2nd Quarter 2007 Commentary

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Asset mANAGemeNt

Financial Market Review

end o inon

It is a widely held belie that an inverted yield curve is

a precursor to an economic recession and in act has

predicted nine o the last six recessions. This aulty logic

rang true in the most recent markets1. Beginning in the

spring o 2006 and lasting or over a year, interest rates

on short maturity treasury bonds have been higher than

longer maturities, a phenomenon known as an inverted

yield curve. This oten is a signal that investors in bond

securities believe the economy is headed or a slowdown.

Throughout the duration o the curves inversion, the

Bernanke-led Fed has been consistent in its message

that the risk o infation was greater than the risk o

a severe economic downturn. Ater eight meetings

without a change in the Fed Funds rate, bond investors

have nally stopped predicting lower interest rates. The

benchmark 10-year bond began the second quarter at

a yield o 4.64%, nearly a hal percent lower than the

90-day T-bill. The markets adjustment in bond yields to a

more normal shape resulted in the 10-year bond ending

the quarter at a 5.02% yield, slightly higher than the

T-bill rate.

The change in bond investor sentiment was not due to

increased condence in the rst term Fed chairman, but

rather increased comort that the risks that existed at the

onset o the quarter did not worsen as originally eare

These risks included a weakening domestic housing

market, extreme volatility in oreign stock markets, an

liquidity crisis concerns caused by increasing deaults

the sub-prime mortgage market. Though each o thes

risks has not been eliminated, they were trumped in t

quarter by positive corporate earnings reports.

Nw Hgh

During the quarter, 75 percent o the companies in th

S&P 500 announced increased sales growth compared

to the same period last year. More impressive is the a

that two-thirds o these companies earnings surpasse

analyst expectations2. These announcements providedpositive catalyst or the stock market.

Mergers and acquisitions (M&A) activity continue to u

market growth. Global M&A activity advanced by a

record $1.65 trillion in the second quarter, an increase

o 90 percent over last year3. The growth in private

equity rms war chests, coupled with low interest rat

has created an insatiable demand or companies with

strong cash fows and attractive valuations.

Fueled by positive quarterly earnings and M&A activit

the stock market advanced into early June as both the

Dow Jones and the S&P 500 established new all-time

highs on June 4th. The Dow Jones reached 13,676 and

the S&P 500 closed at 1,539, surpassing its previous hig

o 1,527 achieved on March 24, 2000. The strength

in the rst two months o the quarter did not carry

through the third month, but ull quarter results or

the Dow Jones o 9.1% and the S&P 500 o 6.3%

were both impressive. International and small compan

stocks continue to provide solid returns. International

secOND QUArter 2007QUARTERLYCommentary

INDEX PERFORMANCE Q2 07 YTD

Dow Jones Industrials 9.10 8.75Standard & Poors 500 6.27 6.95

EAFE (international stocks) 6.73 11.18

Russell 2000 (small stocks) 4.42 6.45

Lehman Intermediate -0.14 1.44

Lehman Municipal -0.66 0.13

Inside this Issue

Asset mANAGemeNt

: : Financial MarketReview

WeALtH mANAGemeNt

: : Health SavingsAccounts

irm perspective

: : A GraduationInspiration

www.nelsonroberts.com | 650.322.4


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During the quarter, 75 percent of the compaS&P500 announced sales growth.....two-thcompanies earnings surpassed analyst exp

5.20

5.10

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4.90

4.80

4.70

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(10 year yield up 0.38%)

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4.60

3 6 2 3 5 10 30

6/29/07

4/02/07

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2ND QUARTER 2007 TREASURY YIELD CURVE SHIFT

Bloomberg LP

Current Top

Fiteen Equity

HoldingsSchlumberger

Matthews Pacifc Tiger Fund

iShares EAFE Index Fund

Emerson Electric

Masters Select International

Goldman Sachs Group

Walgreen

Texas Instruments

Procter & Gamble

Marathon Oil

General Electric

Chevron

Intl Business Machines

Utilities Sector SPDR

Cisco Systems

stocks, represented by the EAFE Index advanced 6.73%

and small company stocks improved in the quarter by

4.42%. We continue to anticipate that international

growth will help U.S.-based companies perorm in

an environment where the U.S. economic growth

has moderated.

polal cyal Ball

Even though it is still over six months away rom thePresidential primary elections, the undraising and cam-

paign machines o a long list o potential candidates

are in ull swing. While the Republican Party has not

conceded the Oval Oce and the race appears to be

wide open, many political insiders are predicting Demo-

cratic leadership in 2009. Should a change in party

leadership occur, we expect that energy prices would

moderate, taxes would increase, and governments

spending on deense would decline. The regulatory

environment would also likely become more strin-

gent, slowing the rate o activity in the merger and

acquisition arena.

tadng Ay

During the quarter we purchased positions in Genen-

tech, Novartis, Volcano, and Graco. Genentech aug-

ments our portolio exposure to the growing biotech

industry with a robust pipeline o intriguing drugs.

