SONORA INVESTMENT MANAGEMENT, L.L.C.

Review and Outlook Mid-Year 2010

Stock market gains, fueled by hopes of a global economic recovery, faded in the second quarter leaving all of the major U.S. stock indices lower than they began the year. The Dow Jones Industrial Average and the S&P 500 Index fell 6.3 and 7.6%, respectively, during the first half. Comparatively, international markets faired worse. China was the hardest hit losing 27%, while most European indices fell by more than 10%. 

Globally, markets lost value primarily because of fears of a “double-dip” recession that intensified as the first half of the year progressed. Domestically, concerns over high unemployment, weak consumer confidence, continued softness in real estate, the growing U.S. deficit, higher tax rates coming next year, and onerous regulatory policies, to name a few, fueled the downturn. The Gulf oil spill added to economic woes as many businesses including oil drilling, tourism, and fishing have seen their businesses damaged. Yet, according to Credit Suisse’s economic model the probability of a “double-dip” recession is close to zero. 

One of our main concerns remains the longer-term effect ever-increasing debt will have on our economy. U.S. Treasury debt, Fannie Mae and Freddie Mac, civil-service and military pensions, Medicare, Medicaid, and Social Security all total over $100 trillion in unfunded liabilities. Contrast that with current U.S. tax receipts of just $2.5 trillion and a growing deficit of $1 trillion, annually, and one can see that we are going to face challenges if nothing is done to address these liabilities soon. States like California and Illinois are in similar circumstances too.

In spite of these issues, our economy is growing and corporate profitability is quite healthy. Companies now hold more cash on their balance sheets than at any time in history and corporate earnings continue to improve. S&P 500 earnings for the year will hit about $77 and grow to $85 to $90 next year, according to analysts’ estimates. These earnings make the market appear quite attractive. The S&P 500 is trading at 13.5 times projected 2010 earnings and only at 12 times 2011’s estimate compared to the historical average P/E of 16.

Also during the second quarter China raised their interest rates and allowed their currency to strengthen against the dollar. This is beneficial for us because a relatively weaker dollar makes our goods more attractive and will increase our exports. 

At some point, business sentiment will improve and companies will start investing more of the cash they have on hand in equipment and people. But, until there is a comprehensive government policy supporting businesses and addressing the above economic issues, there is a good chance the stock market will face significant headwinds. As a result, we have turned more defensive despite stock valuations. We have been adding to convertible bonds more than common stocks and will continue to do so for now. The bonds are less volatile and will appreciate if stocks move higher. As for the companies we own, we particularly favor those that have a large international presence and that pay dividends.

As always, we thank you for your trust and support. We remain committed to delivering the best performance and service possible to you.