1st Quarter 2011 Commentary

7/31/2019 1st Quarter 2011 Commentary

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economic overview

Sturdy Market Withstands Challenges

As 2011 opened, the stock market continued the

rise that began on July 2nd last year, only to alter on

February 22nd when unrest in the Middle East pushed

oil over $100 a barrel. First Tunisia, then Egypt, Yemen,

Bahrain, Libya, Saudi Arabia and most recently Syria,

have experienced popular uprisings sparked by social

media-coordinated days o rage.

Then on March 9th, Japan was struck by a major earth-

quake and tsunami. Fear sent the Dow Industrials down

600 points in fve days as investors struggled to under-

stand the implications o these related natural disasters.

This is a human tragedy o immense proportions, yet

economically, like past disasters, the repercussions

will be limited to disruptions in the supplies o certain

manuactured goods. Ultimately, there will be economic

stimulus, especially or Japan, as massive reconstruction

gets underway in the next year. Once the market realized

this, it rallied back over the next ten days, closing the

quarter very near its post-2008 crash high.

Political instability and natural disasters are not the only

concerns investors should have. In addition, we see the

ollowing issues:

Stateandlocalbudgetsandbalancesheetshave

both signifcant defcits and ballooning debt.

Politicalleaderscontinuetoallowbloatedand

ineective expenditures without producing viable,

long-term solutions to our countrys biggest problems,

including entitlement spending.

TheFederalReservepersistsinkeepingshort-term

interest rates near 0% and creating money aster than

it ever has beore.

Inationisrising.

F QUArter 2011QUARTERLYCommentary

nsidethis Issue

conomic overview

: Sturdy Market With-

stands Challenges

Asset mAnAGement

: Putting Our Investment

Themes into Practice

eAtUred stocK

: Myriad Genetics

ixed income

: Understanding the

Municipal Bond Market

nvestment themes

: Molecular Diagnostics

Holds Huge Promise

www.nelsonroberts.com | 650.322.4

State and local governments, unlike the Federal govern

ment, cannot run defcits. Declining tax revenues

necessitate real-time cutbacks and the resulting reductio

in expenditures restrains the economy. Many view this

asasourceofcontinueddeationarypressureandth

believe this is osetting the extremely high fscal and

monetary stimulus o the Federal government. With

the current very low long-term interest rates, the bon

market is saying that the Fed will cut the stimulus

beforeinationbecomesaproblem.Ontheotherhan

the US dollars persistent weakness tells us that oreig

investors do not believe this is likely. Who is right? Webelievethatinationwillrisetoofarandtoofastfort

Fed to manage perectly. This will cause bond prices t

all, interest rates to rise and the consequent rise o th

US dollar.

In Congress, the budget-cutting ocus is entirely on

discretionary spending. Medicare, Social Security and

Deense account or over hal o total ederal spending

but no one is debating cutting these, at least yet.

Healthcare reorm will broaden coverage to care or

those currently uninsured but has completely ailed to

index PerFormAnce Q111 Ytd

Dow Jones Industrials 7.06 7.06

Standard & Poors 500 5.92 5.92

EAFE (international stocks) 3.50 3.50

Russell 2000 (small stocks) 7.93 7.93

Barclays Interm. Gov/Credit 0.34 0.34

Barclays Municipal 0.51 0.51


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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

December 31, 1999 February 28, 2INFLATION

CPI YOY Index

CPI Index

Ocial infation statistics shbut those o us who eat

top

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economic overview

Sturdy Market Withstands Challenges (contd)

a standard 5-lb bag to 4 lbs and baby wipes come 72

to a box instead o 80. Retailers seem to think that

consumers will not notice that volumes are dropping

and prices are staying the same. Where size cannotbe adjusted, producers are warning that prices will

be going up. Last week, Hershey

announced a 9.7% price increase

foritsproducts.Ofcialination

statistics show a benign CPI o 2.1%

year-over-year. Excluding ood and

energy, the rate is 1.0%. Forgive ou

sarcasm, but those o us who eat,

drive and heat our homes are just

not buying it.

