The broad market posted positive returns the past four consecutive quarters and the DJIA and S&P 500 recently hit 18-month highs. Over the past year, the S&P 500 is up about 46 percent, and the aggregate earnings of the companies within that index are 79 percent higher than they were a year ago.

This is ironic because many investors and most of the media expected a meltdown last year. As a result many investors completely missed huge gains. In the face of criticism, we encouraged investors to be fully invested since the market lows in March 2009. In July 2009 our indicators showed the recession had ended. We put our money where our mouth was and have been fully invested since the market lows, which has significantly benefited our account holders.

Our portfolios have continued to perform well during the first quarter of 2010. Our conservative portfolio, Managed Income, gained 3.27 percent for the quarter versus 1.78 percent for its benchmark, the Barclays Bond Index. From its inception in October 2001 through March 2010, it has gained 71.3 percent versus 55.4 percent for Barclays Bond Index.

Our growth portfolio, Top Flight, lagged slightly for the quarter but still delivered 4.7 percent versus 5.4 percent for the S&P 500. Because of the steep sell off in February, our models forced us to be more defensive. Being defensive cost Top Flight some of its return for the quarter. It is not unusual for us to lag slightly from time to time. Sometimes we lag at turning points but then more than make it up during the longer-term trends. From its inception in January 1998 through March 2010, Top Flight earned 382 percent versus 49 percent for the S&P 500.

REASONS FOR CONCERN AND OPTIMISM

Even with the stabilization of the global economy, there is no shortage of short-term causes of concern:

• How strong is this recovery?

• Has the market factored in the recovery?

• Is the market about to run out of steam?

• We know interest rates will go up. The question is when, and how much?

• How will the depressed housing market affect the stock market?

• What does high unemployment mean for the market?

• What is the impact of healthcare legislation?

• How will government deficits affect the market?

The good news is there are offsetting positives. Even though headlines ignore the positive news, our indicators show that the global economy has improved steadily since June 2009.

For example, last month alone, ISM non-manufacturing improved, vehicle sales surged on incentives, employment indicators pointed to sustainable job growth, pending home sales rebounded, housing affordability remained high and trade activity indicators improved.

The Wall Street Journal recently ran a story about dividend hikes as a result of rising profits by U.S. companies. The article also mentioned that cash on hand on U.S. corporate balance sheets was at the highest level since 2007. The same day The Financial Times ran a similar story about dividend increases in Europe.

Many of the positives that drove market optimism two years ago are still in place, among these the continued emergence of a global middle class in developing countries like Brazil, China, India and Turkey. If this continues to evolve, these emerging markets will be powerful drivers of growth going forward.

FORECASTING THE FUTURE

Regardless of where we are in the cycle, the question always remains the same. Where do we go from here? After listening to forecasts from some really smart people over the past 24 years, I’ve concluded that no one has a clue what will happen in the future. There are too many variables. John Kenneth Galbraith wisely said, “There are two classes of forecasters: Those who don’t know - and those who don’t know they don’t know.”

Whether you choose to focus on the positives or the negatives, there is a broad agreement that we are no longer on the cusp of a global depression. The issue is not whether the economy will recover, but when, at what rate, and whether there might be another stumble along the way.

If I guessed what will happen next, I would say that the current advance might run out of steam in April or May. After such a big run up, it would not be unusual for the market to go sideways or down between May and October and then resume the uptrend again sometime in November. Longer-term, my expectation is that we see better than average gains over the next two to three years, but not like the incredible gains we saw the past year. For the record, this is just my best guess of what may happen. As I write this newsletter, all of our models are still bullish. Fortunately, we do not follow my guesses; we only follow our quantitative models.

I am often asked about the impact of politics on the market. I believe that the U.S. economy is the strongest in the world. It goes through normal cycles of boom and bust. Through mid 2007 it was booming and by March 2009 it was completely busted. Politicians try to make themselves seem more important than they really are, so they do their best to convince us that they control the keys to our economy.

The fact is that our economy has gone through its cycles since 1776 in spite of their tinkering. If anything, it can be argued that their previous efforts to “save us” have been ineffective at best and costly mistakes at worst. Of all the possible negatives outlined above, I believe that political meddling is the most onerous. The rate at which the government insists on spending is not sustainable. At some point they will run out of other people’s money to finance their enormous deficits. We have not crossed the tipping point yet, but are approaching it.

If we elect people who step up and deal with these important issues, we will move past these problems as we have in the past. Effective tax policy, responsible spending and pro economic growth policies are where our government needs to be focused. If they do not figure that out before we reach the tipping point, we will need to take necessary steps to protect our investments. Either way we will continue to follow the models that have guided us in the past.

IN CONCLUSION

In his annual letters to shareholders, Warren Buffett wrote that it only takes two things to invest successfully – having a sound plan and sticking to it. He went on to say that of these two, it is the “sticking to it” part that investors struggle with the most.

Boom times such as we saw in the late 90’s and scary conditions such as we have seen in the past two years can make that difficult, but as we have seen, difficult conditions can also represent opportunity. In the face of economic and market uncertainty, another key to success is having a diversified plan customized to your particular risk tolerance. It can be hard to ignore the short-term distractions, but ultimately that is the only way to achieve your long-term goals with a manageable amount of stress along the way.

Thank you for giving us the opportunity to work together. If you have any questions or if there is anything you would like to discuss, my team and I are always happy to take your call. You can reach us at 800-748-4451.