3rd Quarter 2009 Commentary

7/31/2019 3rd Quarter 2009 Commentary

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AssET MANAGEMENT

Equity Market Activity

In the third quarter, the market continued to climb awall o worry. This old saying reers to the tendency

or a rising market to make gains even in the ace o the

problems and worries o the day. Ater declining or six

quarters in a row (through March 31st, 2009), the S&P

bounced 16% in the second quarter ater losing 11%

in the rst. These positive results continued in the third

quarter as the index rose another 15%.

We made signicant progress in putting our cash to

work during the quarter. We swapped our Pepsi or

Diageo the rst o July. Our view is that the carbonated

sot drink and bottled water business is going to be atough place to make money over the next year or two.

Mid-range alcoholic beverages will continue to be in

demand almost regardless o the economic environment and

Diageo pays a 4.7% dividend. We exited a Medtronic

position in mid-July ater concluding that the company

is too embroiled in the controversy surrounding

consulting payments made to physicians who use the

companys products. Becton- Dickinson declined to

a near-term low shortly thereater so we decided to

double our position in early August at about $65. We

received a nice git when Krat announced an inormalbid or Cadbury. The shares we bought in mid-April at

$31 closed at $51 at the end o the third quarter. Inter-

estingly, the reason that Krat gave or their oer was

largely the same one that we used when we decided to

THIRD QUARTER 2009QUARTERLYCommentary

Inside this Issue

AssET MANAGEMENT

: : Equity Market Activity

FEATURED sTOCk

: : Power Integrations(POWI)

OUTLOOk

: : What Shape are

We In?

FIXED INCOME

: : The Search or

Yield Continues

WEALTH MANAGEMENT

: : Moving Parts

www.nelsonroberts.com | 650.322.4

buy the stock. This rationale was Cadburys strengthin emerging markets. We were especially struck that

over hal the people in India had never tasted chocolat

and Cadbury was making serious inroads into that

market. When it became clear that there would not be

a bidding war or Cadbury, we elected to take our

handsome prot.

The TJ Maxx we bought in January has nearly doubled

and is very close to reaching the price at which we

plan to sell the shares. The stocks rise has been large

an expansion o its valuation multiple. Earnings have

increased slightly, but the Price/Earnings ratio hasrisen rom below 10 to nearly 20.

INDEX PERFORMANCE Q309 YTD

Dow Jones Industrials 15.77 13.52

Standard & Poors 500 15.57 19.27

EAFE (international stocks) 19.51 29.16

Russell 2000 (small stocks) 19.26 22.41

Barclays Interm. Gov/Credit 3.25 4.92

Barclays Municipal 7.12 14.00


2/6

We think that the recovery will mthat is, a strong bounce off the bott

top

FiFteen Holdings

CisCo systems

ishares eaFe index Fund

ishares s&P small CaP index

adobe systems

masters seleCt intl Fund

Chevron

Fastenal

tJx ComPanies

Gilead sCienCes

oraCle

CostCo Wholesale

sChlumberGer

3m

intl business maChines

beCton diCkinson

Our current shopping list includes Nucor, Lindsay Corp.

and AAON. Lindsay makes circular pivot irrigation systems,

which create those green circles we see when fying

over the western U.S. Their products improve agricul-

tural productivity while conserving water. The water is

delivered much closer to the ground and thereore less

is lost to evaporation. The irrigation systems can also

be used to deliver liquid ertilizer. Once again, because

the design is so ecient, less ertilizer is required. (Seealso comments in What Shape Are We In? on page 4

regarding uture trends.)

AAON makes commercial (or large buildings) air condi-

tioning systems, which are very energy-ecient. In act,

this companys research and development is specically

ocused on gaining energy eciency. AAON is also a

leading choice or the commercial air conditioner

replacement market. Their market niche is higher

quality units which are usually what businesses shop

when the initial lower cost, lower quality original air

conditioners die. Nucor is the best steel company in th

U.S. and a stock we have held in the past. The company

the most ecient producer o steel because it uses elec

tricity rather than coal-based power. This allows Nucor quickly change production volume and product type. W

are also considering adding to our holdings in Disney, Co

Products and Dynamic Materials. Our overall equi

cash position is 11% and we anticipate reducing th

below 5% on any market pullback beore year-end.

Equity Market Activity Contd

PRICE CHART

180

160

140

120

100

80

January 1, 2009 - September 30, 2009

JAN 2009 FEB 2009 MAR 2009 APR 2009 MAY 2009 JUN 2009 JUL 2009 AUG 2009 SEP 2009

TJX USCBY USBDX USDEO US

TJ Maxx purchase Kraft announces desireto acquire Cadbury

Diageo purchaseBecton Dickinson

purchase


3/6

ikely be square root sign shaped....llowed by a period of low-growth malaise.

Power Integrations designs, develops, and markets

analog integrated circuits or use in alternating current

(AC) to direct current (DC) power conversion. More

simply, POWI, using a silicon microchip, takes the powerrom the wall outlet and converts it to power usable by

consumer electronics.