So what is driving the markets rise?To us, it looks like it is all about

individual company perormance.

Costs have been cut, earnings are improving, actory

orders are up and the economy is slowly, sluggishly, bu

fnally turning around. The steady march o demograph

changes will continue to drive macroeconomic growt

world-wide.

address ever-increasing medical costs. Common sense

dictates that Social Security cannot survive the baby

boomers retirement without signifcant changes. The

question we should all be asking our congressionalrepresentatives is: what are you waiting or?

The Federal Reserve continues on its path o expanding

monetary stimulus. Quantitative Easing Two (QEII) is

underway and will take the assets on the Feds balance

sheet to a record high. Short-term interest rates are still

at 0 or all practical purposes, leading to a alling dollar.

(For more details on this particular

issue, see our May 2010 white paper

Deault or Devaluation.)

Inationiseitherbeginningtospinout

o control or is a non-event, depending

upon which data one chooses. A

March 29th New York Times article

wasentitledFoodinationkepthidden

in tinier bags. Canned vegetables,

pasta and other staple ood items now

come in 13-oz containers rather than

16-oz sizes. Sugar has dropped rom

75.962

2011 Bloomberg Finance L. P.

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

70

90

100

110

February 4, 2000 April 4, 2011US DOLLAR

80

120

LAST PRICE 75.962

HIGH ON 12/29/10 119.900

AVERAGE 91.548

LOW ON 07/02/ 71.657


3/6

benign CPI o 2.1%. Forgive our sarcasm,e and heat our homes are just not buying it.

Asset mAnAGement

Putting Our Investment Themes into Practice

As our confdence in the recovery has increased, we

have ocused on investing our cash while reshaping our

exposure in the healthcare sector and increasing our

weighting in materials. In February, we began to initiateour investments in molecular diagnostics (see Page 6

article on Investment Themes) by buying Gen-Probe,

which ocuses on nucleic acid testing or inectious

agents. That initial purchase was ollowed closely by

related investments in Myriad Genetics (see our Featured

Stock article) and Illumina, Inc. (the leading DNA

sequencing company).

To und these purchases, we sold a proftable position

in Volcano Corp. Though we think the prospects or

the companys products continue to be attractive,

the companys acquisition strategy is being met with

increased litigation, which is oten a distraction or

management. Furthermore, a substantial amount o

company revenues are generated in Japan, which will

likely result in short-term challenges or Volcano as

Japan slowly recovers rom its horriying natural disaster.

We also added a position in REMX, a Rare Earth Material

Exchange Traded Fund (ETF). We introduced the rare

earth material investment theme in our Q4 2010 quarterly

commentary and elected to pursue that investment

using an ETF. The demand or rare earths is on the rise

and companies that may participate span both size

and the geographic spectrum. The ETF enables us to

gain diversifed exposure through a 1% position in our

equity portolios.

The equity markets continue to claw their way back

toward the high water marks set in October 2007. The

appreciation in the market has been supported by a solid

recovery in company earnings and healthier corporatebalance sheets. The Dow Jones Industrial Average ended

the quarter up 7.06%, to 12,319 and 13.0% below its

high o 14,164. The S&P has been on a similar trajectory,

also up 5.92% to 1,326, or 15.3% below its October

2007 high o 1,565.

For Nelson Roberts, the energy sector has ueled a quarter

o solid market gains. The combination o economic

recovery and Middle East unrest has sent oil over $100

a barrel. Our position in Marathon Oil rose 44.7% vs.

an overall energy sector increase o 13.8%. Lindsay

Corp has also beneftted rom rising commodity prices.

As a supplier o irrigation equipment to the agriculture

industry, the demand or Lindsays products rises with

the price o crops. Lindsay is up 35.1% or the frst

quarter o 2011.

Our worst-perorming stocks or the quarter were in

technology, with Cisco (down 11.1%) and Akamai (down

21.5%) both underperorming. Akamai retrenched in

Q1 o 2011 ater the stock doubled in value in 2010.