Novartis, a Swiss-based pharmaceutical company,

maintains protable businesses in both the generic

and branded drug arenas. Volcano is a provider o

Intravenous Ultrasound (IVUS) equipment that has an

opportunity to become a critical diagnostic imaging to

providing doctors with inormation more valuable tha

a standard angiography in combating heart disease.

Graco is a provider o fuid handling systems and com

ponents used in a plethora o industrial and commerc

applications. We sold protable positions in Equiax,Hain Celestial, and Wellpoint. Equiaxs credit rating

business will continue to be aected by higher mort-

gage rates and weak housing. Hain Celestial, though

positioned in the attractive natural ood industry, raise

too many red fags with its option granting history an

its unwillingness to provide detailed sales data. We

exited our position in Wellpoint as we anticipate the

prot opportunity in the healthcare industry resides in

the development o drugs and equipment rather than

the administration o claims. We also trimmed our

position in Emerson Electric.

Our concerns today mirror those o the last quarter. W

closely watch the impact o a slowing housing market

on consumer spending. Nationally, housing inventorie

are currently at 8.4 months, which is at the high end

its historical range o 3-9 months4. We anticipate that

we have not yet seen a bottom in the housing market

and that we will see a gradual decline in prices rather

than a sharp and dramatic correction.

We also closely watch the debt issuance o nancial

institutions that have helped support the sub-primelending environment, as well as the debt rom com-

panies going private as they look to urther leverage

their cash fow. A lukewarm reception or either o

these types o debt oerings could be a harbinger o

signicant changes in both the equity and xed incom

markets. Currently though, these are more o a conce

than a ear and we eel that market appreciation will

match the high single digit earnings growth we expec

rom our portolio companies.

1. Federal Reserve 2. Bloomberg, LP 3. Wall Street Journal, July 2, 2007 4. Fortune, June 25,


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Bnf o eloy and eloy

Many employers are now oering HSA medical insur-

ance options as part o their benets package. To

encourage employees to utilize these lower premium

plans, employers oten make contributions on behalo their employees to help und their HSAs. Employers

reduce their monthly expenses since the premium or

these plans are typically much less than low deductible

group plans.

Employees will still benet rom the contracted rates o

their plan sponsor. They spend their HSA dollars at the

reduced rate negotiated by their HSA Plan Sponsor in-

stead o the health care providers quoted rates. It does

continue to be dicult to nd resources to access the

negotiated reimbursement rates or healthcare providersand plan sponsors.

Unlike a fexible spending account in which money

must be spent by year-end or it is lost, an HSA balance

can accumulate and roll over rom year to year. The

HSA grows tax-ree and the individual does not pay

income taxes on distributions used or qualied medical

expenses. Unlike many other tax breaks, there are no

income limits to HSAs. Anyone under age 65 who buys

a qualied high-deductible policy can open an HSA. A

new law, The Tax Relief and Health Care Act of 2006,allows a one time rollover o IRA assets to be used to

und up to one years maximum HSA contribution.

No o eyon

Health Savings Accounts are not appropriate or every-

one, but or the right situation they can help mitigate

the cost o medical care or both the employee and

the employer. Nelson Roberts Investment Advisors has

added the HSA option to its benets plan.

the

f these

tions...

i

i n t e g r i t y

WeALtH mANAGemeNt

Health Savings Accounts Highlights oHealth Saving

Accounts

Tax-avored medical

savings vehicle

Value can grow or us

uture years

Employers may

contribute on behal

o employees

www.nelsonroberts.com | 650.322.4000

Where do you nd 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 whom we employ.

Several clients have recently inquired about an increas-

ingly popular medical insurance optionThe Health

Savings Account (HSA). Both businesses and employees

are looking or ways to maximize health benets while

reducing their overall expensesa signicant challengeas the cost o health care and insurance premiums

continue to rise.

