PDF version of the Market Outlook

We have adopted a far more cautious tone over the past three months. That caution has yet to be rewarded, as stock prices continue to creep higher, pushing through the February highs that we believed would mark a longer lasting peak. The Dow Jones Industrials (+3.9%), Standard & Poor’s 500 (+2.9%) and Nasdaq Composite (+3.3%) all finished the month of April in positive territory. Healthcare led sector performance with a gain of 6.2%, while the financial sector was the worst performer, posting a loss of less than 1% (source: Bloomberg.com).

We began to temper our optimistic outlook in February as commodity prices continued the surge that began last fall, despite what appeared to be slowing rates of global economic growth. Domestic consumer price inflation has risen 2.7% over the past year due to the rise in food and energy prices, but at a 4.7% annualized rate over the past six months and at a 6.1% annualized rate in the first quarter of this year. At the same time, real economic growth slowed from a rate of 3.1% in the fourth quarter of last year to just 1.8% in the quarter just ended. The unsettling word used to describe this economic phenomenon, which defined the decade of the 1970’s, is stagflation. A slow or declining rate of economic growth combined with rising rates of inflation is now only a faint memory, if one at all, for most investors. The Federal Reserve tells us that the surge in the consumer price index (CPI) is “transitory,” while the consensus view of economists is the expectation that economic growth will snap back to a rate of 3% or better through the remainder of this year. Investors, whether they be sipping from the QE2 punchbowl or bathing in it, seem to be hanging their hats on these forecasts without question. We, on the other hand, while not forecasting a prolonged period of stagflation, do sense a more difficult journey ahead than what we have seen since the onset of the Fed’s second quantitative easing program last September.

We wrote about similar concerns we had for stock prices exactly one year ago in the Market Outlook. The S&P 500 had risen 9% during the first four months of 2010, just as it has during the first four months of 2011. We stated last May that, “Our greatest concern has been the potential for a financial crisis in Europe, and the complacency with which investors and markets have addressed such a possibility.” The sovereign debt crisis that followed roiled financial markets throughout the summer months. We also stated that, “As heightened levels of risk are brought to the forefront of investors’ minds, they will be factored into market prices very quickly, and lead to what we believe will be yet another opportunity to invest in domestic equities. We see the S&P 500 having strong support near the 200-day moving average, which approximates 1100, and a decline from the recent highs (1219) to that level would be a healthy 10% correction.” The correction that followed approximated 16%. Today we see a similar complacency over a different set of circumstances, and the possibility for yet another correction, albeit more modest than what we saw last summer.

We believe economic growth will fall below consensus estimates in the second and third quarters as we work through a multitude of headwinds on both international and domestic fronts. We have previously discussed the impact that negative developments in Europe and Japan are likely to have on global growth, but what is occurring on the domestic front has us more concerned today. We thought that economic activity would have been far more balanced across the socio-economic spectrum within the United States at this point in the recovery/expansion with respect to income and spending figures. That would have buffered the risks we now see with regard to inflation. This has not happened. Chairman Bernanke’s monetary policy experiment of trickle down economics through the wealth effect of stock market gains has a plug in the drain. The trickle down part has yet to show up in the data. Consumer spending rose at a rate of 2.7% in the first quarter, the greatest contributor to economic growth, but the only consumers we see spending are those with stock portfolios and household incomes in excess of $100k. Now the rate and quality of spending is starting to slow, which doesn’t bode well for consensus expectations of economic growth.

Retail sales increased .4% last month, which was the ninth increase in a row, but when we exclude gasoline sales, the increase was just .1%. Wal-Mart’s CEO commented last week that, “our shoppers are running out of money.” Wal-Mart averages 140 million shoppers nationwide on a weekly basis. While we are seeing job creation numbers we anticipated, the quality of jobs and the incomes associated with those jobs is not inspiring. McDonald’s received one million job applications last month for 50k openings and hired 62k. Is it any wonder we haven’t seen any growth in wage or salary income? And now gas prices are once again approaching $4/gallon, which brings us back to the inflation Chairman Bernanke calls “transitory.”

Gas prices are surging commensurate with the rise in oil prices. Chairman Bernanke and Wall Street point to growth in the developing world as the root cause. Republicans say we must explore and produce more at home. Democrats are convinced the rise in price is the result of fraudulent price manipulation and speculation. President Obama wants to form a commission that will conduct an investigation. The media is once again vilifying the big oil companies. We are still waiting for lawmakers to have the “adult conversation” that never took place in 2008. Perhaps the reason they refuse even to address what we see as the root cause is that they would be taking dead aim at the latest money making enterprise for Wall Street banks along with all the future campaign contributions from the industry that they depend on to hold office. Revenues from trading in commodity markets accounted for nearly 10% of total revenues for the industry last year.

We believe commodity prices have soared in recent months due both to speculative and long-term-oriented investment flows into futures contracts. These activities are legal, because Congress opened the floodgates to these investment flows through legislation it passed 10 years ago. Perhaps we would have addressed this systemic risk back in 2008 if commodity prices, led by oil, had not collapsed along with other financial assets during the credit crisis that hit just weeks after oil peaked. We are now concerned that we are in the midst of a repeat of the summer of 2008. This latest boom won’t result in a bust until the price increases destroy so much demand that the investments flows reverse, or public enlightenment and corporate outrage force the hand of lawmakers and the Commodity Futures Trading Commission to place limitations on Wall Street’s latest profit machine.

Chairman Bernanke needs to pray we are wrong, for it is not just food and energy that are seeing a so-called “transitory” rise in price. As the home ownership rate is declining, the demand for rental homes and apartments is increasing, and rents are beginning to rise substantially. Gas prices are on pace to exceed the $4.11/gallon highs we saw three years ago, which would equate to more than $100 billion in additional cost for consumers this year, more than negating the entire 2% employee payroll tax cut for 2011. We see real incomes for the vast majority of American households continuing to decline, and we expect the nominal rate of inflation to approach 5% this summer, slowing dramatically what has been the most significant contributor to growth—consumption.

