3rd Quarter 2011 Commentary

7/31/2019 3rd Quarter 2011 Commentary

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The Era of the Sovereign Debt Crisis

History books will call this era the Sovereign Debt

Crisis. In the last two months, the focus has shifted

from the US governments debt limit and credit rating

downgrade to daily reports of the markets concern

about a possible default by the government of Greece.

The US debt limit debate and the European debt

situation are rooted in the fundamental problem that

governments world-wide are wrestling with: govern-

ment payouts for retirement and healthcare are rising

and will soon be unsustainable. Most developedcountries have birthrates that are just high enough

to maintain current population levels and medical

advances are increasing average lifespan. Consequently,

the ranks of the retired are rising as a percentage of

the total population. Because people use more health-

care services as they age, healthcare costs are increasing

at twice the rate of current economic growth.

During this time of rapidly rising benet costs, economic

malaise is reducing governments revenues, exacer-

bating the problem and adding urgency to the need

to address it. In the US, politicians are continuing to

dodge the hard decisions that must be made. No one

wants to be the first to propose legislation to slow

the growth of Social Security and Medicare spending,

despite good bipartisan commission reports that map

out a sensible approach.

hrd qurr 2011QUARTERLYCommentary

nsidethis Issue

conomc ovrv

: The Era of the

Sovereign Debt Crisis

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: What Do You Buy in

This Environment?

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: US Downgrade

in Perspective

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: Verizon Commun-

ications, Inc.

nvsmn hms

: Nanotechnology

www.nelsonroberts.com | 650.322.4

Greece has waited too long, been too generous wit

its benets and lied about its borrowings. Greece

reminds us of the star athlete who constantly violate

team rules because he knows the coach cant afford

to kick him off the team. This is a country that claim

to have adopted nancial austerity yet res no governme

employees. Financial reporting from Greece is suspect

best and false at worst. The Greeks just keep borrowi

money with essentially no intention of changing the

ways or paying it back. Now the country is widely

expected to default on its debt obligations. But how

can a country equal in population to Los Angeles

County with an economy the size of Wisconsins be

threatening world nancial stability? Why doesnt th

EU just kick Greece out and force that countrys leade

to decide what to do?

ndx PrFormnc q311 yd

Dow Jones Industrials -11.50 -3.92

Standard & Poors 500 -13.87 -8.69

EAFE (international stocks) -18.91 -14.59

Russell 2000 (small stocks) -21.86 -17.02

Barclays Interm. Gov/Credit 2.39 4.92

Barclays Municipal 3.82 8.40


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are born in pessimism, grow in skepticism,We think pessimism is nearing an apogee.

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What Do You Buy in This Environment?

ultimately reect the intrinsic value and performance of

each company. This value is increasingly attractive. Stock

dividends now exceed the return on a 10-year Treasury

notes and are growing.

We have therefore added to the positions we hold

in Diageo, Verizon (see featured stock on page 5)

and XLU . Diageo has a 4.22% dividend yield, Verizon

pays 5.40% and XLU 3.98%. We continue to research

companies that are industry leaders, nancially strong

and pay solid dividends.

It is impossible to know when the fear that is currently

gripping the market will ease. While we are waiting,

rational market participants (like us) will focus on

company fundamentals and be diligent in our research

and patient in our approach.

In our rst half commentaries this year, we wrote that

we were concerned about ination and the negative

effect it would have on interest rates and bond prices.

We also said that the market would experience an

increase in the aggregate value of stocks that matched

the rate of earnings growth from corporations. Instead,

despite increased ination (the CPI has risen from 1.5%

to 3.8% and the PPI has increased from 3.8% to 6.5%),

interest rates have fallen, dropping to a 1.9% yield on

a 10-year Treasury note. And the stock market has

declined 8.7% in the face of strong corporate earnings

and prot growth of 14.4% for the S&P 500. The

stocks of small companies have been hit even harder,

now down 17.0% since the beginning of 2011.

What is going on here? The market is not trading on

the fundamentals of individual corporations but rather

on the concerns about US domestic growth and the

unknown implications of a potential debt default in

Greece. In such a fearful environment, good company

performance does not seem to matter. Irrational behavior

is everywhere. For example, Varian Medical (VAR)

reported record sales and prots and a growing market

share in a growing world-wide market last quarter. On

this news, the stock has dropped 26%.

Investing in a market that behaves more or less rationally

is challenging enough; participating in one that is

irrational frustrates everyone. Despite our frustrations,

however, we are condent that the stock market will

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January 15, 1971 September 30, 2011

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US Downgrade in Perspective

The recent downgrade of the US debt rating by Standard

and Poors marked the first time in the nations

post-World War II history that the US has not held the

highest rating of AAA. Prior to that, ratings agencies

did not exist. The change has raised concerns that the

US dollar is in jeopardy of losing its status as the worlds

reserve currency and several countries have called for a

new global currency. However, the fact is that the US

remains the most stable economic global power and as

a result the dollar will continue as the reserve currency

for the foreseeable future.

Sovereign country credit downgrades are not as unusual

as people might think. Nine sovereign borrowers have

lost their AAA rating since 1998. Spain lost its top ratingin 1990, regained it, only to lose it again in 2009. Japan

lost its AAA rating in 2001 but has never regained it.

Canada and Australia were both downgraded, but

were able to regain AAA status after several years of

scal discipline. There are currently fourteen countries

with AAA ratings, although four are under credit

watch, meaning a rate cut could be pending.

On the rst trading day after the US downgrade was

announced August 5th, the yield on the 10-year Treasury

note fell from 2.55% to 2.31%. The market was not

concerned that the US would have difculty paying its

bills or making interest payments. If that were the case,

interest rates would have risen as investors demanded

higher yields for the increased risk. The downgrade was

based on skepticism that Washington policy makers

would actually make signicant progress on reducing

the decit, given the acrimony we witnessed during the

debt ceiling debate.

