3rd Quarter 2010 Commentary

7/31/2019 3rd Quarter 2010 Commentary

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ECOnOmiC OvERviEw

The Lost Decade

Markets have remained volatile and unproductive this

year, as they have or the last ten years. The decade

began with the dot-com bust ollowed by a huge real

estate bubble-then-bust that nearly pushed the US into

a depression. In retrospect, this has truly been a Lost

Decade or investors, with stocks producing low single

digit annual returns, bond yields at historic lows and

the return on cash at zero.

We are perhaps early in calling the end o this discour-

aging period. Some proclaim that the US is doomed to

another 10 years similar to what Japan has experienced.

We disagree. On the other hand, we are not proclaiming

that happy days are here again. The end o this prolonged

period o malaise is in sight, but will take many months

to work through. The basic ingredients are nally in

place, however.

First o all, many companies are holding cash reserves

that are signicantly beyond their cash needs or

operations. Some, like Cisco and Microsot, are initiating

or raising dividends. Others are using excess cash or

mergers and acquisitions. Bank reserves have grown

rom $600 million beore the nancial crisis to over $1

trillion. With bank reserves earning less than o 1%,

it is only a matter o time until banks expand lending.

Investors cash and bond holdings are at 49.1% compared

to stock holdings, well above the long-term average

o 40%.

ThiRD QUARTER 2010QUARTERLYCommentary

nsidethis Issue

COnOmiC OvERviEw

: The Lost Decade

ASSET mAnAGEmEnT

: Equities Climb in Fitsand Starts

ixED inCOmE.....OR nOT

: The Search or

Yield Continues

EATURED STOCK

: Lindsay Corporation

nvESTmEnT ThEmES

: Water Wars?

www.nelsonroberts.com | 650.322.4

Secondly, despite much hand-wringing about defation

and the possibility o a double dip, we believe that

infation is continuing to build. Everywhere we go, we

ask: other than housing prices and interest rates, o

the things you buy every day, what has declined in

price? The unanimous reply is nothing. Investors

will begin to deploy cash as condence builds that th

world is past the worst o the crisis. Because infation

is bad or the bond market, cheap stock values will

attract cash.

Finally, the Congressional Budget Oce reports that

$818 billion o stimulus money has been spent to dat

and this has saved 3.3 million jobs. This represents

$248,000 per job saved, a clear indictment o the

stimulus plans lack o eectiveness. Despite the ailur

o the stimulus plan, the economy is orging ahead.

Corporate prots have been rising or eighteen mont

inDEx PERFORmAnCE Q310 YTD

Dow Jones Industrials 11.13 5.60

Standard & Poors 500 11.30 3.91

EAFE (international stocks) 16.57 1.64

Russell 2000 (small stocks) 11.29 9.13

Barclays Interm. Gov/Credit 2.75 7.44

Barclays Municipal 3.40 6.83


2/6

The end of this prolonged permany months to work through

top

FiFteen Holdings

iShareS intl emerging marketS

akamai technologieS

emerging aSia Pacific SPDr

Volcano corP

iShareS S&P Small caP

ciSco SyStemS

oracle corP

iShareS eafe inDex

Paychex

emerSon electric

cheVron corP

3m comPany

royal Dutch Shell

coStco

Varian meDical

ECOnOmiC OvERviEw

The Lost Decade (contd)

As David Brooks put it in his September 24 New York

Times editorial:

When you listen careully, you notice the public ange

doesnt quite match the political class anger. The politic

class is angry about ideological things: bloated govern

ment or the predatory rich. The public seems to be ang

about values. The heart o any moral system is the

connection between action and consequences. Today

public anger rises rom the belie that this connection

has been severed in one realm ater another. What

the country is really looking or is a restoration o

responsibility. I some smart leader is going to help us

get out o ideological gridlock, that leader will reram

politics around this end.

When this occurs, we will once again have a positive

environment or solid and sustainable economic grow

We look orward to the end o the Lost Decade.

Two years o do more, spend more and borrow

more government policies have led to growing voter

dissatisaction. Political rhetoric is shrill and respect or

the opposing viewpoint is non-existent. Voters, exhibitingmuch more sense than Congress, realize that ederal

debt and decits have to come down and the country

needs to come to grips with entitlements o all ilks,

rom Social Security to Medicare to pension obligations.

We view this political divisiveness as historically the rule

rather than the exception. Our country has a long history

o a undamental tension between what began as the

Federalist/Anti-Federalist argument. This argument is

embodied in the current rise o the Tea Party Republicans

against the incumbent Democrats. We can despair

about the lack o bipartisanship and lament the mostradical elements o each group. However, we observe

that neither o these are in sync with the majority in

the middle. We are optimistic that the growing sense

o public outrage regarding the lack o responsible

decision-making will culminate in material changes.