We suspect that QE2 is temporarily inoculating the market from the foreboding developments we see, and devaluing stock price performance as a leading indicator. Still, we expect investors to start factoring into stock prices these risks to growth and corporate profitability prior to the current program’s end in June, given that a third round of quantitative easing seems politically untenable. What might convince us we have come to the wrong conclusions about the market? A halt in the rise of commodity prices prior to the resultant level of demand destruction that will ultimately stall economic growth.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

PDF version of the Market Outlook

The stock market has been resilient despite renewed concerns over sovereign debt in Europe, a heated military exchange between North and South Korea, and efforts by China to slow its economy with more restrictive monetary policy. We do not believe that the latest wave of geopolitical turmoil will derail the economic recovery in the United States. Our economy is regaining strength, following the summer slowdown, as evidenced by the recent upward revision in economic growth estimates for the third quarter to 2.5%. This bull market is on solid footing. We continue to look opportunistically for the next period of risk aversion to take hold, so that we can increase our exposure to domestic and international equities at lower prices. Our sense is that this period may currently be underway. The Dow Jones Industrials, Standard & Poor’s 500 and Nasdaq Composite all declined by 1% or less for the month of November. Energy led sector performance with a gain of 5.1%, while the utility sector was the worst performer, posting a loss of 3.6% (source: Bloomberg.com).

We are not without concerns. The greatest risk we see moving forward for investors is that of the fiscal challenge we must surmount with respect to our national debt and budget deficits. President Obama’s bipartisan debt commission tells us a “shared sacrifice” will be necessary in the form of higher taxes and cuts in spending. The problem is that most Americans come to the same conclusion so long as it isn’t their taxes being raised or their entitlements and government services being cut. Making matters worse are the professional politicians that make a living placating the public with catch phrases and slogans that embolden the misguided view that we can have our cake and eat it too. Freezing pay increases for federal workers and eliminating earmarks are symbolic gestures that don’t begin to address the problem. If this delusional world we live in is allowed to perpetuate without significant changes in fiscal policy, we will ultimately find ourselves in a crisis similar to the one Europe finds itself in today – one where austerity measures are force-fed to us by our creditors. We are encouraged by Chairman Bernanke’s resolve. We believe the Federal Reserve is taking matters into its own hands through monetary policy, despite unrelenting criticism, on the basis that Congress will not act on the fiscal front until it is too late. Yet the Fed’s most recent policy move, commonly referred to as quantitative easing, has, in our view, been both politicized and greatly misunderstood.

The Federal Reserve announced last month that it would purchase an additional $600 billion in Treasury debt, over the next several months, with the stated objective of accelerating gains in employment and economic growth. A slew of academics, economists and politicians have collectively denunciated this policy as both risky and ineffective. Some members of Congress have gone as far as to recommend removing the Fed’s mandate to seek full employment, leaving it to focus exclusively on price stability. These critics claim that printing money will not stimulate the economy or employment, but instead will ignite inflation and weaken the value of the dollar. What this army of armchair central bankers failed to recognize is that quantitative easing has already had a positive impact on economic activity and employment, and that stoking inflation and weakening the dollar will lead towards progress in dealing with our debt and deficits. In fact, it may be a necessity, since Congress and its fiscal policies are failing us. Following the several degrees of separation between the Fed’s policy and its desired effects is not an exercise for the simple minded, which leaves the majority of Chairman Bernanke’s critics in the dark.

The recent improvement in economic indicators following the announcement of the Fed’s intentions to purchase bonds in late August is no coincidence. The uninterrupted rise in stock prices has coincided with upticks in consumer confidence and retail sales. Unemployment claims have fallen below 450,000 for the first time since September 2008, and private sector job creation exceeded estimates by rising 159,000 in October with upward revisions to the prior two months. Quantitative easing has had a discernable impact on economic activity through the wealth effect. Job creation is an inevitable result, but so is inflation.

At this point in time, the inflation the Fed is stoking may be beneficial to its cause, because of its impact on currency valuations and trade. Today’s inflation has been concentrated in food, energy and materials. These items constitute a relatively small percentage of our overall inflation measure (CPI) when compared to that of our most important partner in the developing world. Food alone accounts for nearly one-third of the inflation gauge in China, and rising prices are pushing its CPI well above its 3% target. Beijing has exhausted every available option to contain inflation other than to accelerate the appreciation of its currency, the yuan. China has pegged the value of the yuan to the dollar rather than allow it to float freely in currency markets, intentionally undervaluing it, so as to promote the exports that drive its economic growth. An appreciation of the yuan relative to the dollar would make our exports more competitive in the global marketplace, improving the balance of trade by narrowing our trade deficit and contributing to our own economic growth. If quantitative easing leads to inflation that ultimately results in China accelerating the appreciation of its currency, the benefits will far outweigh the consequences with respect to our own economic growth.

Weakening the dollar in the current environment has similar economic benefits with respect to global trade, which once realized, in terms of faster rates of economic growth, actually serve to strengthen the dollar. Chairman Bernanke recently said, “The best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in the United States.” The policy he is referring to is quantitative easing, and the robust growth he references is derived from a rise in exports that results from the policy. We interpret his statement to mean we must weaken the dollar now in order to see it strengthen on the back of more robust rates of growth later on.

Agriculture is one industry in the United States that is seeing results. The surge in agricultural commodity prices combined with the increase in demand from our trading partners in the developing world, due in part to the declining dollar, has led to a record rise in exports. The increase in revenues is having a multiplier effect in related industries that serve agriculture. These developments have ultimately led to job growth, which is why states in the Midwest have the lowest unemployment rates in the country. We expect to see a similar scenario play out in other segments of the U.S. economy. Pro-growth fiscal policies like the $100 billion investment tax credit proposed by the Obama administration, when combined with effects of quantitative easing, should encourage businesses to expand domestically and foster growth.

Economic growth is critical in order to overcome the burden of debt and deficits. It is not the absolute amount of debt or deficit that presents the obstacle, but the amount as a percentage of our economic output, which is currently unsustainable. This is not to say that reductions in spending and increases in revenue will not have to be part of the solution, but austerity combined with tax increases absent pro-growth monetary policies will shrink the economy. If the economy shrinks as outstanding debt is retired and deficit amounts are reduced, there is no reduction in the percentage as it relates to economic output. This ill-advised experiment is currently underway in Greece and Ireland, because the European Central Bank has refused to pursue as aggressive a monetary policy as that of the Federal Reserve. The Fed has implemented a quantitative easing program to source the growth we need through a combination of the wealth effect and exports. We believe it will be successful and silence its critics. We expect the economy will continue to surprise to the upside until the consensus of estimates for economic output, employment growth and corporate earnings catch up with reality.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

PDF version of the Market Outlook

Stock prices continued the surge that began two months ago as investors discounted the probability of a power shift in Washington and a second round of bond purchases by the Federal Reserve. With or without these positive catalysts for financial markets, we continue to see improvement in underlying economic trends. The arguments supporting a negative outlook are running thin. The Dow Jones Industrials (+3.0%), Standard & Poor’s 500 (+3.7%) and Nasdaq Composite (+5.8%) all finished the month with impressive gains. Materials led sector performance with a gain of 6.6%, while the telecom sector was the worst performer, posting a loss of less than 1% (source: Bloomberg.com).

