First Quarter 2010
Last year at this time, we published a “road map” to
investing in equities for 2009 (the letter can be
found on our website at
We are raising cash levels in
www.lebenthal.com/aj/jamesb.htm). The road map
your account to protect
proved useful enough that we continue the endeavor
against the probability of a US
in this letter as we project the next twelve months in
equity market correction of
the US equity markets. What follows are our
10% in the first quarter of
thoughts for tactics in stock selection. As always, we
will stick to the fundamentals of our investment
If our projections come to
philosophy, which we invite you to read at our
pass, we will be reinvesting
website (see address above).
the cash we are currently
We expect 2010 to be a tale of two halves for the US raising at more attractive
economy and equity markets: the first a bit dismal, purchase prices this spring
and the second more robust. At the end of 2010, we and summer
expect the US economic recovery to be fully Our Economic Forecast
confirmed and stock markets to be higher than appears on page 6
current levels. Properly navigating the year can In 2009 our average account
enhance investment returns. Here are our thoughts returned 25.78%, net of fees
on the right course to take.
Lebenthal’s Outlook: First Half 2010
The stock market’s accelerating climb through the fourth quarter of 2009 was a technical rally, as
we wrote about in our last newsletter (again, please see our website). Portfolio managers caught
with too much cash by summer’s end played catch‐up to their indices by chasing the rally. Now that
the year has ended, this technical rally should too. Portfolio managers have the whole New Year
ahead, with plenty of time to put economic and market theory to practice.
Some may say that the market climbed the “wall of worry” the past few months. This is true, but
there is still quite a bit of scaling left to be done and without relative performance‐chasing money
managers, we think the markets will slide in the first quarter before gaining strength anew.
Consider the “wall of worry” as it looks today:
• The US federal deficit is huge with no signs of fiscal restraint in the executive or legislative
branch of government. Gross US debt is almost $13 trillion, up 50% in three years. With
annual deficits above $1 trillion, this bad situation is set to get worse.
• The Federal Reserve and Treasury Department, along with their counterparts around the
world, have pumped an enormous amount of liquidity into the economy. The Federal
Reserve’s balance sheet has grown to $2.1 trillion from $800 billion three years ago.
• The two points above should pressure the US Dollar down as foreign investors downgrade
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• The three points above should lead to higher interest rates along the Treasury curve outside
of the overnight rate (prediction: 10‐year Treasuries will spend most of 2010 in a range
centered on 4.5%).
• Municipal government fiscal positions are across‐the–board troubling. Consider that
California paid some debts in IOU’s earlier this year and New York nearly overdrew its
checking account this month. This situation stands to get worse in the new year.
• All of the above should lead to growth‐encumbering tax rate hikes, at the state, federal, and
• The consumer is being relied on to drive GDP growth while simultaneously increasing
savings: an impossible paradox.
• While the labor market, home sales, and manufacturing are getting better, they are a long
way from healthy. This economic recovery, while certainly underway, is off to a very slow
• None of the above will help a precarious commercial real estate sector. Financial companies
are out of the intensive care unit, but earnings pressure continues to build. This will inhibit
banks’ willingness to lend, a central component to a robust economic recovery.
• Real time indicators (railroad car loading, petroleum demand, capacity utilization) indicate
we face a winter slow‐down in an already tepid recovery. The graphs below illustrate the
Cars Originated US Freight Railroad Trends Weekly Shipment Volumes (Billions)
(Billions of TonMiles)
Cars Originated Total Volume (Billions)
1/7/2006 7/7/2006 1/7/2007 7/7/2007 1/7/2008 7/7/2008 1/7/2009 7/7/2009
Source: Association of American Railroads
Equity Portfolio Newsletter Page 2 of 7
U.S. Weekly Petroleum Products Product Supplied
(YearOverYear Change, 4Week Average)
U.S. Weekly Petroleum …
Jan‐03 Jan‐04 Jan‐05 Jan‐06 Jan‐07 Jan‐08 Jan‐09
Source: US Energy Information Administration
• Geopolitical risks are high: Al Qaeda in Yemen, Taliban in Afghanistan, Iranian nuclear
negotiations, Palestinian‐Israeli standstill, and a stunning property boom in China are just a
negotiations, Palestinian‐Israeli standstill, and a stunning property boom in China are just a
few overseas matters that can affect US investors.
