Bad news sells newspapers. That really tells us what is happening today in the financial markets. This is manifesting itself in poor, emotional decisions by investors (selling stocks and buying bonds). In our last market update, we talked about how the stock market is now selling at one of its cheapest levels relative to bonds and cash that we have seen in our lifetime. From a fundamental standpoint, companies are strong financially and have enough cash to weather any storms ahead. Listed below are a few of the most prescient technical indicators that we now see:

- AAII’s (American Association of Individual Investors) survey is now 20% bullish; it was 48% bullish on April 15th – near the peak of the market. Other times that the bullish percentage was lower than today was back in 1988 (right after the ’87 crash), 1990 before the start of the Gulf War and at the most recent stock market bottom on March 5, 2009 (it was at 18.9%). All great times to buy equities.

- The Consumer Conference Board just announced today that consumer confidence was up +2.5% in the month of August. This (along with an increase in consumer spending) shows us that even with all the bad news, consumers are not dead. Consumers have been building their balance sheets over the past 18 months. In fact, credit card debt is back to 2002 levels with an average balance under $5,000.

- For the first time since 2008, insiders (directors and officers) are buying stock in their own companies. Insiders know best what their companies are worth. That is why Hugh Hefner bought back Playboy (at a 40% market premium!!!) and took it private.

We believe the overriding concern of investors is the upcoming election. If the elections were held today, it appears that the Republicans will have more votes in both the House and the Senate. History tells us that a stalemate is not a bad thing from the market’s perspective. Businesses will adjust to new regulations and taxes going forward. What they need is certainty about the future. If the “rules” of the road ahead are uncertain, businesses will hoard cash (the S&P 500 companies currently have $2 trillion in cash). As we have stated many times in the past, the opposite of progress is Congress. Once investors and businesses realize that certainty is coming, the stock market and economy should stabilize and move higher. Whether this occurs before or after the election, we can not predict. However, with the market selling at very attractive valuations, we believe the current downside risk in the market is very limited at this time.

Schwab cost basis information

We wanted to take this opportunity to address an issue relative to your monthly Schwab statements that has generated multiple questions and concerns on the part of our clients. For some time now, Schwab has reported the “cost basis” and the “market value” of each individual position in your account. In many cases, the cost basis is higher than the market value, giving one the perception that the position has lost money. What Schwab fails to report for each position though, is the amount of money used to make the initial purchase. This is important. If there is a difference between the amount of the initial investment and the cost basis, it is likely because dividends have been distributed for the position. As a shareholder, you must report these dividends on your personal income tax return in the year of the distribution. This distribution will increase your cost basis if your dividends are reinvested, but otherwise does not affect the amount of money gained or lost on a particular position. So, subtracting your cost basis from your current market value does not always tell you whether you have made or lost money on that position. We recommend using our quarterly reports to assess the performance of each position as we report all three values – initial investment, cost basis and current value.

New Employee

We would like to welcome our newest employee, Neal Ritondaro, to the THOR team. Neal comes to us as a new graduate of the University of Akron and will be learning all aspects of the THOR process before settling into a formal position at THOR. Please take a minute to welcome Neal to the team. He will be attending the client appreciation dinner so this is another great reason for you to attend the dinner!

Sincerely,

Your THOR Team

Is The Next Bubble The Bond Market?

In the 90’s we had the “tech” bubble and in the 2000’s we had the “real estate” bubble. Going forward, is there another bubble investors should be concerned about? We believe a bubble could be forming in the bond market. A bubble occurs when money rushes to a sector of the economy and that sector is bought at any price. There have been unbelievable flows into bonds over the past year and a half. On a weekly basis, average inflows into bond funds are in the range of $6-8 billion per week. However, many do not realize the low yields they are getting on bond funds. Just last week, Procter & Gamble two-year bonds were trading with an annual yield of 0.65%. IBM was able to issue a three-year note with an annual yield of 1.0%. What is interesting is that bank CD’s offer a higher yield. So why on earth would an investor buy these bond funds over a bank CD that is fully backed by the Federal Government? It is a function of supply and demand and irrational behavior. We are seeing more and more money going into bonds/bond funds and bidding up prices beyond what they should be “normally.” The dividend yield on a share of P&G stock is currently 3.21% (and, at least this year, is taxed at a lower rate than bond interest) compared to the 0.65% yield on the P&G bond. This is the complete opposite relationship that was in place in 2007. In our opinion, bonds are not currently a rational investment. This is a clear sign of a bubble.

