TREES INVESTMENT COUNSEL VIEWPOINT (Q3 2007) 

Our last letter, "As Good as it Gets", was written this summer as new highs were being reached in the Standard & Poor's 500 and the Dow Jones Industrial Average, just a couple of days before the market panicked about subprime mortgages.  The upheaval knocked the market down 9% from the July highs, not quite the 10% decline we were looking for, but pretty darn close.

As we write today, the market has quickly rebounded from the August malaise, and is about square in the same spot as last quarter.  So, does that mean a correction has taken place and we are now ready to progress along an upward trajectory? Perhaps, but also perhaps no.

What we do know is that we are pleased with our position in high quality well established companies, and we continue to enjoy being internationally diversified.  The housing dilemma is going to be present for a while.  After all, only a fraction of the ARMS have begun adjusting, and as we have learned, even when an individual is unable to make a mortgage payment it can take many months if not well into a year before the bank is able to foreclose.  For the time being, employment remains extremely high, which is fundamental in enabling individuals to make payments on their homes, most people's most prized possession.

Still, credit has tightened, and it is harder and more expensive to get a mortgage.  There is no doubt about it.  Also, there is a plethora of inventory on the market, and in many areas housing prices are stagnant or declining.  If this trend continues or does not turn around, many Americans will find themselves cutting discretionary spending (consumer spending is 70% of GDP) and even more challenged to retire.  Let's not forget that the first of the baby boomers are just eligible for Social Security!

In general, we are still seeing the glass as half full.  P/E ratios are not egregious at about 16x 2008 earnings.  However, with operating margins at all time highs, we are watching for potential deterioration in earnings, particularly with the impact of rising commodities costs and inflation in certain areas of the economy.  Credit has gotten tighter, but rates are still low on a historical basis, fostering investment.  As we said before, employment is very good, probably helped by the weak dollar, and the consumer is still spending, albeit with a little bit of belt tightening.  While we have our eyes open for warning flags (as always, we see many challenges), there us nothing we see as an overarching shadow on the horizon.  We are just playing it safe.

  
October 18, 2007