Investment Outlook from Coronado’s Orion Capital Management LLC

Dear Investors, The third quarter of 2009 saw a continued strong rebound in the global equity markets following what appeared to be broad investor recognition earlier this year that the Great Depression, Part II was not under way. The S&P 500, after having been down by as much as 25% in early 2009, ended the third quarter solidly in positive territory with a year-to-date gain of 17%. The bounce off the March 9th low of 666 has been a breathtaking rise of nearly 59% in just under seven months, and the riskier asset classes-most of which were beaten to a pulp in 2008 and the first quarter of 2009-led the charge higher. Around the world the 2009 year-to-date equity market return figures are very strong, but when put into a longer-term context represent only partial retracements of the losses suffered since the global markets peaked in October 2007. High-quality bonds had a stable summer, with the yield on the ten-year U.S. Treasury note falling 21 basis points to keep yields within a stone’s throw of generational lows. The 30,000-foot view of the U.S. economy looks a lot better today than it did a year ago. Markets are rebounding, the Great Recession is likely over (at least by the strict definition of a recession), and a collapse of our financial system appears to have been averted. Beneath the surface, however, potent economic challenges are stirring. To avert an economic collapse, our federal government has not only injected hundreds of billions of taxpayer dollars into the economy, but it is also providing ongoing life support to the credit markets. The so-called “shadow banking system,” which enabled banks to bundle up their loans, dice them into securities and sell them to investors around the world, is functioning at only a fraction of its pre-crisis levels. While this may seem an arcane little corner of our financial system, it is critical because it is the mechanism through which banks are able to make loans. Now, with the securitization market on life support, banks are less willing (or able) to make loans and are thereby hindering the flow of credit through our credit-dependent economy. With our economy still hunched over in a moribund state, interest rates are likely to remain low for some time. Many economists worry about the potential for this easy stance on rates to stoke inflation. With an ample amount of spare capacity in the economy, however, and unemployment of 9.8%, inflation-at least how the government measures it-has so far remained low. However, a policy of low interest rates makes our dollar less attractive to foreign investors, whom our government relies upon heavily for funding. During the crisis the dollar soared in value relative to other currencies because it was perceived to be a safe port during a horrific storm. Now that the crisis is ebbing, foreign investors are coming to view the dollar as simply an asset that 1) pays very little interest income and 2) is having its value diluted away by our government’s impertinent creation of many more dollars. Whether our currency will be able to turn itself around is, of course, unknown, but as PIMCO bond guru Bill Gross has stated “One of the ways a country gets out from under its debt burden is to devalue.” While the obvious near-term consequences of a weaker currency are that it costs more to travel abroad and to buy imported items, the real long-term threat posed by a sliding dollar is permanent capital flight from the U.S. by global investors and foreign corporations. The three main actors in our economy are the government, consumers and corporations. The government, at both the federal and state levels, is in a very difficult financial position. Tax revenues are down sharply and entitlement spending is set to soar over the coming decades. Consumers are still debt-laden and remain cautious after the crisis, though there are signs that their spending has stabilized. Corporations remain in by far the best shape, and this is because they have done what neither the government nor consumers have been able to do: repay debt, reset their spending levels and build up cash. Consequently, the third quarter earnings that companies are now reporting are impressive and show the significant progress that they have made in adjusting to the world’s post-crisis economy. Now, with markets having made a significant leap off the bottom, the burden is on the economy to catch up and justify current asset price levels. The key will be to see how the economy responds (or doesn’t) as the government gradually removes its monetary and fiscal support. Only when the patient can actually get up and leave the hospital under his own power will we know that we have left the Great Recession behind. The big news here at Orion is that I have brought on a new partner. His name is Seph Huber and he has extensive trading and money management experience at top-tier institutions in the U.S. and the U.K. I am very confident that he will be a terrific asset for the firm. For more about Seph and his background, please visit: www.orioncapitalmgmt.com and click on “Management”. 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