DOW JONES INDUSTRIAL INDEX

10000

9000

8000

7000

6000

2010 Bloomberg Finance L. P.

January 1, 2000 - December 31, 2009

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

11000

12000

130000

140000

From 2000 to 2009,the stock market returned 1.3% annually

10428

10-year average


3/6

f malaise is in sight, but will take

ASSET mAnAGEmEnT

Equities Climb in Fits and Starts

Stock market indices have again fuctuated dramatically

in the third quarter as the markets tried to get a x on

the defation/infation probabilities. However, at least at

this time, the markets look to be on the rickety climbupward on this years roller coaster ride. At quarters

end, the DJIA had

recovered rom its second

quarter drop and was

up 5.6% or the year.

The S&P 500 has also

rebounded and is now

up 3.9%. We ended the

quarter with just 3.8%

o our equity allocation in

cash, refecting our belie

that equities are oeringattractive returns.

In late August, we exited

a protable position in

Corn Products (tkr: CPO).

We initiated our holding

o CPO in the spring o

2009 when the stock had allen dramatically in step with

the decline in corn prices. The P/E ratio had plummeted

to 5x earnings. We thought that the stock would benet

rom the stabilization o revenues and a better-dened

strategy. The P/E did recover and we sold our position.

Using the proceeds rom the sale, we doubled our

position in Power Integrations (tkr: POWI). We high-

lighted POWI and its energy ecient power conversion

technology in our third quarter 2009 commentary.

The company is relatively small as measured by market

capitalization, but we continue to have condence that

the companys products will benet rom increasing

government standards or power eciency in consumer

products as well as the transition to LED (light-emitting

diode) lighting solutions. We took advantage o a

temporary dip in the price to increase our holdings.

Earlier in the quarter we swapped holdings in

international stocks, ater concluding that the broader

Asia-Pacic region oered better opportunities or

growth than Japan, which is still struggling with itseconomic recovery. The Emerging Asia Pacic

SPDR (tkr: GMF) is one o the tools we use to hold

non-US investments in our equity portolios. The largest

geographic holdings include China, Taiwan and India,

all economies with impressive growth prospects.

The most recent earnings cycle conrmed our belie

that the longer-term returns in the equity markets

will be attractive. The volatility o the markets and the

continued debate about infation vs. defation suggest

that we are not completely out o the woods. However,

while the market remains range-bound, the component

companies o the broad market indices are improving

their balance sheets while strengthening their revenues

and earnings opportunities. The improved valuations o

these companies will ultimately lead to returns in line

with historical expectations.

10

0

-10

-20

-30


2004 2005 2006 2007 2008 2009

20

30

37

US CORPORATE PROFITS, 2003-2010

2010

JANUARY 1, 2003 - OCTOBER 1, 2010

40


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FixED inCOmE.....OR nOT

The Search or Yield Continues

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STOCK YIELD VS. BOND YIELD

0.5

1

1.5

2

2.5

3

3.5

%

Yield

Dow Jones Yield

5 yr US Treasury Yield

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

In contrast to the wild swings o the stock market this

quarter, the bond market has been relatively stable.

Interest rates remained at record-setting low levels.

Despite these remarkably low rates, investors continuedto pour enormous amounts o money into the bond

market. Demand or yield has been so strong that

numerous US companies successully issued debt at

yields lower than the dividend rates they are paying

to their common stockholders.

Low interest rates in the bond market refect concern

over the risk o defation, high levels o sovereign debt

and the underlying ear that we could experience

another large decline in the stock market. Many investors

are electing to put their money into bonds because

their memories o recent stock market declines are too

painul and too resh. They would rather take lower

investment returns and have the comort o knowing

their principal is secure. From January to the end o

August o 2010, approximately $200 billion fowed into

the bond market, compared to the roughly $42 billion

that fowed out o the stock market. These are staggering

numbers, particularly considering that a 5-year Treasury

is yielding 1.25%.

Many US companies are taking advantage o this

opportunity to access cheap capital by issuing debt

and locking in low interest rates. Microsot recently sold

almost $5 billion in debt with our dierent maturities.

The maturities ranged rom three years to thirty years.

$1 billion o 3-year debt was sold at 0.88%, or 0.25%

more than a 3-year US Treasury. The 5-year note sold or

1.63%, or 0.40% over Treasuries. These are remarkably

low levels considering that Microsots dividend yield is

currently 2.6%. Another example is IBM, which success-

ully issued 3-year notes at 1.0%, while its stock pays

out a 2.0% dividend.

The average dividend yield o the DJIA is 2.5% while

the broader S&P 500 Index has a 2.0% yield. We have

made a concerted eort to choose strong companies

with high dividend yields, such as Verizon (6.0%), RoyalDutch (5.9%), Paychex (4.6%) and Diageo (4.2%).

Investors do need to beware o high dividend yields on

stocks that are declining in price. As stock prices all,

dividend yields increase. An exceptionally high yield

may refect a company in trouble, with an unsustainable

dividend payout.

For investors dependent on interest payments or income,

the search or yield in the xed income market has

been rustrating. High quality stocks present an oppor-

tunity to generate income when the companies issuing

them combine high dividend yields with strong balance

sheets and consistent cash fow.


