There’s nothing like a debt crisis to get everyone’s attention.  This year we have sovereign debt issues in Italy and Spain; last summer it was Greece.   Last week Congress raised the debt ceiling while Standard & Poor’s downgraded the credit rating of the US government.  And, as the third quarter earnings season winds down, investors are seeing deterioration in the economy and uncertainty about corporate profits.  Three years after the collapse of Lehman Brothers, the emotional wounds are still there.

Last week’s selling started in Europe and worked its way to US markets.  While Friday’s July unemployment number wasn’t as bad as expected, it certainly wasn’t noteworthy this far into a recovery.  Today’s selling appeared to be an acknowledgement that another recession is a real possibility, and the government and Federal Reserve may be out of rabbits, to say nothing of hats.

Ken Rogoff, co-author with Carmen Reinhart of the 2009 book This Time is Different, argues that governments and central bankers have misdiagnosed the credit collapse as the “Great Recession” rather than the “Great Contraction”.  Like the 1930’s Depression, “the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation”.  The misdiagnosis has led to mistaken policies.  The Fed meets again tomorrow (8/9/11), and investors will be looking for encouragement.

In the meantime, we want to reiterate that our equity allocations have been at the low end of our benchmarks for much of 2011.  We hedged US and worldwide stock positions with structured notes back in June, and have been increasing global and high yield bond positions, where appropriate, in portfolios over the past year.  While it really is impossible to effectively “time” markets, it is possible to manage risk.  The recent sell-off has been fast and steep, perhaps, too much.  But, we are keenly aware of the need to preserve capital while maintaining an investment discipline.  Be assured that we are taking steps to do both. 

As always, we welcome your questions or concerns.  

Mark Miller    Eric Lai    John Wenzel