Sincerely,

Your THOR Team

High unemployment can be fixed today

There is nothing more frustrating to us (and many of you) than to continue to hear pundits say that we will have a sustained high level of unemployment for years to come. There are a number of ways to solve the unemployment problem – one of which is to lower corporate income taxes (we discussed the benefits of a lower corporate income tax extensively in The THOR Plan located at http://thorinvestment.com/thorplan.shtml ). The impact of a lower corporate income tax on unemployment is fast and measurable. One only needs to look at Germany as an example. Germany lowered its corporate income tax rate twice in recent history. Germany first lowered its corporate income tax rate from over 55% to below 40% in 1999-2000. In 2007, it lowered the rate to 30%. By lowering the corporate income tax rate, Germany became more competitive globally and jobs flooded into Germany. The unemployment rate in Germany was 9.05% in 1998 and dropped to 7.61% in 2001 (in the middle of a recession!). In 2006, the German unemployment rate was 9.8% and fell to 7.4% in 2008. At the end of 2009 it stood at 8%. The US unemployment rate stood at 10% at the end of 2009 compared to just 4.4% at the end of 2006.

The US should also consider going the way of Hungary – yes, we said “Hungary.” Hungary is cutting spending (including the salaries of many bureaucrats), slashing the income tax rate for small and medium-sized companies from 19% to 10% and has gone to a flat tax of 16% on personal income. This is a good response to spark economic growth. The US, unfortunately, has and is taking the wrong course of action.

We at THOR believe that there should have been stimulus to help the US economy back at the end of 2008. There is, however, good stimulus and bad stimulus. Good stimulus creates private jobs and encourages investing. Bad stimulus creates more government bureaucracy with higher paying jobs in the public sector than the private sector. The economy in Washington, DC is doing quite well – see http://www.politico.com/news/stories/0710/39851.html - but what about the rest of the country? Government needs to create an environment where individuals and companies are encouraged to make long-term capital investments, which in turn, will create jobs. We are not espousing a political point of view here, but, rather, an economic one. One only needs to listen to JFK’s words back in 1962 espousing his economic policies that helped create an economic boom in the 60’s - http://www.americanrhetoric.com/speeches/jfkeconomicclubaddress.html. In our opinion, JFK’s policies are the same policies that we should use today.

Sincerely,

Your THOR Team

The Tale of Two Cities

What are the two cities? The news of woe – a possible second dip in the economy - and the expected good corporate earnings reports. The media has been replete with negative news about the economy for the last two months. We stopped counting how many articles we had read about the coming “double dip recession”. These news items were part of the reason for the stock market correction in May and June. As to good corporate earnings – we have recently had meaningful conversations with numerous fund managers and continue to see a consistent theme. The information gleaned from these fund managers is that business is not as bad as the media is portraying it to be. In fact, many said that profits and earnings should be very good. In other words, what the media is saying and what is happening within the companies themselves are completely different. The tale of business is now surfacing with the first few companies (State Street Bank, Intel, Alcoa, etc.) releasing earnings well above estimates over the past week. This in turn is why the stock market is up over 6% so far in July.

Survey Results

We want to thank all our clients who responded to our survey earlier this month. The disparity between the news reports and what we are hearing from fund managers is why we wanted to see how the current business conditions are compared to March of 2009 and to two months ago. We wanted to see which “tale” is true. Whenever you sample a cross section of different industries, you do get a wide range of results. What is most important however, is what the majority of people are telling us. The survey results confirmed the good “tale” with no indication that we are falling into another recession (and definitely not like the one we just came through). Business is still reasonably better than it was back in March of 2009 and roughly about the same as it was two months ago. This indicated to us that the economy is not nearly as bad as the media is portraying it to be. This information, along with what we heard at a recent Morningstar conference, gives us more confidence that the downward move in the market in May and June was a simple correction and not the start of another recession.

Request: We know that our survey is just a snapshot that can change at anytime. If you do see a noticeable shift in your company’s business, either positive or negative, please let us know. These early signs can be very beneficial to us, and, in turn, your portfolio. Please email Jim at jgore@thorinvestment.com with any noticeable changes.