Established as part o the Medicare Modernization Act

in 2003, the Health Savings Account is a tax-avored

medical savings tool or individuals enrolled in qualied

high-deductible health plans. A plan qualies i its

deductible is at least $1,100 or an individual and

$2,200 or a amily. The HSA is similar to an IRA but

designated specically or medical expenses. Deposits

are tax-deductible and can be easily withdrawn ree otax to pay routine medical bills.

How h HsA Wok

Here is an example o how the HSA works:

Sally Smith works or an employer who oers and

pays the premium or the Blue Cross 1500 plan, a

qualied high-deductible health plan. Under the

plan, Sally pays 100% o medical costs until her an-

nual medical expenses reach $1,500. Ater Sally has

reached the $1,500 deductible in a calendar year,

Blue Cross pays 100% o health care expenses orthe remainder o the year. To pay or her potential

annual liability o $1,500, Sally can makepre-tax

contributions to her HSA which can be used to pay

or medical expenses and can be invested similar to

an IRA. Any unused portion o Sallys HSA can grow

to be used or medical costs in uture years or even

in retirement.

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


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irm perspective

A Graduation Inspirationby Brooks Nelson

We are pleased to highlight one o our neighbors in East Palo Alto who continues to

do wonderul things to improve our community. Recently I attended the commence-

ment ceremony o Eastside College Preparatory Schoolan institution committed to

providing opportunities or students historically underrepresented in higher education.The 26 graduates o the class o 2007 have all been accepted to top-tier our-year

colleges. Even more impressivenearly all o these graduates will be the rst in their

amilies to attend college. Sixty-six schools oered admission to these students including

Stanord, UC Berkeley, Columbia and Amherst, to name only a ew.

Eastside Prep is a remarkable story, rising up in a community that had not had its own

high school since 1976. It has come about through the involvement o a blue-chip

board o community volunteers and the support o the greater Peninsula community.

But none o this would have been possible without the vision and tenacity o the

ounder and principal, Chris Bischo. I rst met Chris as an opposing basketball coach

in 1997. He ran a disciplined team and instilled a strong sense o commitment and

air play, which is oten an exception today in childrens competitive sports. Little did

I know this was the very passion that led him to ound Eastside Prep.

Today, as you tour the Eastside campus, you will see newly constructed buildings

with well-supplied, spacious classrooms. This is a big contrast rom the small house

and portable trailers where the class o 2000 spent our years. The school strives to

achieve the admission o each o its graduates to a our-year college or university.

In a community with a 65% high school dropout rate, this is no easy undertaking.

However, to date, they have achieved this outstanding goal with all eight classes o

seniors who have graduated since the schools inception in 1996.

The ceremonys keynote speaker was Angelique Burton, a recent graduate o Smith

College and an alumna o the Eastside Prep class o 2003. Angeliques poignant

message urged the graduates to explore the breadth and depth o their uture

academic homes. She implored them to search out diverse people, explore unamiliar

subjects, and expand their knowledge so they too can make a signicant dierence in

the world. As a testament to the school and its leader, Angelique is pursuing graduate

studies in education and wants to work toward improving inner-city education.

Eastside Prep and Chris Bischo have accomplished so much. I encourage you to

visit www.stanord.edu, search or Shoot or the Stars, and get the ull story o

Eastsides remarkable evolution. Everyone at the schoolstudents, alumni, aculty,

sta and volunteers should be proud o what they have accomplished or our

community. Congratulations to you all!

Firm Updates: : Nelson Roberts is a proud sponsor o the Peninsula Humane Society

& SPCAs summer eventsFashion or Compassion and the MuttStrutt 2007

: : The rm surpassed $200 million in assets under management

: : Brian Roberts was selected to teach an Ethics Course or a MastersProgram through St. Marys College

2000 University Avenue, Suite 601

East Palo Alto, CA 94303

l 650-322-4000

wb www.nelsonroberts.com

al [email protected]

Kimberly Carlisle, Images o Light Photography

iNvestmeNt ADvisOrY teAm

Brooks Nelson, CFA

Brian Roberts, CFA

Stephen Philpott

For additional inormation on the services o Nelson Roberts Investme

Advisors, or to receive our Newsletters via e-mail or be removed rom

our mailing list, please contact Elizabeth Fannon at 650-322-4000 or

[email protected].

2007 Nelson Roberts Investment Advisors

CP Larson Photography

Documents

2nd Quarter 2007 Commentary