5/6


: : For twenty years governors have been lying to you about the kind o benets

they can provide you. Im the rst guy whos telling the truth, which is i we

dont do these reorms, we are going to wind up with you not having a pension

in 10 or 15 years.

New Jersey Governor Chris Christie,speaking at the frefghters convention

FEATURED STOCK

Lindsay Corporation

$40.00

$38.00

$36.00

$34.00

$32.00


February 1, 2010 September 30, 2010

FEB 12 FEB 26 MAR 15 MAR 31 APR 15 APR 30 MAY 14 MAY 28 JUN 30 JUL 15 JUL 30

$42.00

$44.00

2010

$43.32

JUN 15 AUG 16 AUG 31 SEP 15 SEP 30

DAY SESSIONLAST PRICE

HIGH ON 09/29/10

AVERAGE

LOW ON 07/06/10

43.32

44.28

37.65

31.44

LNN EQUITY GP

One o the companies oering an investment in water eciency is Lindsay Corporation (tkr: LNN). Lindsay

has two major business divisions: irrigation equipment (75% o revenues) and moveable road construction

inrastructure (25% o revenues). Company revenues or 2009 were $336M, coming o a high o over

$400M the previous year. Last years results refected armers caution about capital investment in view o

the overall state o the economy, but revenues in 2010 are recovering nicely.

World-wide, 17% o agricultural land is irrigated; however irrigated cropland produces 40% o the worlds

ood. Flood, or gravity irrigation, uses twice as much water as mechanized irrigation, and crop yields are

signicantly lower. Flood irrigation also increases runo o ertilizers and pesticides. LNNs irrigation equipment

delivers both water and agricultural chemicals close to the ground, directly onto the plants. The majority

o LNNs sales are o pivot irrigators, the machines that create the big green circles in the western plains.

In 2008, or the rst time, more acres (46%) were irrigated by ecient pivots and laterals than by any

other method.

LNN derives its revenues rom conversion o dry land to irrigated land, conversion rom less ecient to

more ecient irrigation methods, and sales o replacement systems and parts. As we discuss in the article

about water on page 6, the population is growing, more ood needs to be grown to eed the additional

people, and water has to be careully and eciently used. This is why LNN appears regularly on the Best

Small Companies lists.


6/6

1950 University Avenue, Suite 202

East Palo Alto, CA 94303

tel 650-322-4000

eb www.nelsonroberts.com

eal [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.

2010 Nelson Roberts Investment Advisors

Water is increasingly being described as the next scarce resource. A special report in The Economistin June, 2010,

provided some ascinating and alarming inormation. The root cause o water scarcity is the continuing growth o

the worlds population. In 1950, 2.5 billion people lived on the planet. In 2010, this gure is almost 7 billion. By

2050, it is projected to be 9 billion. The green revolution (higher crop yield per acre), decreased inant mortality

and improved sanitation and healthcare in much o the world have all led to longer lie expectancy. As a result,the amount o water used or arming has grown by a actor o three. As recently as 60 years ago, only 8% o

the worlds population was chronically short o water; by the turn o the 21st century, the percentage stood at 45%.

There are two major uses o water in addition to arming: industrial and domestic. 70% o world water is used

or agriculture, 22% or industry and 8% domestically. In developed countries, these numbers are almost reversed:

60% o water goes to industry, about 33% to agriculture and 11% to domestic use. Industrial use o water is

growing twice as ast as agricultural use. Big industrial users include power plants (cooling), companies drilling or

and extracting oil, and manuacturers o petroleum products.

An astonishing 60% o resh water is ound in only nine countries. China and India, with 1/3 o the worlds

population, have less than 10% o the worlds resh water. Fresh is o course the key word. 97% o the Earths

water is salty. O the remaining 3%, 70% is rozen, which leaves just under 1% or all living creatures outside the

ocean. Most resh water is stored in aquiers and alls as rain through the water cycle. Because water is heavy andthereore expensive to move, it is extracted locally. In many locations, it is being drawn rom aquiers aster than it

can be replaced.

Humans need, on average, 2 liters o water a day to sustain their bodies. The water must also be clean. Dirty

or contaminated water causes poor health rom intestinal illness. This in turn leads to malnutrition, resulting in

a population that is too ill to improve its economic output. Hygiene and protected storage or clean water are

essential to improving sanitation and health in poorer countries.

There is growing awareness o the need to conserve water. To do this eectively, however, the big water users,

agriculture and industry, have to be engaged. This is starting to happen. (See our article on Lindsay Corporation

on page 5.) In recent years, the ratio o GDP (which is growing) to water use (which is declining) has improved

signicantly. Companies such as Nestle have committed to decreasing their water use by up to 1/3 over the next

ve years. We believe that the investment theme o ecient water use will be increasingly important in the next

decade and will be looking or companies oering products that support this need.

invESTmEnT ThEmES

Water Wars?

Investment Team

Brooks Nelson, CFA

Brian Roberts, CFA, MBA

Steve Philpott, CFP, MBA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

Documents

3rd Quarter 2010 Commentary