Sincerely,

Your THOR Team

The stock market is down ~ 6% since our last update and as such, bonds have rallied. At the risk of stating the obvious, basic supply and demand gives a very top level approach to why. For example, depending on the figures used, 2009 saw an inflow to bond mutual funds of between $357 billion to $375 billion. This was the highest recorded since 2004. To date, we have seen around $150 billion flowing into bond funds, putting us just shy of those record numbers (if 2010 continues on this pattern). However, the record flows are not what are surprising. What is surprising is the level of yield investors are willing to accept in light of investment alternatives.

To illustrate, let us look at Johnson & Johnson. Currently JNJ stock offers a dividend yield of ~ 3.6%, while its bond, maturing in 2017, offers a yield of ~ 2.8%. So why would an individual investor make this choice? Possible explanations include a perception that the company will soon cut its stock dividend or a poor estimation of the underlying business risk. Being literally one of a handful of companies that have maintained their AAA rating and have increased their dividend every year since 1972, we do not see either of these being major risks. What we do see is that this example is one of many situations that represent a dislocation within the financial markets. Investors have given absolute preference to bonds over stocks. As is the case with JNJ, investors are saying they are willing to take a lower yielding investment and give up the potential upside appreciation in preference for holding fixed income. We would argue that owning the stock is a better (and more rational) investment decision.

Events like this show us how easy it is for market participants to lose sight of the big picture and focus on the news of the day. Although it can make it tough for rational investors to maneuver in the short-term, it does provide for long-term opportunities to build wealth.

Sincerely,

Your THOR Team

The extremes in the market in the recent past – overbought in mid-April and oversold just a couple of weeks ago - have dissipated. Volatility has fallen and the market has held support at a critical point 4 times, which is a good sign. It is not unusual (actually it is expected) to have a correction of greater than 10% in a bull market, especially when the initial run up stage has been completed. A correction in a bull market takes out some “froth” and rebuilds the market for the next up leg. The oversold/overbought conditions we look at are shorter-term indicators and currently show that the market is still oversold, but not at the extreme level they were just last week. The recent action in the market over the last few days is encouraging as we have seen lower volatility and steady upside performance.

Some clients have become very concerned about problems in the US and around the world. Yes, we agree that there are some major hurdles for the future: high unemployment, the potential collapse of the Euro, Middle East tension, increased government spending, inflation expectations, etc. These issues are real and significant. This cautious outlook by individual investors is why fixed income assets were at record levels in the month of May. However, investors that jumped out of the market early last week may have made a critical mistake. The market, as defined by the Dow Jones Industrial Average, is still 26% below its all-time high, is currently trading at a reasonable valuation, and should continue to see earnings surprise’s on the upside. US companies, growth companies in particular, have balance sheets that are in the best shape in decades and are cheap relative to the peers on the value side of the ledger. Additionally, interest rates are still very low and, in our opinion, will continue to be low for an extended period. Looking at the chart below shows the returns of various asset classes compared to the average investor. One can quickly see what short-term emotional decisions can do to the returns of the typical stock market investor.

Source – J.P. Morgan Guide to the Markets 2Q 2010

Our technical analysis of the market shows that the long-term uptrend of the market is still intact. Our analysis though requires us to be vigilant on a daily basis, looking for signs that might indicate a reversal of the current trend. The number one signal that would give us pause is if we started to see short term interest rates starting to rise. We don’t expect to see that in the near future. This may be the start of the proverbial “Summer Rally”.

Sincerely,

Your THOR Team

P.S. - If you get a chance, please give a warm welcome to our newest employee, Susy Hisch. She will be taking Mary Ann’s place at THOR and will likely be the first person you speak with when you call into THOR going forward.

Calm Waters ahead?

The past three weeks have probably been the strangest shift in individual investor psychology we have ever seen in our 24 years of investment experience. We went from a calm steady market to almost complete panic in three weeks. We now believe the market is trending to a more stable period ahead. To illustrate our point, consider the VIX, a widely followed index that measures volatility in the market The VIX was selling just below $16 on April 21st. Last week it peaked out just above $47 - a 300% rise - and is slightly above $30 - a 35% drop - today. The falling price of the VIX is a sign that volatility is coming down. That is a good sign. The last time the VIX was above $47 was in March 2009 and it gradually fell in price until April 21st of this year. Even though we had a good pop in the market yesterday, we are more encouraged by the fact that the volatility level is falling. The fall in volatility, an oversold condition and bouncing off major support are all good signs that the bull run that started in March of last year has not yet peaked.