Republicans are likely to win a majority in the House of Representatives, while Democrats retain control of the Senate. The significance a balance of power would have for investors is the resulting improvement in business confidence that could ultimately translate into more robust payroll job growth. Under a divided government corporate leaders would feel less threatened by the potential for more onerous regulations, the possibility of tax increases and the costs associated with pending healthcare legislation. There is also the possibility that both political parties take ownership of the path that lies ahead and move toward the center to promote pro-growth initiatives, but we believe that Federal Reserve policy will be a more influential determinant of future market performance.

There has been relentless debate in recent weeks amongst market pundits about the need for another round of quantitative easing, the varying approaches to its implementation, and the amount of debt that will ultimately be purchased. These debates, in our view, are irrelevant. What is important from an investment standpoint is that the commitment by the Federal Reserve will be open-ended and substantial up to the point that it believes it has achieved its Congressional mandate of full employment and price stability. The Fed has indicated this to be an unemployment rate of 5% and a core inflation rate approaching 2%. To accomplish this goal, we believe the Fed’s intentions are two-fold: first, to inflate stock prices in an effort to ignite a wealth effect that will boost consumer and business confidence, and second, to weaken the dollar with the objective of boosting exports and corporate profits. Both should stimulate economic growth and job creation.

Each of the previous episodes of quantitative easing that occurred in Japan, the United Kingdom and the United States coincided with significant increases in both stock prices and the rate of economic growth. One notable difference is that each of the previous periods occurred coincident with economic contractions, while the one to be announced by the Federal Reserve this week will be implemented during a period in which the economy is reaccelerating. The desired effect in the near term may be even more pronounced as a result, but there could also be unintended consequences. If the Fed is underestimating the strength of the economy, as we believe it is, then the deflation it is attempting to thwart could lead to a rise in commodity prices reminiscent of 2008. We believe history is destined to repeat itself.

The initial estimate that the economy grew at an annualized rate of 2% in the third quarter was uninspiring for most investors, but we continue to be encouraged by the steady progress. During the last two recoveries (1991 and 2002) economic growth temporarily slowed to less than 2% for two quarters before reaccelerating to twice that rate in the year that followed, and we anticipate a similar scenario unfolding again. The election results we expect, combined with the quantitative easing likely to be implemented, would serve to turbo-charge our forecast. Consumer spending increased at the fastest pace (2.6%) since the fourth quarter of 2006 and was the largest contributor to growth, yet most investors assume the consumer to be the weakest link in the economy. The greatest detractor from the headline number was again trade, which subtracted 2% from GDP growth. However, we expect trade (exports) to be the key driver of economic growth as the newest expansion progresses.

A gradual rebalancing of power between the developed and developing world is occurring in the global economy. Developing countries are now home to more than 80% of the world’s labor force. Their economies have been growing at a significantly faster rate than those of the developed world, and their workers have realized far more rapid increases in wages and compensation. A middle class of consumers in developing countries may be in its infancy, but aggregate consumer spending in the developing world now exceeds that of the United States. The Chinese, which are leading the transformation, are on pace to purchase more than 17 million vehicles in 2010 compared to less than 12 million in the United States. The significance of this rebalancing is that developing world currencies should slowly appreciate in coming years, while developed world currencies depreciate, to more accurately reflect the growth rate differentials. A measured depreciation of the dollar should lead to a steady increase in U.S. exports to the developing world, in addition to rising corporate profitability and job creation. This brings us back to the subject of quantitative easing. The Federal Reserve is simply accelerating a process that in our view is already underway.

Two years ago, in the midst of the financial crisis, we made what most considered at the time an outlandish forecast for the U.S. stock market—“We believe we may embarking on one of the best five-year periods for U.S. stock performance despite the dire outlook.” Since that time the S&P 500 has risen approximately 23%. Our call would have been more prescient had we waited five months. The S&P 500 has risen more than 70% from the March 2009 lows. We still feel confident in our prediction with three years left to go, because common stocks remain the most undervalued, unloved and under-owned asset class in our view. This doesn’t mean we have blind faith in the stock market, and we continue to devote ourselves to a tactical approach with respect to emphasizing asset classes, but at this stage we believe domestic and international equities will outperform all other investment alternatives.

We are all compelled to invest more following a substantial increase in prices. The S&P 500 has soared nearly 14% in two months time from the lower end of the summer trading range without as little as a 2% correction. The markets are extended on a technical basis, yet Wall Street professionals are all looking for the same 5% correction to increase equity exposure, which leads us to believe any correction will be shallow and brief. We do see one potential pothole between now and year-end that could resolve the current overbought condition with a temporary decline in stock prices. Congress will return to Washington for one week in mid-November following the mid-term elections. The financial markets will be acutely focused on legislation to extend the Bush tax cuts. We do not believe the tax cuts will be extended during this lame-duck session, and likely won’t be addressed until December, but we do expect the tax cuts to be extended for at least one year. This should be another positive market catalyst as we begin 2011, but the risk of political gridlock in two weeks’ time is highly probable.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

Performance History

*Composite inception 12/28/2009

Trailing Total Returns

PDF version of the Market Outlook

The stock market has been mired in a trading range all summer. Two months ago we forecast “the market (S&P 500) to remain range-bound between 1050 and 1150 through the remainder of the current quarter, providing investors the opportunity to position for what we believe will be a breakout to the upside that will challenge the April highs before year-end.” The lowest closing value for the S&P 500 since that prediction was 1047 in the month of August, and the highest was 1148 in the month of September. We briefly exceeded the 1150 level on the last day of the quarter, which we interpret as an indication that a new leg up in this bull market will soon be underway. The Dow Jones Industrials (+7.7%), Standard & Poor’s 500 (+8.8%) and Nasdaq Composite (+12%) all finished September with tremendous gains. Technology led sector performance with a gain of 12.1%, while the utility sector was the worst performer, posting a gain of just 2.6% (source:Bloomberg.com).