The US government cannot continue to borrow money

the way it has been and this country will certainly have

issues with debt as long as major policy directions for

taxes and entitlement spending are unresolved. In

2001, the US dollar made up approximately 70% of

all foreign exchange reserves around the world. Today,

that gure is down to about 60%. This compares to the

euro at 26.6%, the next largest reserve currency and

one that certainly has its own problems. The day when

the world decides that the dollar is not a safe place todeposit money may arrive, but it will not be anytime soon.

What is money?

At its simplest, it remains a form of barter, an exchange of energy for goods.

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

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

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

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h crd rnGs By s&P

Australia Hong Kong

Austria Netherlands

Canada Norway

Denmark Singapore

Finland Sweden

France Switzerland

Germany United Kingdom


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Furd quy

Verizon Communications, Inc.

Verizon is the market leader in a growing and very protable business. For nearly a decade it has been

our sole holding in the telecommunications industry. The shares pay a 5.40% dividend and are only half as

volatile as the S&P 500 index. In a world where money market funds pay 0.01%, it is a stock we love to own.

Verizon is a huge business. 2010 revenues were nearly $107 billion and the company employs 196,000

people. It sounds like an elephant-sized, stodgy corporation, but it is not. What is most remarkable about

Verizon is its ability to evolve and transform itself in an industry that is changing at a dizzying pace.

Verizon was formed in 2000 when GTE and Bell Atlantic merged. At the time, the combined company

had $70 billion in revenues, 53% of which came from the wireline or POTS (plain old telephone service)

business. POTS is going the way of the buggy whip. Most of our children will never have a traditional

telephone line. Today just 15% of Verizons revenue comes from POTS. The rest comes from the best cell

phone service in the US and from FiOS, Verizons ber optic broadband internet and TV network. FiOS

service provides customers with ber optic cable all the way to the TVs and computers in their homes.

This service gives unrivaled speed and quality.

The proliferation of smart phone and tablet devices such as the iPhone, Blackberry, and iPad and the

migration of databases to the cloud (storing information over the internet instead of keeping it on the

hard drive of the computer on your desk) point to the continued growth of wireless and broadband

communications. As the leading high quality provider of these services, Verizons growth seems assured.

Firm Update: : We are pleased to announce the addition of a new employee, Edwina Tran,

who joined the rm in July as a portfolio managers assistant. A recent graduate

of the University of California Davis, with a degree in Managerial Economics,

Edwina has returned to the Bay Area to launch a career in investment management.

2004 2010

Revenue $70 billion $107 billion

% Wireline 53% 15%

% Wireless 40% 63%

% FiOS/Strategic 0% 14%

% Other 7% 8%

Local Lines 55 million 26 million

Cell Phone Customers 40 million 106 million


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1950 University Avenue, Suite 202

East Palo Alto, CA 94303

tel 650-322-4000

web www.nelsonroberts.com

eail [email protected]

Past performance is not necessarily a guide to future performance. There are risks involved in investing,

including possible loss of principal. This information i s provided for informational purposes only and does

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

contact us for a complete list of portfolio holdings.

For additional information on the services of Nelson Roberts Investment Advisors, or to receive our

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

2011 Nelson Roberts Investment Advisors

For those of you of a certain age, nano may be one of the words you recall Mork saying to Mindy. However, it is in

fact one-billionth of something and is most often used to refer to one-billionth of a meter. Nanotechnology is the

development and manufacture of materials at the nanometer (nm) scale. To get an idea of how small a nanometer is,

a virus is about 50-100 nm in diameter. A single hemoglobin molecule is 30 nm wide. There are two reasons that we

are hearing so much about nanotechnology now: materials can be reliably made at the nano scale (that is, they aremanufacturable and reproducible) and the tools to see nanoparticles are available and getting better all the time.

Current predictions are that nanotech materials will be incorporated in more than 50% of new products by 2015.

Moreover, 15% of all global goods will have some type of nanomaterials in them, which represents a $3 trillion market.

There are four key features of nanomaterials that are driving this market:

1. Nanoparticles are tiny, which means that a lot of them can be packed into a small space.

2. Nanoparticles have a large surface-to-volume ratio, so there are a lot of atoms on the surface and the

surfaces can be used to carry other substances or interact with other molecules in a certain way. Moreover,

surface forces dominate over bulk forces (like gravity) and this allows particles to stay in solution indenitely.

3. The wavelength of visible light is greater than the radius of nanoscale structures, so light scatters and diffracts

when interacting with them.

4. Nanoparticles exhibit unique chemical bonding properties (for example, the type of carbon-carbon bonding

seen in buckyballs and carbon nanotubes does not occur at the macro level). As a result, nanomaterials have

physical properties such as incredible strength but very low weight. Pound for pound, carbon nanotubes are

stronger than steel.

Industries in which nanotechnology is already playing a role include medicine, sporting goods, clothing, cosmetics,

appliances and electronics. In medicine, silver nanoparticle-impregnated bandages are being used to decrease infection.

Baseball bats, golf balls, tennis rackets, skis, and bicycles are all benetting from the much greater structural strength

and lighter weight of carbon nanobers and carbon nanotubes. In microelectronics, nanotechnology is being used

every day to make the smallest transistors. Manufacturers may soon understand how to create self-assembling transistors,a game-changing technology.

nvsmn hms

Nanotechnology

Investment Team

Brooks Nelson, CFA

Brian Roberts, CFA, MBA

Steve Philpott, CFP, MBA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

Documents

3rd Quarter 2011 Commentary