Client Update

January 2012

Dear JCFA Client:

The global village became very small as 2011 was consumed by debt, debate, downgrades, and potential default both here and overseas. U.S. economic data had to struggle for months against headwinds from abroad that preoccupied Wall Street, even as Wall Street itself got occupied.

Driving markets worldwide were concerns about the impact of the Spring Arab revolts on oil markets, the triple disaster in Japan that left the world gasping for autos and parts, and most especially the shaky state of Europe's finances and banks with heavy sovereign debt exposure. After Greece, Portugal, and Ireland turned to their peers for financial support, the contagion threatened to spread to larger and more economies. As Italian and Spanish bond yields hit the 7% level considered unsustainable, investors worried they might be both too big to fail and too big to bail out despite an enhanced rescue fund and a new agreement increasing the Eurozone’s ability to impose fiscal discipline on members.

However, some of the turmoil was home-grown, such as the congressional deadlock that held the United States' credit rating hostage and threatened a first-ever default. Though the buck-inheriting Super committee failed to prevent $1.2 trillion in budget cuts scheduled to start in 2013, the conflict ultimately didn't faze bond investors, who sought refuge from Europe's travails in U.S. Treasuries.

Despite the upheaval caused by the global financial system's need to deleverage, the U.S. economy ended the year looking a bit stronger, with increased potential for continued recovery in 2012--assuming that Europe can manage not to implode in the meantime.

Three of the Dow’s 12 largest daily point gains in history occurred in 2011 (two in August alone). Unfortunately, August also featured three of the Dow’s 12 largest point declines ever. Nevertheless, the Dow was the only index of the four to show a gain for the year. The Dow ended the year with a respectable 5.5% gain. More representative of broader-market performance was the Standard & Poor’s 500-stock index, which was flat at year end after the market’s sharp ups and downs. Investors received a 2.1% return, mostly from reinvesting capital gains and dividends. At its extremes, the S&P 500 had been up as much as 8.4% in late April and down nearly 13% for the year at its 2011 nadir in early October. The volatility cost the small-cap Russell 2000 dearly; despite a good start and strong finish, it ended the year down 14% from its April high. The Nasdaq also suffered, ending 2011 with a 9% fall from its April high and its first losing year since 2008.

Not surprisingly, global equities were harder-hit than their U.S. counterparts as credit markets showed signs of strain, threatening both emerging and developed markets. The gloom hanging over the developed markets is overshadowing the generally more optimistic views about emerging markets. While many emerging markets are seen as able to counter some effects of slowing economic growth by lowering interest rates or by fiscal stimulus, a European credit crunch could still have a meaningful impact because European banks have been big lenders in the developing world. Understanding the opportunity for growth, JCFA is cautiously re-entering emerging markets but keeping positions small to limit exposure to downside risk.

Here's how the market settled out as of December 31, 2011:

Year to Date Change

Dow Jones Industrials 5.53%

NASDAQ -1.80%

S&P 500 0%

Russell 2000 -5.45%

Global Dow Jones -13.69%

10 Year Treasuries -1.41%

Starting at 9.4% in December 2010, the unemployment rate remained stuck within a point or two of 9% until November, when the biggest monthly decline in more than 13 years cut it to 8.6% (a level last seen in March 2009). Cuts in state, local, and federal government employment partly offset gains in private-sector jobs.

After a slow start during Q1--the economy gradually began to improve. Though Q3's 1.8% annualized gross domestic product was much lower than 2010's 2.5%, it kept hope alive for continued recovery in 2012. The manufacturing and services sectors both avoided contraction, and by Q3, corporate after-tax profits were up more than 11% from a year earlier.

Ominously high inflation at the wholesale level in Q1 failed to flow through to consumers as retail spending remained tentative for much of the year, at least until the weekend after Thanksgiving. By November, consumer inflation was running at an annualized 3.4% -- not far above its historical average -- but wholesale prices were up 5.7% year over year.

Housing starts and home sales showed signs of life by year's end. Housing starts were up 24% from last November, and new home sales were almost 10% higher. Though home prices seemed to stabilize a bit, by October they were back to mid-2003 levels and 3.4% lower than a year earlier.

We knew that economic growth in the late 2000’s was unreasonable. In our management of your portfolios, we appreciated what we were able to earn in the market but pulled back our positions to reflect our more cautious outlook going forward. 2010 showed growth that was unsustainable after the 2008 debt crisis – we had not made amends for our over-extended spending. The political quagmire we saw in 2011 was an unwelcome, but necessary, response to the current situation. There are tough decisions to be made, both in the U.S. and abroad. The ramifications of the U.S.’s liberal spending will not be smooth or easy but difficult decisions will lead to progress. The slight economic growth we are seeing now indicates progress – progress that is slow and measured and will ultimately lead to long-term growth.

If there is a common theme among analysts’ forecasts for stocks, commodities and currencies, it is to brace for more of the kind of wild swings that were the hallmark of 2011. In 2011, JCFA clients noticed a shift towards "risk-off " in the second half of the year as we shifted client holdings towards fixed income and value investments rather than riskier growth opportunities. Though our outlook for the future is optimistic, we are working hard to ensure preservation of capital while collecting returns through income payments of bonds and stock dividends.

The poor market returns of 2011 have brought stock prices down making this a favorable time to buy. As you hear from us regularly, we tilt our outlook towards value investing. With U.S. stocks selling at 14 times trailing earnings, the U.S. market is cheaper than it has been in two decades with a historical trading at 20 times earnings for the S&P 500 index. Earnings underlying the S&P 500 index are expected to increase 10% in 2012, according to a consensus of Wall Street estimates published by Standard & Poor’s. With a focus on higher-quality and dividend-paying stocks, this is a value investor’s market.

Moving forward we continue to employ a core-satellite approach in which the majority of our clients’ investments are conservatively oriented towards preservation of capital. A select portion of client assets, depending on unique client investment objectives, are positioned to take advantage of new opportunities in the market. Though we maintain a long-term strategic approach, we are implementing a shorter-term tactical approach in seeking these opportunities. Our overall firm approach is to achieve long-term strategic growth. Though the short-term may be rocky, we approach the long-term with measured, informed decisions, and confidence. As always, we appreciate your trust, confidence and ideas.

Warm wishes for the New Year ahead,

Joyce and Priscilla