There are two primary camps of thought prevailing today: one believing that the economy will fall back into recession, the stock market will again decline into bear market territory and a deflationary period will take hold; the other believing that we will avert such an onerous scenario, but will still remain jailed in a prolonged period of very slow growth, low interest rates and minimal investment returns under the burden of enormous government and consumer debt. The latter view has been coined the “new normal.” We believe both camps are wrong. Our analysis has consistently led to a far more optimistic outlook dating back to the birth of this bull market in early 2009.

Economic growth decelerated during the first half of this year. As a result, economic forecasters gradually reduced estimates for real (inflation-adjusted) growth to what is now a consensus of just 2% for the second half of the year. The improvement is expected to be a modest 2.5% in 2011. Such tepid growth, should it occur, would not support the level of job creation we need to bring down the unemployment rate. Consumer spending and business investment would likely slow as the effects of economic stimulus subside–a scenario consistent with the “new normal” view. We believe the stage has instead been set for an upside surprise in the months ahead. Domestic growth has been much stronger than pundits, politicians and the public are willing to acknowledge. The headline numbers that serve as lagging indicators are depressing, but this is what the media and the majority of the public focus on, which is why sentiment is so discouraged. We expect real growth will average 3-4% in the second half of this year and well into 2011, driven by a steady pace of real consumer spending growth, a continuation of the surge in business investment and a gradual improvement in the trade deficit.

Consider the fact that nominal consumer spending has already surpassed the highest level achieved in the previous expansion, with measures of consumer confidence and sentiment at dismally low levels and the unemployment rate at 9.6%. What happens when confidence improves and the unemployment rate declines as recent trends would dictate? Combining the increases in wages with the number of hours worked over the past year reveals that compensation has risen at a rate of 4%. With the savings rate approaching 6%, there is plenty of room for consumption to increase as confidence improves, and to allow consumers to continue repairing balance sheets.

We expect businesses to continue to invest and spend at an accelerated pace financed by the surge in profits and record levels of cash that sit on corporate balance sheets. The durable goods report for August, which included an upward revision to the July number, showed orders increasing in every major category with the exception of the transportation sector. In addition, it is likely Congress will support the Obama administration’s recent proposal to allow corporations of any size to fully expense, rather than depreciate, the equipment they purchase between now and year-end 2011. This would serve to bolster capital spending, which we already believe will be a significant contributor to economic growth.

We believe increased levels of consumer spending and business investment will result in more significant payroll job gains following the mid-term elections, yet we don’t view the current employment numbers as negatively as does the consensus. In the past two recoveries, payroll job growth has led the household number, so it makes sense to focus on payrolls to measure economic strength. Private payroll gains have averaged nearly 100K per month this year, which is modest by historical standards, but household employment gains, which include small business and the self-employed, tell a much different story. The surge in household employment by 891K in August brings the average monthly gain closer to 300K for this year. It appears that household employment is leading payroll employment in this recovery. We expect the payroll numbers that investors focus on to catch up with the household numbers in the months ahead. A leading indictor to this improvement will be a decline in the four-week average of unemployment claims below the 450K level, which we expect to see in the fourth quarter.

Trade has been a drag on economic growth over the past year, but in our view that is about to change. Our imports should slow as the inventory rebuilding cycle matures, while we see growth in the developing world re-accelerating, which should boost our exports. The trade deficit, which subtracted a record 3.5% from economic growth in the second quarter, should be a net contributor to growth in the second half of this year and in 2011. In June we opined that “efforts by China and other developing countries to slow their own economies may come to an end.” In August we advocated that “the PRC will implement measures to stimulate the economy in the months ahead.” Last month we learned that August industrial production in China rose a stronger-than-expected 13.9%. This makes us more confident that global growth is re-accelerating. Further confirmation comes from the steady rise we have seen in the CRB Commodity Index, led by the price of copper, as well as the decline in value of the dollar.

As optimistic as we are about the economic fundamentals, we have learned the hard way that stock market performance can be as significant a determinant of those fundamentals as it is a reflection of the same. It is for this reason that we are even more confident in our bullish outlook based on our interpretation of statements made by the Federal Reserve following its September meeting. Chairman Bernanke indicated that the Fed would employ another round of quantitative easing as early as its November meeting, should economic activity and employment growth not accelerate. The Fed also openly expressed concern for the first time, perhaps as cover for such a policy move, about the risk of deflation. Quantitative easing occurs when the Federal Reserve purchases Treasury debt or other debt securities held by banks in exchange for dollars, thereby increasing the money supply. Those opposed to such measures argue that quantitative easing has no direct impact on economic growth. Just because a bank has more liquidity on hand doesn’t mean it will lend more, nor would lower long-term interest rates resulting from bond purchases necessarily spark loan demand. We have no argument here, but we think the opposition doesn’t fully appreciate Chairman Bernanke’s true intentions.

We know that an increase in the money supply has historically lifted stock prices and weakened the dollar. We believe that is exactly what Chairman Bernanke wants to do, though it would be central bank sacrilege to openly say so. Another significant rise in stocks prices would likely trigger what is known as the wealth effect, which in turn could start a positive feed-back loop that achieves the Fed’s ultimate goal—faster rates of economic and employment growth. As stock prices rise, so do consumer confidence and spending. As consumer confidence and spending rise, business confidence and spending follows. Businesses then hire more workers. A weakening dollar increases profits for multi-nationals and our competitiveness in global trade. As the unemployment rate falls, home prices begin to rise again, and stocks continue to move higher. This is the loop.

We believe informing investors of its intentions at the September meeting is designed to have a positive effect on financial markets between now and November. The Fed hopes that stock prices will rise and the dollar will weaken in anticipation of further quantitative easing to such a degree that the wealth effect takes hold. There is the possibility that the economic and employment numbers improve to such a degree that the Fed holds off on further quantitative easing. If we don’t see measurable improvement in the numbers, which is more likely, we believe the Fed will announce another round of bond purchases. Either way, the deck is stacked in favor of the bulls.

