. The banks’ reluctance to let credit flow easily back into the economy is working against the Fed’s loose monetary policy. Simply put, low interest rates are of little use to consumers or businesses that cannot get a loan. Second, the $787 billion fiscal stimulus has not actually put much money into the economy yet. Despite policymakers’ talk of fast-tracking the cash to “shovel-ready” projects around the country, as of June 30th less than 10% of the money had been spent. Thus, while it is too early to judge the stimulus package a success or not, it is not too early to say that it isn’t really helping yet. To wit, in the first week of July as the Bureau of Labor Statistics estimated that 467,000 jobs were lost in June, reversing a three-month trend of improving job figures. Policy makers are now beginning to ruminate about the need for a second stimulus package. Investors would be prudent not to expect much of an economic rebound in 2009 and to expect that the recovery, when it comes, will be weak and drawn out. Job losses will continue to mount through the year (we’re at 9.5% unemployment now and likely headed for double digits) and these losses, along with anemic income growth, will depress consumer spending and dampen consumer confidence. Furthermore, because the official unemployment rate does not take into account the growing number of workers who are underemployed or who have stopped looking for work, it actually understates the awful state of today’s jobs market. The markets have obviously adjusted dramatically to this economic situation. Asset prices—whether you are talking about stocks, commodities or real estate—are significantly lower across the board. But companies and consumers understand that we are facing formidable problems and they have begun to take action. Companies are revamping themselves for a world with less demand. They have reduced their workforces, tightened their supply chains, and leaned their inventories. Consumers have responded to the recession by significantly increasing their savings rate to 6.9% of income, up from 0.4% in 2007 and now at the highest level in fifteen years. Because consumer spending accounts for about 70% of the U.S. economy, however, Americans’ increased propensity to save will not help to accelerate our recovery. It is, however, unambiguously good for the long-term financial health of the country to have a more financially secure citizenry. There will be consequences—likely in the form of higher taxes and inflation—down the road for our ballooning government deficit (which may top $1.8 trillion in 2009), but for now the government’s actions appear to have stabilized the markets and to have begun to arrest the economy’s downward slide. Given the magnitude and multitude of our economic challenges, however, getting the economy back on a healthy trajectory will take some time. As is the case this time each year, my investment advisor registration (Form ADV) has been updated. Please let me know if you would like to receive a copy. I welcome your comments and feedback. Best Regards, Peter Peter C. Thoms, CFA Orion Capital Management LLC 1330 Orange Ave. Suite 302 Coronado, CA 92118 Tel: 619-435-1701 Fax: 619-435-1706 [email protected] www.orioncapitalmgmt.com