The catalyst for a stock market correction may well be higher interest rates. This will not be the
case at the short end of the yield curve. The Federal Reserve dare not raise the overnight rate,
not with unemployment at 10% and capacity utilization barely above 70%. Longer maturities
are harder to control. The Fed can continue to buy Treasury bonds to keep long rates low ‐
quantitative easing ‐ but Bernanke’s Fed is on the verge of an unprecedented loss of autonomy
in pending congressional bills. Further expanding its portfolio of bonds might not be the most
pleasing of sights to legislative eyes. Say what you want about the Fed – and for the record, we
think it has done an admirable job over the past two years – but it is not a politically tone‐deaf
No, the Fed will remain sidelined by political considerations, allowing the market for Treasuries,
and the rest of the credit markets on which our economy depends, to set interest rates at a level
commensurate with federal and municipal deficits that are staggering.
There is not the political will to attack deficit spending prior to it becoming a crisis. Not at the
federal level, not at the state level, not at the local level. Budgets blown out of balance by
entitlement spending and stimulus plans will not be brought back into balance in the US, in New
York or California, or in New York City, until higher interest rates force the issue.
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The Chinese are too much invested in US assets – especially US Treasuries and agencies – to
abandon the US to higher rates, but there are limits to what they can do. And if their glorious
economic boom turns to bust, those limits will fast be reached. History would regard us
unkindly if we thought the Chinese economic miracle could end in anything other than a rout
proportionate to current exuberance. That is how such episodes invariably end.
As you read this letter, we are raising cash levels in your account to protect against the
probability of a US equity market correction of 10% in the first quarter of 2010.
Second Half of 2010
Most of the correction in equity markets can take place in fairly short order. The ten‐year
Treasury rose 55 basis points last month in the space of two weeks. We expect the remaining
rise to 4.50% to be done by the start of the second quarter. The markets may take until summer
to fully digest the higher interest rates. At that point, the positives in the economy should start
• US unemployment rate may top out in the first quarter; jobless claims have shown a clear
peaking process in the past several weeks.
• The banking sector is stable in that we are no longer talking about waves of bankruptcies.
• GDP is growing.
• Consumer confidence is picking up.
• Manufacturing surveys show expansion.
• Home sales are increasing; home price declines are easing.
• The Federal Reserve seems inclined to keep short‐term rates low.
There has been much press attention to the “lost decade” for equity investors. It is true that
buy‐and‐hold has resulted in negative returns over the past ten years. Just as prior gains do not
presage future returns, nor do prior losses beget more of the same.
There is a catalyst to move stocks higher in the second half of 2010. A simple one. Earnings.
Historically, S&P 500 earnings exceed the prior cycle’s peak in the second year of a recovery.
The second year!
Intuitively, this should make sense. During a recession, costs are cut to the bone. As the
economy picks up, company managers are still scared to hire, so they make do with what
they’ve got. Similarly, workers are still scared to demand more wages, so they make more with
what they get. The result is a rebound in earnings, more quickly than they fell in the first place.
You can see the phenomenon at work in the past two decades.
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Source: Standard & Poors, National Bureau of Economic Research
Those who disagree may say that this may have been the case in the past, but this time will be
different. The circumstances that led us in to this recession were far worse than those
preceding prior downturns ‐ that history does not apply here. To them we offer a reminder of
the most dangerous five words in the English language: This Time it is Different.
It is never different at the top, nor is it different at the bottom. During the second quarter’s
earnings season, the potential to achieve new peak earnings of around $88 per share in 2011
should become apparent. Should those expectations be met, then a 15x multiple – more than
warranted under those circumstances, would give a 1320 value for the index. Indeed, after a
10% correction in the first half of 2010, we expect the S&P 500 to close at 1320 for the year.