We believe the recent breakout above the 1150 level on the S&P 500 to be significant. Investors have been digesting the gains we saw from the March 2009 lows for five months, and we suspect this breakout indicates a new leg up is approaching. We want to be fully invested in stocks at this time, but it is still critical in this new era of man against the machine to be selective on entry points for new investment. The computerized trading that accounts for nearly two-thirds of the volume on the exchanges has no investment outlook other than the handful of seconds that occupy each trade. This has dramatically increased volatility. A move of 5-10% in the market averages in either direction can occur in a matter of days, with complete disconnect from real world fundamentals. Pundits then rationalize these market moves by grasping for data points that support their respective confirmation biases. We refuse to be sucked into the high-frequency vortex, and we work relentlessly to fend off our own biases each day. October is not likely to be a repeat performance of September, and a temporary pullback in prices to digest the record monthly gains in September would be welcome, but we are confident that any pullback will be a final opportunity to purchase common stock within the summer trading range. We expect the S&P 500 to close above the 1150 level in coming weeks, challenge the April high of 1217, and exceed it before year-end.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

PDF version of the Market Outlook

The stock market (S&P 500) tested the lower end of the trading range we identified last month (1050-1150) as a downward revision to second-quarter economic growth, along with disappointing numbers on housing and employment, weighed on investor sentiment. The Dow Jones Industrial (-4.3%), Standard & Poor’s 500 (-4.5%) and Nasdaq Composite (-6.2%) all finished with heavy losses. Telecommunications led sector performance with a gain of 2.3%, while financials were the worst performing sector, posting a loss 7.9% (source:Bloomberg.com).

Stocks are inexpensive at current levels, presenting tremendous upside potential over the long term, while bonds are wildly overvalued, posing significant interest rate risk over the near as well as long term from our perspective. Yet fund flows in recent months show investors continue to sell stock funds and purchase bond funds, as they have since the bull market began, in what appears to be one of the most staggering episodes of risk aversion turned performance chasing on record. This is insanity in our view and clearly not the type of investment activity consistent with a looming bear market; to the contrary, just the opposite. The dividend yield of the Dow Jones Industrial Average is greater than the yield on the 10-year Treasury. The last time this occurred was in the midst of the financial crisis, just before the historic advance in stock prices from the bear market lows. We are not predicting a repeat performance, but we do think that we are in the early stages of this bull market and that bond fund investors face a rude awakening when interest rates rise and fund flows reverse course.

The consensus has clearly bought into an outlook that either we are headed for a double-dip recession or that our economy will grow at stall-speed for years to come, while the rate of inflation endlessly channels between zero and 1%. There are even rumblings that we may be facing a Japan-style era of deflation reminiscent of the deflationary warning espoused by Alan Greenspan in 2003. In our view, these scenarios can’t be substantiated by the economic fundamentals. Investors need to factor in the politically driven hyperbole that is fostering these views in advance of the mid-term election before they follow the herd.

Corporate America is boycotting the Obama administration, and perhaps even the economic recovery. Business leaders are opposed to many of the new reforms and regulations, the increase in the size of government that accompanies them, as well as the possibility of higher tax rates in 2011. Some begrudge the administration for vilifying them in the wake of the financial crisis. Others are simply Republicans. They have expressed an understandable hesitation to hire and expand without knowing the potential impact of the administration’s policy initiatives. This has damaged business confidence. At the same time, we speculate that the political environment has become so hostile that many business leaders don’t want to contribute to the recovery in the near term in any way that may improve the economic and financial market report card for this administration and the congressional incumbents that support it.

For these reasons, we feel that the mid-term election will be a significant catalyst for stock market performance if the results are consistent with where current polling stands now. The polls indicate that we will have a divided government at year-end similar to the one we had in 1994. A divided government would undoubtedly improve business confidence, as much of the uncertainty surrounding the impact of Obama’s policies would be lifted. An improvement in business confidence should lead to an acceleration of job growth, which in turn would result in an improvement in consumer and investor sentiment.

Sentiment is nothing more than a reflection of today’s market valuations and the absolute numbers we see day-to-day that measure economic health. The economy grew at an annualized rate of 1.6% last quarter and the unemployment rate is 9.5%. These numbers are dismal when taken at face value, but it is the direction of these numbers over the long term and the rate of change in the numbers that determine future market performance. We believe both will continue to move in a positive direction.

Economic growth was revised down to 1.6% for the second quarter from a prior estimate of 2.4%, but the reason for the revision should not be cause for discouragement. Both consumer spending and business investment were revised upward, but not enough to offset an even larger surge in imports than originally calculated, which led to the lower figure. This revision indicates that the domestic economy was stronger than previously thought—not weaker.

The headline number on unemployment is equally as depressing when taken at face value, but unless this rate is going to climb from 9.5% to 10, 11, even 12%, it should be viewed positively. The gradual improvement we anticipate for the duration of this expansion is in front rather than behind us, and market prices do not yet reflect this improvement. Our confidence in better numbers comes from the fact that layoff announcements are near a ten-year low, temporary employment is approaching levels not seen since the peak of the prior expansion and permanent employment surveys continue to improve. The number of hours worked per week also continues to climb. These trends are not consistent with an economic recession.

Despite high levels of unemployment, consumer spending has increased in five of the last six months at the same time the savings rate has climbed to 6%. There was a sequential decline in the number of homeowners that fell delinquent on their mortgages in the second quarter. Consumers reduced the amount owed on their credit cards to the lowest level in eight years. The delinquency rate fell below 1% for the first time since 2007. These are characteristics of an improving economic landscape.

Yet investor sentiment has fallen to levels we have not seen since the financial crisis. Amen. We view this negative sentiment as nothing more than an opportunity for new investments and upside in stock prices. Those who are waiting for clarity will be run over by reality as we move forward. We still expect the S&P 500 to challenge the April highs before the end of the year and our fair value estimate for this benchmark remains 1350.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

PDF version of the Market Outlook

Bulls successfully defended what we defined in July as an important support level (1000) for the S&P 500 index, and the surge in stock prices that followed led to the best monthly performance in more than a year. The Dow Jones Industrials (+7.0%), Standard & Poor’s 500 (+6.9%) and Nasdaq Composite (+6.9%) all finished with significant gains. Materials led sector performance with a gain of 12.2%, while healthcare was the worst performing sector, posting a gain of just 1.2% (source:Bloomberg.com).