Time to remember and thank our Soldiers

This weekend we at THOR will be remembering the sacrifices of the proud men and women that have given their lives for our country. This Memorial Day we will especially remember Jenna’s brother-in-law, who died in Afghanistan, and Brando’s sister’s boyfriend, who died in Iraq. It is because of their sacrifice that we as a nation are free. Not only do we remember the fallen, but we also give thanks to all our clients - and their family members - who have served (or who are still serving) in the military. Thank you.

Gratefully,

Your THOR Team

There is one constant in the financial markets – emotions. All markets go through bouts of “fear and greed.” The length of these emotional ups and downs is different each time. It was only three weeks ago that we were receiving phone calls from clients who were very optimistic about the market. One client left the message “Don’t miss out on any of this good market action.” What a difference three weeks makes! We are now getting a handful of calls from jittery clients asking if they should cash out of everything. So what is THOR’s take on the current market? Before we review our thoughts, please remember that just a few weeks ago, when investor optimism was high, we were characterizing the market as overbought. In addition, we continue to have the lowest exposure to international stocks that we have had in our 18-year history as a firm. This continues to be a good strategy.

The main question is “Is this just a short-term correction in a bull market, or is this the start of a bear market?” In our opinion, this is just a short-term correction that is technically starting to reach an oversold condition. It is important at times like this to look at the facts and not make an emotional decision based on the current news on CNBC or other media outlets. Below are a few of the facts that we are looking at that cause us to believe this is not the start of a bear market:

• Banks are healed. In 2008, banks were significantly undercapitalized and many large institutions were on the brink of collapsing. Today, large banks are now overcapitalized and actually have more cash on hand than commercial loans.
• Interest rates. Almost all bear markets have been preceded by rising interest rates – especially short-term rates. Rates have not gone up. In fact, in the last few weeks, we have seen interest rates decrease with the yield on the 10-year Treasury note falling from about 4% to 3.26% today. The bond market also is very healthy. There are no signs of the liquidity crisis we suffered in 2008.
• Inflation. We do not see any inflationary pressures at this time. In fact, the problems in Europe are making the dollar stronger, which has a deflationary impact. Commodity prices are falling (in just the last 4 days, gold has come off the panic buying and is down over 4%). We don’t believe the Fed will raise interest rates anytime in the near future, which strengthens the prior argument about interest rates.
• Corporations are healthy and sitting on lots of cash (which can be used to repurchase stock, pay dividends or buy other companies). Please read the lead article in this weeks Barron’s which discusses this subject: click here.
• Put/Call ratio. A put is a bet on the market going down. A call is a bet on the market going up. In mid-April, there was significant call volume as investors were optimistic about the market. Today, the put ratio volume is significantly higher than the call ratio volume. In fact, the put volume is more than 3 standard deviations (occurs less than 1% of the time) from the norm. Even more striking, put volume is at its highest reading since 1995 - this encompasses the Asian crisis, technology stock collapse and the bear market of 2008. This reading shows extreme pessimism. This is a very good contrary indicator which says we are near the bottom of this short-term correction.

We know that many of you are concerned and we certainly understand. Please keep in mind that a short-term correction in an overbought market is actually very healthy in a bull market. Please don’t hesitate to call if you have any questions or concerns.

Sincerely,

Your THOR Team

Greece coming to America?

To say the last couple of weeks have been interesting is an understatement. The Greece problem boiled over, necessitating a bailout costing almost $1 trillion. Some of that money comes from the International Monetary Fund (IMF), of which the US is the largest contributor. America’s portion of the bailout is now over $50 billion. Some people are concerned that this could happen in the US. In our opinion, if it does hit, it will first hit the states and municipalities. For this reason, municipal bonds (as a whole) may be one of the most risky investments available today.