The Power Integrations microchip is a superior solution

or several reasons. First o all, it allows the end device

to use energy more eciently, particularly by reducing

energy drain during downtime by as much as 75%.

Second, an integrated silicon solution allows a substantial

reduction in the labor required or manuacturing.

Finally, the ENERGY STAR program in the U.S. is setting

new energy eciency standards or manuacturers o

consumer electronics. In Europe, the EcoDesign standards

are also becoming more strict. These more stringentstandards will drive increased demand or the type o

solutions Power Integrations provides.

We believe that the increase in demand will benet

Power Integrations and that this will be refected in a

growth in the stock price. The company has rewarded

shareholders in the last twelve months by announcing

its rst dividend. This refects well on the company and

its desire to return some o its cash fow to investors,

even in this dicult economic environment.

POWI PRICE CHART

35

30

25

20

15

2009 Bloomberg Finance L. P.

June 30, 2008 - September 30, 2009

JUL 31 AUG 29 SEP 30 OCT 31 NOV 28 DEC 31 JAN 30 FEB 27 MAR 31 APR 30 MAY 29 JUN 30 JUL 30 AUG 31 SEP 30

2008 2009

FEATURED sTOCk

Power Integrations (POWI)


4/6


What shape are we in? Economists are debating whether

this will be a V shaped recovery like we had ater the

bottom in 2002 or a W shaped recovery like we had

during the 1980-82 recession. We think that it is actuallymost likely to be a square root shaped recovery. By

this, we mean that there will be a strong bounce o the

bottom ollowed by a period o low-growth malaise.

To prevent economic Armageddon, the Federal Reserve

stepped in last all with a potpourri o bailout programs

and a huge monetary stimulus. Now that the Fed believes

the recession is easing, it is starting to ratchet these

programs back. The consumers borrow and spend habits

that preceded last alls crisis are unlikely to resume in the

oreseeable uture. The consequences o this consumer

caution in the ace o a declining Federal stimulus willbe a mild and weak economic recovery.

The Good: Some recent signs are now clearly pointing

to recovery. The Purchasing Managers Survey showed

that orders rom businesses are rising. The University

o Michigan Consumer Condence survey also demon-

strated substantial improvement. The monthly change

in Non-Farm Payrolls hit a high o 741,000 jobs lost in

January and has since improved to only 200,000 jobs

lost in August. Lastly, pending home sales, which had

declined over 20% a year ago, have risen 10% in the

most recent report.

The Bad: Infation expectations have rebounded rom

the -0.5% lows last December to about 1.5% today.

However, this is still below the 2.25-2.50% range we

saw in June 2008. Defation is still the biggest single

threat to the economy, and until this risk is completely

gone, the Fed is not likely to increase interest rates.

Stock valuations concern us. From the March low o 10

times earnings, we have seen stock prices rise by over50% without a commensurate rise in earnings. The ew

companies that have actually reported modest increases

in earnings have largely accomplished this increase by

cutting expenses. This is not sustainable.

The Unknown: Prior periods o economic malaise ended

with the advent o some major innovation. The denitive

end o the infation-plagued, no-growth 1970s coincided

with the 1982 introduction o the PC. The mid-90s

slowdown, though mild, ended with the astonishing

prolieration o the Internet. We see no signs o a lie-

changing innovation on the horizon; however, we are

optimistic that the U.S. will successully innovate again.

Potential new external economic drivers include:

1. Green Technology especially i an alternative to the

internal combustion engine is ound.

2. Nanotechnology broad applications in many areas

o the economy including healthcare, inormation

technology and manuacturing.

3. Biotechnology has taken longer than many thought

to begin to ulll its promise, but the speed oinnovation is accelerating.

4. Resource conservation continued world-wide popu-

lation growth increases demand or clean water,

ood, energy and other natural resources. Experts

estimate that with current technology alone, 30%

o our total energy costs could be eliminated.

What is money?

At its simplest, it remains a orm o barter, an exchange o energy or goods.

At its most complex, its a symbol o mastery, a measure o power. At its center

are people with vision, talent, skill, amilies, children, hope and dreams.Vv i s i o n

[vizh en] n. the ability to perceive or foresee through mental acuteness

OUTLOOk

What Shape are We In? The Good, the Bad and the Unknown


5/6


Firm Updates: : We are pleased to announce that Steve Philpott has successully completed

the Certied Financial Planner certication process and has been authorized

to use the CFP certication mark. The certication process required that

Steve meet the certication requirements o Education, Examination,

Experience, and Ethics. Congratulations to Steve.

Investors looking to the bond market or yield continue to be disappointed. Demand or high quality bonds

is outstripping supply as shocks in the equity markets over the last 12 months have sharply limited investors

appetite or risk. Cash has poured into xed income, causing bond prices to rally and yields to trend

downward. In addition, the Federal Reserve alone has purchased $1.75 trillion o debt and stated at its

September 25th meeting that it has no intention o raising rates anytime soon. Although the central banksaw signs o economic improvement in the U.S., the decision was to maintain ederal unds at exceptionally

low levels to ensure that economic improvement will not be derailed.

