Better Late Than Never
Our economy is finally showing the same signs of strength that corporate earnings have shown during the past year. While the weak housing market and high unemployment in our country remain problematic, signs of positive GDP growth are encouraging. In this Quarterly Update, we discuss our optimistic outlook for equities and commodities, along with our view on the challenging market environment for fixed income investments. Finally, we discuss the importance of establishing a proper asset allocation for your overall portfolio.

US Economy Expanding
The US economy is no longer recovering—it is actually expanding!  US Real GDP has now climbed above the pre-recession high of Q4 2007. While this was generally expected by leading economists, it seems the trend is now set to continue throughout the year. We believe there are a variety of other factors that also bode well for US investors, including:

• Quantitative easing boosts stock market and economy

Over the past three years, the Federal Reserve has instituted a form of loose monetary policy called Quantitative Easing. The goal of this policy is to help banks become better positioned to loan more money to businesses and individuals. We expect this ongoing stimulus to improve investor confidence, aid consumer spending, and revive credit for small business. This should ensure our economy continues to at least inch higher.

• Strong earnings likely to support equities in 2011

2010 earnings for the S&P500 companies totaled approximately $84 (Index adjusted). This represents a gain of nearly 40% over 2009 results and is nearing the $87 peak reached in 2007. For 2011, consensus expectations are for record earnings of $95 (+13% over 2010). Revenues, an important indicator of the strength of the earnings recovery, should also grow due to improving domestic demand and robust international growth. This growth, coupled with below-average equity valuations, is good news for equity investors.

• Public companies in great financial shape

Since 2008, businesses have been reluctant to increase capital spending. Therefore, the profits generated during the last two years have accumulated on the books of most public companies. As of December 31, approximately $24T in cash sat on S&P500 company balance sheets. Some of this cash has been used to pay dividends and to make acquisitions. Most remains available for future deployment. We believe companies will continue to deploy their capital in response to an improving economic environment and better growth prospects.

• Significant tax relief for next two years

The recent agreement on tax policy between the Obama administration and Congressional Republicans provides significant tax relief for the next two years. Not only were the Bush tax cuts extended through 2012, but a $120B reduction in payroll taxes was approved. This clarity is welcome to investors and businesses as they make plans for 2011 and beyond.

• International markets offer robust growth potential

Strong demographic trends within international markets, especially emerging markets, should support record levels of growth and spending. Many emerging market governments realize they must continue to spend on infrastructure to meet their populations’ surging demands. With approximately 50% of S&P500 company profits originating overseas, this robust international growth offsets our sluggish domestic recovery. This is a major reason why these companies should grow their profits 13% this year.

• Interest rates remain low

In an attempt to revive economic growth, the Federal Reserve has kept short-term rates near 0% for over two years. Because of the ongoing weakness in our housing market, we expect this accommodative policy to remain throughout the year. Inflation on the other hand is likely to gradually increase. However, high unemployment and excess manufacturing capacity, will likely cause any increase in inflation to be gradual.

• Demand for commodities remains strong

Growing global populations, industrial and investment demand, and signs of emerging market inflation should continue to support commodity prices in 2011. Because of this, we believe investing in a broad-based basket of commodities is prudent. Gold remains a core portfolio holding due to its low volatility and defensive characteristics.

Potential Challenges for Investors
While there are a number of positive trends in the global economy, there remain some challenges as well.

In addition to the frequently mentioned problems of high unemployment and weak residential real estate in the US and abroad, escalating sovereign debt is a real concern. The problems of Greece and Ireland are well chronicled, but other countries like Spain, Portugal, Japan, and the US (including state and local governments) are all servicing historically high levels of debt. This growing burden will not disappear and may ultimately require reduced government spending and higher taxes – both negatives for economic growth and corporate profitability. Fortunately, low interest rates make this condition tenable for the time being.