Ciscos stock has stagnated despite announcing the

companys frst-ever dividend to shareholders. We

believe both companies will continue to beneft rom

the dramatic increase in the amount o video trafc

over the Internet.


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Fau sk

Myriad Genetics

Myriad Genetics (MYGN) is a molecular diagnostics

company ocused on developing and marketing

novel predictive medicine, personalized medicine and

prognostic medicine products. In English, this meansthat the company has or is working on products to

predict the likelihood o a person getting a disease,

products that help determine how a person will

respond to a drug and products that predict how an

individual with a particular disease will likely do in

the uture. The company aims to understand the link

between genes and human disease in order to identiy

important disease-mediating genes, the proteins they

produce and the biological pathways in which they are

involved. MYGN employs 870 people and is headquartered

in Salt Lake City.

Revenues or fscal year 2010 were $363 million. The

majority o revenues come rom the companys breast

cancer analysis (BRACAnalysis) tests. It oers seven

other commercial products, including tests or hereditarycolorectal and uterine cancer, hereditary melanoma,

tests to assess patient response to a particular

chemotherapeutic agent, a prognostic medicine

product or prostate cancer and an immunochemistry

test that looks or loss o a particular gene that suggests

a cancer will be more aggressive. Most tests are covered

by insurance and range in price rom $500 to $3,500.

In addition to researching new tests, MYGN is also

ocused on getting the word out about its current

products. The companys goal is to introduce one new

test a year and to expand rom the United States into

Western Europe over the next two years. Its products

are covered by numerous patents.

i

n t e g r i t y

Where do you fnd integrity?

It emanates rom tradition, endures market cycles, and sustains long-term

partnerships. Trust lies at the heart o what we do, how we serve and who

we employ.

[in tegr te] n. honesty, sincerity, completeness

22

21

20

2011 Bloomber Finance L. P.

OCT 15, 2010 MAR 31, 2010MYRIAD GENETICS

23

OCT 29 NOV 15 NOV 30 DEC 15 DEC 31 JAN 14 JAN 31 FEB 28 MAR 15 MAR 31

LAST PRICE

HIGH ON 12/17/10

AVERAGE

LOW ON 02/23/11

20.15

23.71

20.54%

18.00

19

24

FEB 14

DAY SESSION

18

PURCHASE 2/16/2011 @ $19.4420.15


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Fixed income

Understanding the Municipal Bond Market

The municipal bond (muni) market took a big hit during the frst quarter o 2011 as ear o deaults

caused many investors to panic and dump holdings o state and local government debt. Meredith Whitney,

a research analyst who gained notoriety in the all o 2008 by warning o Citigroups downall, predicted

in a December 2010 appearance on 60 Minutes that 50 to 100 local and state governments would deault

on billions o dollars o debt in 2011. Since that interview, record levels o money have exited munis,

causing prices to all and liquidity to dry up.

Bid-wanted activity is a measure o the volume o bonds designated or potential sale by investors. It has

grown and is now above its 12-momth average. Yet trading volumes have remained relatively low, meaning

that there are very ew buyers out there, especially or lower quality bonds. As a result, muni yields have

risen to levels not seen since the late 1990s.

Last all, prior to Meredith Whitneys interview, Nelson Roberts sold several municipal bonds. We were

concerned that liquidity was declining and headline risks were increasing as the 2011 budget discussions

heated up. We view the probability o deault on the bonds our clients currently own as quite low, since

we have adhered to our discipline o buying only high quality issues that are backed by essential service

revenues or general obligations.

Caution is certainly warranted given the current poor fnancial health o state and local governments, but

the selling renzy has been overdone. Many state and local governments have problems that will not be solved

in the immediate uture, but the vast majority will continue to make timely payments on their debt obligations.

How Do Municipal Bonds Trade?

The municipal bond market has very little transparency compared to other capital markets. Unlike the

stock market, muni bonds do not trade on an exchange, but rather through bond dealers at brokerage

frms. The brokers make money by marking bonds up and selling them to investors. The spread

between what a broker buys a bond or and what it is sold or is typically not disclosed. The only way

to know you are receiving a air deal is to shop around.