We believe the macroeconomic malaise experienced in recent months, as quantified by the initial estimate that economic growth advanced at an annualized rate of just 2.4% in the second quarter, will soon be behind us as growth reaccelerates this fall. It would be easy to jump on the bandwagon of slow growth, endlessly low interest rates and sub-par equity returns, coined “the New Normal” by popular pundits, but that’s not the way we see it. We found the GDP report encouraging. The greatest detractor from economic growth was trade, with the deficit subtracting 2.8% from the growth rate, but not because our exports plunged. To the contrary, exports have surged more than 20% in the past year, but imports are growing at a faster rate and off of a larger base number. The surge in imports is indicative of a strengthening domestic economy. We also found encouragement in that corporate spending increased at a 17% annual rate, helping boost overall growth relative to the modest increase in consumer spending. But those questioning the strength of the economy, seemingly hoping for failure, continue to point to tepid job growth. Despite six consecutive months of private sector job creation, the numbers have been less than we expected, perplexing considering the improvement in other indicators.

Our best guess is that politics is playing a key role. The Obama administration and the Democrats that control Congress have declared war on corporate America, or at least that is the way it is being perceived by corporate America. Is it out of the question to suspect that corporate America may be fighting back by doing what it can to stall the improvement in payrolls leading up to a pivotal mid-term election, under the guise that the future remains “unusually uncertain”? The punishment for such inaction, in terms of new hires, would be nothing more than another quarter of improved productivity. Even if our conspiracy theory proves inaccurate, the balance of power is very likely to shift come November, leading to divided government and neutralizing many of the anti-business initiatives underway in Washington. We believe such an outcome will boost corporate confidence and lead to a measurable increase in the monthly gains we have seen in payroll employment to date.

Another conundrum facing bulls is the dramatic decline in Treasury yields to record low levels this year, and the message similar declines have sent to investors in the past–anemic growth, deflationary risks and minimal investment returns. We must admit that our forecast for interest rates this year has been completely inaccurate, given our sense that yields would rise instead of fall as the economy recovered, but we think the mechanics behind the decline are obvious and not indicative of what the bears suggest. Financial institutions in the U.S. purchased large quantities of Treasury debt last year, along with the Federal Reserve, due to slack loan demand and in an effort to increase “quality” capital holdings in advance of the stress tests. We think it was no coincidence that the decline in yields this year coincided with the unfolding of the sovereign debt crisis in Europe. We suspect that European financial institutions also increased their Treasury holdings, in lieu of sovereign debt, and in advance of similar stress tests, the results of which were reported last week. As loan demand recovers, employment growth accelerates and the strains in European financial markets ease, the forces driving yields lower will abate. For the time being, we view this particular barometer of future economic growth as having been broken.

We are encouraged by developments in international markets. Efforts to slow growth in China have ended abruptly, and we think the PRC will implement measures to stimulate the economy in the months ahead. We believe the Shanghai Composite, having declined as much as 32% from its 2009 highs, has bottomed. The rally in recent weeks leads us to the conclusion that a soft landing will take place, and that growth will reaccelerate by year-end, leading to significant gains in the benchmark index as a new bull market begins. Such events, should they transpire, would be a boon to the developing world, offsetting to some degree the anemic growth in Europe and further supporting U.S. economic growth.

If it sounds like we are striking a more bullish tone than last month, we are. The money supply (M1), which has been flat for nearly six months, broke out to the upside last month to reach a new cycle high. This tells us loan demand is starting to rise again. GE raised its quarterly dividend by 20%. Federal Express raised its profit forecast for the year ahead, and announced it would fully reinstate its company match for 401(k) plan participants. The American Bankers Association reported that credit card delinquencies fell to an eight-year low in the first quarter of 2010. These developments speak volumes about what lies ahead in terms of economic activity and confidence, both of which are improving, and are not indicative of a looming recession or even a deteriorating outlook.

We recognize that consumer sentiment is dismal today, but is that really a bad thing for investors? The University of Michigan has reported results for its consumer sentiment survey each month since 1978. When the results of the monthly surveys are ranked in deciles from the most pessimistic level of sentiment (last decile) to the most optimistic (first decile), recent results fall in the next to last decile. Perhaps ironic to most investors, when consumer sentiment has fallen into one of the bottom three deciles, the performance for the S&P 500 in the subsequent five-year period has been an annualized 12%. When sentiment rose to the top decile, implying extraordinary optimism, subsequent five-year period returns were actually negative! Statistics like these are powerful tools when forecasting because they often lead to conclusions that run counter to consensus thinking.

An even more stunning and timely statistic is one that highlights the impact of mid-term elections on stock market performance, regardless of the election outcome. There have been 15 one-year periods since 1950 that began on October 1 in the second year of a presidential term. The S&P 500 has posted positive returns in every period. The average gain has amounted to nearly 25%. Perhaps this time it will be different, but when we combine the recent dismal consumer sentiment survey results with the mid-term elections approaching during the second year of a presidential term, we feel we have a very strong historical tailwind supporting our bullish outlook for the market.

The stock market bottomed in March 2009 just before leading economic indicators began to rise. The recession officially ended just three months later. The market soared as a stimulus-induced recovery unfolded over the proceeding 12-month period, stalling on April 23rd of this year. As the economy is transitioning from recovery to expansion and the engine of economic growth is shifting from the public sector to the private sector, we are in the midst of a correction in stock prices and a slowing in the rate of economic growth. This is very consistent with the historical playbook. We expect the market (S&P 500) to remain range-bound between 1050 and 1150 through the remainder of the current quarter, providing investors the opportunity to position for what we believe will be a breakout to the upside that will challenge the April highs before year-end. Our fair value estimate for the S&P 500 remains 1350.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

Performance History

*Composite inception 12/28/2009

Trailing Total Returns

PDF version of the Market Outlook

The economy has hit a speed bump, reflected in data on housing, employment and consumer spending in recent weeks. Concerns over China’s economic slowdown, austerity measures in the Eurozone and an anti-business policy agenda under the Obama administration have also been factors in risk aversion and deteriorating investor sentiment. The stock market has corrected approximately 15% from the April highs. The Dow Jones Industrials (-3.6%), Standard & Poor’s 500 (-5.3%) and Nasdaq Composite (-6.5%) all finished the month with significant losses. Telecommunications led sector performance with a loss of less than 1%, while the consumer discretionary sector was the worst performer, posting a loss of 9.8% (source:Bloomberg.com).