Low interest rates have helped both corporations and individuals. Corporations have been able to borrow

cheaply to strengthen their balance sheets and individuals have renanced variable rate mortgages and converted

them to more predictable long-term loans. On the other hand, low rates are detrimental to those who are net

savers and need to generate income. According to Bloomberg, money market und rates dropped to a 42-year

low last month. Tax-exempt money unds are yielding, on average, 0.06%, while taxable unds yield less

than 0.10%. The 90-day T-bill and 10-year T-note closed the quarter at 0.11% and 3.31%, respectively.

Investors desperate search or yield was recently on display as Caliornia sold $8.8 billion o debt, the second

largest municipal deal ever (according to Thompson Reuters). The short-term debt oering, with maturities inMay and June o 2010, had yields ranging rom 1.25% to 1.50%. The deal was oversubscribed (more buyers

than bonds available). This was ascinating, since just a ew months ago, many bondholders were concerned

that Caliornia would not be able to make its general obligation debt payments and would need to issue

IOUs instead.

It is more important than ever to maintain discipline in this low-interest rate environment. We do this by:

1. Focusing on high quality credit and avoiding the temptation o higher-yielding, but much lower quality

bonds. Investors may not be compensated or the risk they are taking with lower quality bonds, because

returns will likely come rom yield rather than rom price appreciation.

2. Keeping durations short and staying away rom long maturities. With rates at historical lows, signicantlosses will occur when interest rates move higher.

3. Being patient. Interest rate orecasting is always dicult, but we are in the early stages o an economic

recovery and interest rates will reverse course at some point.

FIXED INCOME

The Search or Yield Continues

The Nelson Roberts Investment Advisors quarterly commentary will be available electronically in future quarters. If

you would like to continue to receive this piece in hard copy, please contact Tien Tran at [email protected]


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East Palo Alto, CA 94303

tel 650-322-4000

web www.nelsonroberts.com

email [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.

2009 Nelson Roberts Investment Advisors

The American Recovery and Reinvestment Act o 2009

has dominated headlines due to both its size ($787

billion) and the debate about its eectiveness. Lost

in the shufe has been the aging o the Economic

Growth and Tax Relie Reconciliation Act o 2001(EGTRRA). This legislation made signicant changes in

key areas o the U.S. tax code. It was also written so

that many o those provisions would sunset on January

1, 2011, causing a reversion to laws in orce prior to

passage o the Act. A year ago, we wrote about the

changes planned or 2009 as a result o this legislation.

As we head into the nal quarter o 2009, these changes

are worth reviewing.

1. Estate Tax Exemption Increase: In 2009, the total

amount o assets that an individual upon death can

pass to a non-spouse beneciary without paying estateand generation-skipping transer taxes is $3.5 million

per taxpayer, with a 45% tax rate or amounts above

the exemption. Under provisions o the EGTRRA, the

estate and generation-skipping transer tax will be

completely repealed in 2010, only to return in 2011

to the 2001 rate o a $1.0 million exemption and a

55% tax rate on amounts above that.

Congress is expected to be occupied this all with the

healthcare reorm bill and thereore is not expected

to address the need or broader tax reorm until 2010.

Most observers believe that the most likely outcome

is a one-year extension o the 2009 rates in an eort

to avoid the scheduled repeal in 2010.

2. Required Minimum Distribution Relaxed: On December

23, 2008, President Bush signed the Worker, Retiree,

and Employer Recovery Act o 2008. One o the

main provisions o this act was to eliminate the required

minimum distribution (RMD) or the 2009 tax year.

The RMD aects retirement account holders over

70 1/2 years o age. In the event that a RMD was

taken, the taxpayer has until November 30, 2009

to roll the distribution to another plan to avoid

paying income taxes on the distribution.

3. Conforming Loan Adjustment: The San Francisco

Bay Area qualies as an area o high cost housing

and saw an increase in the conorming loan amounts.

Conorming loans are those that total up to $729,

750 in most SF Bay Area counties. Mortgage rates

on loans at or below this value have remained low.In addition, the stabilization o many banks has

caused rates or mortgage amounts above conorming

limits to decline dramatically.

4. Charitable Distributions Direct from an IRA: An IRA

holder who has reached the age o eligibility (59)

can still make a distribution directly rom an IRA

account to a qualied charity or the balance o

calendar year 2009. With an IRA git to charity,

the IRA holders Adjusted Gross Income (AGI) is not

increased as would occur with a regular distribution.

Ask us or more inormation.

WEALTH MANAGEMENT

Moving Parts

Investment Team

Brooks Nelson, CFA

Brian Roberts, CFA, MBA

Steve Philpott, CFP, MBA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

Documents

3rd Quarter 2009 Commentary