We recently put a Caliornia Water Revenue bond out or bid to eight dierent brokers (see table

below). The dierence between the high and low bids, all o which were due at the same time o

day, was over 3.5%. Naive sellers could have given up close to one years worth o interest i they had

used only one broker to sell the bond. In order to insure tight spreads and low trading costs, investors

must be knowledgeable about the inner workings o the muni bond market and have access to a

national network o brokers.

Firm Updates: : We are pleased to welcome the clients o Sylvan H. Kline Jr., Inc., who have

consented to Nelson Roberts acquisition o the frm. We are also delighted

to announce the addition o a new employee, Meg York, who came on board

two weeks ago.

Bids from eight different brokers for the same muni bond:

#1 $100.5

#2$102.7

#3$102.0

#4 $99.0

#5 $102.0

#6 $102.2

#7 $101.3

#8 $102.6


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1950 University Avenue, Suite 202

East Palo Alto, CA 94303

l 650-322-4000

b www.nelsonroberts.com

al [email protected]

Past perormance is not necessarily a guide to uture perormance. There are risks involved in investing,

including possible loss o principal. This inormation i s provided or inormational purposes only and does

not constitute a recommendation or any investment strategy, security or product described herein. Please

contact us or a complete list o portolio holdings.

For additional inormation on the services o Nelson Roberts Investment Advisors, or to receive our

Newsletters via e-mail or be removed rom our mailing list, please contact us at 650-322-4000.

2011 Nelson Roberts Investment Advisors

Molecular diagnostics is the use o DNA, RNA and proteins to test or specifc states o health or disease. Genotypes

(someones genetic make-up), mutations (changes in the normal DNA sequence) or biochemical markers can

either indicate the presence o a disease or suggest a predisposition to certain medical conditions. Many industry

observers suggest that the feld can be divided into our main areas: genetic testing, molecular oncology, inectious

disease testing and pharmacogenomics (the ancy name or personalized medicine).

Genetic testing is done to either look or specifc inherited disorders or to look or particular genetic mutations

that make it more likely that an individual with that mutation will develop a certain disease. An example o a

specifc inherited disorder is cystic fbrosis. Over 10 million Americans carry the recessive gene. A child who inherits

two copies o the gene, one rom each parent, will have the disease. Companies now oer carrier screening

to see i someone carries a copy o the gene. Myriad Genetics, our eatured stock, oers tests that predict a

high likelihood o developing certain hereditary orms o breast cancer, ovarian cancer, colon cancer and

malignant melanoma.

Molecular oncology applications include screening high-risk populations or cancer, monitoring or cancer recurrence

during treatment, and predicting prognosis or responses to certain types o cancer therapy.

In inectious disease testing, highly sensitive, rapid assays are used to look or specifc inectious agents, especiallyviruses, by detecting tiny amounts o DNA in blood or tissue samples. There are now tests available or HIV, Hepatitis

B and C, and human papilloma virus. Other tests are directed at identiying bacteria. In general, the sooner an

inectious disease is diagnosed, the sooner treatment can begin and the more likely it is that a positive outcome

will occur.

Finally, there is personalized medicine, the holy grail o drug therapy. The concept is simple: predict which

patient will respond to which medicine. Much o current therapy is based on trial and error; doctors try dierent

drugs or combinations o drugs until they see which ones work or particular people. Pharmacogenomics will

eliminate this inefcient and sometimes dangerous approach to drug therapy by identiying ahead o time who

might have negative side eects or beneft the most rom a certain medication.

This industry is expanding rapidly. Analysts estimate it will grow to $42 billion by 2019. The number o companies

has quintupled rom 100 to 500 in the last fteen years.

investment themes

Molecular Diagnostics Holds Huge Promise

Investment Team

Brooks Nelson, CFA

Brian Roberts, CFA, MBA

Steve Philpott, CFP, MBA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

Documents

1st Quarter 2011 Commentary