Investors must continuously weigh an exhaustive list of economic indicators, often times sending mixed messages, in order to evaluate the risks and rewards in financial markets. Making this process more difficult, bulls and bears incessantly twist facts to fit a certain fiction that they hope the consensus will buy, so as to realize profits from their respective investment strategies. At this time, a viable case can be made for both a bullish and bearish outlook, but as we balance the tailwinds and headwinds, we come to the conclusion that the glass remains half full. With a steep correction well underway, the media vortex is predictably emphasizing the negatives, which consumes the short attention span of most observers. The bears have come out of hibernation to jeer the possibilities of a double-dip recession and bear-market decline in stocks. We think neither scenario is probable.

To the contrary, the slowing rate of economic growth and the stalled improvement in vital signs for the economy following one year of recovery, as well as the market correction that is accompanying it, has historical precedent. In both the 1991 and 2002 recoveries, real economic growth slowed to less than 2% for two quarters before reaccelerating to 4% in the following year. Bears will argue that the current landscape is far worse than either of these two periods, and in light of this stance we think the following quote from an article in Time apropos – “The US economy remains almost comatose. The slump already ranks as the longest period of sustained weakness since the Depression. The economy is staggering under many ‘structural’ burdens, as opposed to familiar ‘cyclical’ problems. The structural faults represent once-in-a-lifetime dislocations that will take years to work out. Among them: the job drought, the debt hangover, the banking collapse, the real estate depression, the health-care cost explosion, and the runaway federal deficit.” The irony is that this was written in September 1992, and the period that followed for equity investors was one we would gladly welcome today, yet at times like these a pessimistic outlook is simply far more believable.

Earlier this year, we forecast zero economic growth for the Eurozone in 2010. The tax increases and spending cuts proposed will surely send the region back into recession, but we do not see this impeding the U.S. recovery underway. Developing economies play a far more important role. Slower economic growth in China should be expected, as the government has been taking steps to bring about just that for months in an effort to reign in inflation and housing speculation. We expect growth to slow from 12% to 8% in the year ahead, but we wouldn’t call that slow growth. The fact that China is dependent on Europe for more than 20% of its exports leads us to the conclusion that China will halt further efforts to slow its economy and successfully negotiate a soft landing. We do not believe today’s engine of global growth with falter, and it should continue to support the U.S. recovery.

On the domestic front, there was a significant decline in existing and new home sales for the month of May. Retail sales declined more than expected and The Conference Board’s survey of consumer confidence deteriorated. These circumstances fueled negative sentiment. It should come as no surprise that home sales would falter with the expiration of the homebuyer tax credit having pulled future sales forward, and little attention was paid to the fact that existing home prices have risen 4% over the past year despite the tsunami of foreclosures. The decline in retail sales was disappointing, but overall consumer spending rose more than expected, as personal incomes increased even when excluding government transfer payments, and the University of Michigan’s consumer sentiment survey rose to its highest level since January 2008. We expect real consumer spending will continue to advance at a rate of 3% in the second half of the year.

There has been understandable discontent with the lack of a further decline in weekly unemployment claims and the slow pace of job growth this year. However, we believe unemployment claims have remained elevated due to the release of census workers, and we expect the decline to resume in the months ahead. Household employment, which we believe to be a better indicator of job growth, has increased approximately 1.2 million this year compared to the approximate 600,000 payroll jobs created. Layoff announcements continue to decline, and the number of hours worked as well as wages and salaries are advancing at an annual rate of 3%. A new survey of CEOs (The Business Roundtable) planning to ramp up hiring is at the highest level since mid-2007, suggesting to us that these numbers continue to improve. While the employment data is not robust, it is clearly not negative.

On a more positive note, consumer balance sheets are mending as real income increases at an annual rate of nearly 7% and financial obligations continue to decline along with interest rates. This is evident in the fact that 30-day delinquencies have declined for six months in a row. Corporate balance sheets could not be stronger, as profits have surged and the cash held by non-financial U.S. corporations approaches $2 trillion. This bodes well for further increases in capital expenditures and employment. We expect profit growth rates to moderate, but this should not be a concern. Profit growth rates continued to decline during the expansion from 2004 to 2006, yet the S&P 500 appreciated nearly 30%. Even when we lower our earnings forecast for 2010 to $80 for the index, the valuation is approaching the low end of its historical range.

The modern era of money management is a sad state of affairs–one where a single data point released during the course of trading can lead to an abrupt decline of 100 points in the Dow Jones Industrial Average within seconds, as the adolescents that operate computer programs for institutions all hit the sell button simultaneously. Market watchers then extrapolate the decline into a more ominous “state of reality” than truly exists, and the decline deepens accordingly. If we have any concerns, it is that a new paradigm has emerged since 2008, whereby financial markets have more influence over the fundamentals they are supposed to reflect. Volatility has and will continue to increase. It has become more difficult to discern fiction from reality than ever before, and investors, ourselves included, must continue to modify our approach to asset management in order to be more agile in this environment.

We admittedly moved too early towards a more optimistic outlook for the market from the defensive posture we stood by in April, but the lower levels we did not expect to see have not yet changed our outlook. The uptrend in the market remains intact, provided the S&P 500 is able to stay above the 1000 level. Should it violate that level, we will have to reevaluate our economic outlook in consideration of the psychological impact on consumer and business activity.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

PDF version of the Market Outlook

May was a horrible month for the stock market. Fears intensified over the sovereign debt crisis in Europe as concerns shifted from default risk to the impact austerity measures would have on economic growth. Pundits hypothesized that lower rates of economic growth in Europe, combined with efforts underway in developing countries to slow their own economies, could undermine what most see as a fragile U.S. recovery. Financial regulatory reform arose as another headline risk when the Senate debated several amendments to the proposed legislation that investors feared could hurt profits at financial companies. The Dow Jones Industrials (-7.9%), Standard & Poor’s 500 (-8.2%) and Nasdaq Composite (-8.3%) all finished the month with significant losses. Telecommunications led sector performance with a loss of 3.9%, while the energy sector was the worst performer, posting a loss of 11.8% (source:Bloomberg.com).