If our projections come to pass, we will be reinvesting the cash we are currently raising at more
attractive purchase prices this spring and summer.
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Lebenthal Asset Management’s Economic Projections for 2010
123109 30Jun10 31Dec10
US Unemployment Rate 10% 9.60% 9.20%
Ten‐Year Treasury 3.80% 4.50% 4.75%
S&P 500 1125 1080 1320
Inflation (CPI Headline, year‐over‐year) 1.90% 2% 3.20%
GDP (2Q and 4Q, quarter‐over‐quarter) 2.20% 2.20% 3%
Lebenthal Equity Portfolio Performance
In 2009, our average account returned 25.78%, net of fees.
This compares slightly unfavorably to the S&P 500, which had a total return of 26.45%. In the
two years we have managed this portfolio, the total return has been ‐19.88% vs. ‐20.34% for the
S&P 500. Our goal is to beat the S&P 500 over multi‐year periods (i.e. greater than three years).
The past year’s performance gives us a chance to analyze our portfolio choices and determine
what can be done better.
To make a long story short, it was not stock selection that held back performance, but the
amount of cash we held on the sidelines during the year. This ranged from 10% to 25% during
the course of the year. Cash levels this high represent caution for us, and there were plenty of
reasons to be cautious during the first half of the year. That the portfolio came as close as it did
to the index with this much cash is testament to the quality of the stocks selected for the
Nonetheless, we measure our performance against the S&P 500 and we take any deficiency to
heart. It may surprise you to read that we are willing to make the same mistake twice by raising
cash in your account. Hopefully, our dissertation above gives you comfort as to the reasons why.
Make no mistake about it, we are bullish on America and on stocks for the long run. We want to
minimize the pain of a near‐term hiccup, and enjoy the fruits of patient, thoughtful investing in
years to come. We look forward to our next update to you. Feel free to contact us in the interim.
Happy New Year!
James B. Lebenthal
President, Lebenthal Equity Asset Management
Equity Portfolio Newsletter Page 6 of 7
Lebenthal Asset Management, All‐Cap Equity composite is comprised of fully discretionary accounts with a minimum
relationship size $250,000 U.S. Excluded from this composite are individual accounts of client directed restrictions
(non‐discretionary accounts) and balanced account segments or accounts that are not defined according to similar
objectives and/or strategies. All accounts within the composite are primarily invested in the objective of outperforming
the broad equity index, S&P 500 Index.
Returns are presented net‐of‐investment management fees, trading, custody, and other regulatory fees. The
management fee schedule is as follows: 1.50% on first $5,000,000; 1.25% on the next $5,000,000; 1.00% on the next
$10,000,000. Investment advisory fees are further described in Part II of the adviser’s Form ADV.
All information contained herein is obtained by Lebenthal & Co., LLC from sources believed by it to be accurate and
reliable. Please refer to your Brokerage Account statement from Pershing, LLC as your official account statement for
performance information and account activity. The analysis in this report should be construed solely as statements of
opinion and not statements of fact or recommendations to purchase, sell, or hold any securities.
The volatility of any Equity Index is materially different from the actual model portfolio of client accounts. Particularly
Equity Index results do not represent actual trading or any material economic and market factors that might have had
on the adviser’s decision‐making.
The holdings identified do not represent all the securities purchased, sold or recommended for advisory clients and
past performance does not guarantee future results. Individual performance results will vary and may include the
reinvestment of dividends. The recommendations and selection criteria used to select the securities in the report is
available upon request along with a full list of all recommendations made during the preceding period.
Lebenthal Asset Management is a division of Alexandra & James Advisory Services, LLC, which is a wholly owned
subsidiary of “Alexandra & James, LLC". Alexandra & James Advisory Services, LLC, is an SEC Registered Investment
Adviser under the Investment Advisers Act of 1940 (“Advisers Act”). Lebenthal & Co., LLC is a Registered Broker‐Dealer
and Member FINRA & SIPC
Equity Portfolio Newsletter Page 7 of 7