TREES INVESTMENT COUNSEL VIEWPOINT (Q2 2010) 

Not much has changed in terms of our view from last quarter other than the fact that the Standard and Poor's Index retrenched almost 12% from the end of March to the end of June.  In the context of the 50% upswing since March of last year, the markets just took a breather as investors are still figuring out whether to treat the glass as half full or half empty;  the vocal majority seems to be in the empty camp.  After being conditioned to a disappointing decade in the equity markets it's no surprise that pessimism rules the roost.

Negative news is is a lot more sticky, and we have had our share of it this quarter.  Sovereign debt issues in Europe came to a head with Greece (and some sister nations not far behind).  The situation seemed so bad for a while that a collapse in the European Union looked possible, though that level of disruption remains to be seen.  The pundits to whom we subscribe seem to think Europe is actually muddling through pretty well, and even with the austerity measures underway, there is still going to be some economic growth.  The BP Deepwater Horizon oil spill was another catastrophe hammered in the media on a daily basis, resulting in a palpable public malaise.  Fortunately, at least as of recently, it appears that the leaking is behind us with a lot more clean up ahead.  Other indicators such as housing, employment and manufacturing have been mixed, and that has added fuel to the bear camp. 

On the positive fundamentals side, we see strong balance sheets, excellent margins, improving productivity, vast capacity, and a little more optimism out of companies.  Most importantly valuations across the board appear reasonable, especially in some of the best, most steady companies.  With a little luck at some point we may even see P/E multiple expansion which could provide a return boost, but let's not get ahead of ourselves.

These are pretty powerful components that make us want to stay involved in the equity markets, particularly as we observe low yields, narrow spreads and potentially more risk in fixed income.  We are still comfortable with the high quality bond markets in which we play, and believe it is an important balance in our clients' portfolios, but we feel the cycle is close to an end.

Things that worry us are more macro issues, and those cannot be discounted.  We are hearing that the massive infrastructure build out in China is a couple of years from being over and that likely means slowing growth as the focus moves to smaller projects.  As we all know, China and the other BRIC countries have been the world's growth engine for the past 5 years.  Slowing growth does not bode well, especially when it is unclear what country or continent could pick up the slack.  Europe and likely our own USA will be working on deleveraging, which means less government spending, or at the very least less growth in government spending.  At the same time, we are facing increasing taxes (income, capital gains and dividend) in 2011 and more regulatory scrutiny which likely means decreased consumer and business spending. 

Even modest economic growth can still be interpreted as positive, and it is our hope that is what we will see in the next couple of years.  The vast array of challenges will keep a higher level of volatility in the market, as we have seen.  If we play it right, the fluctuations should benefit our longer time horizon and we will look back on this time period as rich stock picking grounds for excellent companies. 

July 20, 2010