We view the recent selloff as nothing more than a correction, defined as a decline of 10-19%, which is customary at this stage of a bull market. We have seen corrections that averaged 15% in each of the previous 12 bull markets dating back to the Great Depression–they are par for the course. Last month we discussed our rationale for having reduced domestic stock exposure in anticipation of such a correction. Investors were simply too complacent with respect to the sovereign debt crisis unfolding in Europe, given the feeble and disjointed policy responses from the EU and ECB up to that point in time. We stated that when “heightened levels of risk are brought to the forefront of investors’ minds, they will be factored into market prices very quickly, and lead to what we believe will be yet another opportunity to invest in domestic equities.” To say that market prices declined “very quickly” would be an understatement. The S&P 500 fell nearly 15% from its April high to its intra-day low on May 25, pushing well below the 1100 level that we believed stood as support. We were not deterred by this decline, as it was expected, and we used it to increase our exposure to domestic equities.

Whereas investors were completely indifferent to the risks posed by sovereign debt a few weeks ago, now they are overwhelmed by systemic risks we simply don’t see. The potential for a debt default has been taken off the table with the near $1 trillion loan package orchestrated by the EU and IMF. Economic growth will undoubtedly slow when the required budget cuts for EU member nations that receive loans under the new program are enacted. We expect the euro will continue to decline in value, and it would not surprise us if Europe slips back into recession later this year. Economic growth has yet to be addressed. We believe the ECB will reactively lower short-term interest rates and implement quantitative easing measures similar to those employed by the Federal Reserve over the past year. They will purchase sovereign debt, so as to support the balance sheets of the banks holding this debt, and give up efforts to sterilize any increase in the money supply. This will be the monetary response to what we see as a deflationary environment, but the EU will ultimately have to grow its way out of this fiscal crisis with economic stimulus coming from the stronger member nations, much the way the United States is attempting to do so now.

The silver lining in Europe’s deteriorating growth outlook is that efforts by China and other developing countries to slow their own economies may come to an end. Inflation no longer poses as serious a threat as waning export growth to Europe. We believe China is on the cusp of ending efforts to reign in growth, and that such steps, should they occur, will bolster our own export growth. More than half our exports now go to the developing world. From our perspective, Europe alone is not a significant headwind for the U.S. economy. Our financial institutions have negligible exposure to sovereign debt, and the percentage of annual revenues for U.S. companies in the S&P 500 coming from Europe account for less than 10% of the total.

Despite Europe’s fiscal crisis, the U.S. economy continues to gain traction as the rate of change in nearly every data point we monitor is moving in a positive direction. Delinquency rates on consumer loans are falling and bank lending standards for consumers have started to ease. Consumer spending has risen at a 4.7% annual rate over the past six months and it has now exceeded its prior peak in 2008 on a nominal basis. Hotel occupancy rates are rising along with airline demand, trucking activity and shipping cargo volumes. Spending on advertising by small business has been steadily improving, rents are on the rise, and state income tax receipts are increasing. These facts tell us that employment growth, which is the foundation to a sustained recovery and the key to a continuation of this bull market, is much stronger than private-sector payroll numbers suggest.

Payroll employment has increased four months a row, and averaged nearly 200,000 jobs over the past two months, but the unemployment rate has remained stubbornly high. The reason for this is a staggering surge in the labor force since the beginning of the year. Yet we believe the household employment figures, which include the self-employed and small businesses, are painting a far more realistic picture. Household employment soared 550,000 last month and has increased nearly two million over the past four months. These numbers clearly justify the improvement we are seeing in credit, consumption and economic activity, and they indicate that payroll employment figures are likely to continue increasing well into 2011.

We are far less exuberant over the prospects for meaningful financial regulatory reform. It appears as though lawmakers have once again sold their souls to Wall Street in exchange for either campaign cash or a cushy job as a lobbyist or consultant should their prospects for reelection not look favorable come November. We will refrain from further judgment until the sausage-making process is complete, but any reform that does not enforce the ban on naked short-selling and regulate the credit-default-swap market is no reform at all. We are confident at this stage that the final product will have little to no impact on the profitability of the banking sector.

We think it is important to address the dramatic increase in market volatility that has unnerved investors in recent weeks. The data points we focus on are far too mundane to even be mentioned on the nightly news, and our commentary is typically devoid of the emotion and sizzle that routinely accompanies the headlines disseminated each day. We are not politically-charged pundits, television personalities or the cheerleaders most rely on for an interpretation of the news through mainstream media outlets. As investors, we concentrate on long-term trends rather than announcements, events or news bites, but there is a relatively new and fast growing sub-species of supposed asset managers that focus on nothing but the daily diatribe. They are known as high frequency traders. They accounted for nearly two-thirds of all the trades placed on the exchanges last year in what has rapidly become the most popular high-octane sport on Wall Street.

Last Tuesday, markets plunged on a rumor that China was considering reducing its holdings of European sovereign debt. Markets reversed course violently on Thursday when Chinese officials denied such rumors. Markets nose-dived yet again on Friday following a downgrade of Spain’s credit rating. This is nuts! First of all, who cares about Spain’s AAA credit rating? We don’t! Ask one of the sleuths on CNBC how a change in Spain’s credit rating impacts the U.S. economy and you will see a blank stare. They have no clue, but they tell you it must be bad, because market prices have plunged on the news. This high-school drama is not where investors should be focused.

High frequency traders are nothing more than computer programs based on algorithms. Firms like Goldman Sachs spend millions of dollars developing and constantly tweaking these programs. Some are designed to interpret the headlines and sound bites as either bullish or bearish, and then buy or sell baskets of securities based on these interpretations. Others are programmed to buy and sell based on technical price levels. The advantage high-frequency trading programs claim to have is that they make decisions faster than humans, but they also receive pricing information from the exchanges faster than we do, because their servers are located on the site of the exchange itself. In our opinion, this is blatant front-running. This latest absurdity is the only rational explanation for the intra-day swoons in market prices we have seen recently, all in an effort to scrape a few pennies per millisecond in front of the order flow sent by commoners like us. The 1000 point drop in the Dow Jones Industrial Average on May 6 was no aberration. We expect there will be more volatility to come in both directions until regulators and lawmakers wrap their hands around this latest waste of intellectual capital.

It takes a strong stomach and an unbreakable will to focus on the fundamentals in this new era of instant communication and the 24/7 news cycle. As unnerving as this increase in volatility may be, it is the mundane statistics we follow, and not the latest sound bite or headline the world chooses to focus on, that determine trend. The trend is far more important than the trade, and from our perspective the trend is still up for the U.S. stock market.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.