Other concerns include commodity inflation and geopolitical uncertainty. Commodity inflation may be offset in the US by a slack labor market, but remains a key issue for the faster-growing emerging markets. Countries like China are attempting to dampen inflation through tighter monetary policy. These efforts, if conducted correctly, will slow price inflation, while having a minimal effect on global economic growth. If not conducted properly, this could stunt growth in emerging markets, leading to weaker global growth. Geopolitical uncertainty has always been a concern in countries like Iran and North Korea. Now we can include previously stable countries like Egypt, Tunisia, and Bahrain. Escalating conflicts could result in increased volatility in financial markets worldwide.

Mixed Picture for Fixed Income Investors
The current economic climate, characterized by a slowly recovering economy, low inflation and low interest rates, is challenging for investors seeking income. Identifying attractive opportunities for our clients, at a time when longer-term rates may begin rising, can be especially daunting. Fortunately, we have developed a diversified approach to fixed income investing that we expect will rise to the challenge. Our goal is to manage credit and interest rate risk through sector diversification, while seeking opportunities for enhancing yield across client portfolios.

We continue to favor investment-grade US corporate bonds. Strong balance sheets and record profits have supported this market since 2008 and the spread, or the additional yield a lender earns over comparable US Treasuries, remains attractive. Another area we currently favor is floating-rate loans. This type of bond offers the benefit of higher yields if interest rates do rise. The interest earned on these bonds is periodically reset, which will be beneficial should rates begin to climb in 2011. Preferred stocks, high yield corporate bonds, and mortgage REITS make up the balance of our diversified fixed income strategy. In total, we have blended six different strategies that, in combination, yield approximately 7% per year.

The Importance of Asset Allocation
Asset allocation is the mix of stocks, bonds, cash and other investments in your portfolio. Studies have consistently shown that asset allocation is the single most important factor in determining your investment success. At Collins & Company we take asset allocation very seriously. When developing asset allocation strategies for individual clients, we consider traditional asset classes, such as stocks and bonds, as well as commodities and alternative investments. Our ultimate goal is helping you develop and maintain an investment strategy that best suits your individual needs, time horizon, risk tolerance and objectives. The benefits of a well-diversified portfolio include lower volatility over the short term and the potential for enhanced performance over the long term.

How are asset allocation strategies created?

In determining a prudent asset allocation, we consider your:

• Financial needs and resources
• Investment goals
• Time horizon
• Income and liquidity needs
• Personal tolerance for risk

If you have a long time horizon (10+ years), a portfolio with a higher allocation to stocks may be appropriate. Historically, this has provided higher returns. As your time horizon decreases, migrating away from aggressive investments into more conservative alternatives such as fixed income securities or cash is more appropriate.

The next step:  Diversification within the asset class
Once an asset allocation is set, the next step is to diversify the portfolio within the selected asset classes.  Diversifying across a wide range of investments can further reduce risk and enhance performance over time.  Within an equity allocation, for example, we consider both US and International securities in a variety of sectors. For fixed income and commodity investments, we utilize a similar approach with the overriding goal of reducing specific risk.

Keeping you on the right track
As long-term believers in the importance of proper asset allocation, we set specific targets for each of our clients based on their unique needs and circumstances. This remains a cornerstone of our wealth management process and is integral in helping our clients achieve their goals. We’ll review your asset allocation strategy with you at least annually and may potentially recommend changes over time as your needs and goals change.

Looking Ahead
We expect 2011 to be a good year for our clients. Global economies are recovering. Corporate earnings are likely to reach an all-time high. We believe there are attractive investment opportunities in all market environments, including our current one. At the same time, we appreciate the delicate nature of our investment climate and actively seek to manage risk in client portfolios. We continue to monitor macroeconomic trends, developing world events and specific holdings in our clients’ portfolios, taking advantage of both tactical and strategic investment opportunities when prudent and appropriate.

As always, we are available to discuss the content of this review anytime. We are optimistic about the long-term health of the financial markets and look forward to helping you achieve all that is important to you.

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