We are all aware of the problems that states and municipalities are having with their budgets. In Greece, the state unions are striking and protesting their austerity measures. In the US, public unions are fighting such measures in court. For example, in New York this week, the public workers union took Governor Patterson to court on his plan to reduce the state’s budget deficit by forcing workers to take a one day unpaid furlough. A judge put a temporary halt to the plan, ruling that that the furloughs violated collective bargaining agreements and would cause “irreparable harm” to workers. “In California, 18 lawsuits have been filed by public unions to stop Governor Schwarzenegger’s furlough program. In a time when many - including all employees at THOR - took pay cuts to help save jobs, it is unconscionable to think that the public unions are not doing the same. These actions only increase the risk of bankruptcy and defaults within the municipal bond market as it becomes tougher for states and municipalities to balance their budgets by reducing costs. Adding even more pressure to the states is the additional Medicaid spending they will be required to make because of the recently passed health care legislation.

If fear does hit the municipal bond market, it could be devastating to investors holding those securities. One has to be very careful about which municipal bonds they own and what assets secure such bonds. Our concern is that if we see any fear in this market, even strong municipal bonds will get hurt - just as strong mortgage backed securities suffered along with sub-prime mortgages. Other aspects of the municipal bond market add additional risks that most investors are not aware of:

• Liquidity Risk - The municipal bond market is a very highly fragmented market. In the “good-ole-days,” brokerage firms held municipal bond inventories which provided liquidity in the market. Currently, there is little liquidity in the municipal bond market.
• Accounting Risk - There currently is no uniform accounting standard for municipalities. This results in very little transparency.
• Disclosure Risk - Not only is there a lack of full disclosure in many municipal bonds, but it can take as long as 6 months after the end of their fiscal year for municipalities to provide financial reports. In many instances, the information comes much too late to react and bond holders suffer the consequences.

We applaud those brave politicians that are trying to reduce spending. Individuals and corporations have tightened their belts. It is time for municipalities, states and the federal government to do the same.

Sincerely,

Your THOR Team

Since our last market update on Greece, the market took a nose dive as
Greece’s deficit problems got worse and the yield on the Greek 2-year note
shot up to 19%. Greek bonds were downgraded to junk status. Both Spain’s
and Portugal’s bonds were downgraded as well. The vultures see wounded meat
in Europe and are starting to put major pressure on the PIIGS (Portugal,
Ireland, Italy, Greece and Spain). Even if Germany and the IMF save Greece,
are they willing to save the other PIIGS? This is a difficult spot for the
Merkel government to be in. Germans were never truly supportive of the
Euro - polling shows 55% of Germans were against joining the EU. Now they
are being asked to bail out their spendthrift neighbors. This could be the
start of the collapse of the EU.

We have been here before. In May of 1997, the Asian collapse began with
Thailand and Singapore spending millions of dollars to defend the Thai baht
against speculative attacks by the vultures (this is why George Soros was
given a death sentence in Thailand in abstentia). Over the next several
months, the vultures continued to attack the currency systems throughout
Asia, which ended in a worldwide financial meltdown in the 3rd quarter of
1998 (14 months after it originally started). Could the same scenario
materialize in Europe? Yes, especially if bond rates continue to remain at
current levels. As you are aware, we have the lowest exposure to
international investments in our firm’s history. We are reviewing the
day-by-day blows of the Asian collapse and comparing it to the EU problem.
There may be some great buying opportunities in the months ahead. When Asia
collapsed, we raised our international exposure significantly in our
client’s accounts. Our worst performing international fund in 1999 was up
55%. The key is to have some powder dry in order to take advantage of the
potential opportunity. Other advisers and individuals that currently have
40% or more in international stocks will suffer as foreign money rushes into
US Dollars for protection of principal and they will probably panic and sell
these funds. It is at that time that we believe we will be able to buy
great foreign companies at rock bottom prices.

Our biggest hope relative to the recent events in Europe is that it becomes
a wake-up call to our government to truly get their hands on cutting the
budgets. Both Bush and Obama promised to cut the budget and it has only
grown exponentially throughout both administrations. If they don’t stop
spending, the next currency collapse may be in the US.

Firm Notes

Mary Ann Ries will be leaving us on May 14th. With the passing of her
father a few months ago, Mary Ann will be working at the family’s fencing
business - EME Fence Company in Anderson Township. We are sad to see her
go, but wish her the best of luck.

Congratulations to Jim for passing the 2nd level of testing on his way to
becoming a Chartered Market Technician (CMT). Jim has only one more exam to
take in October.

Sincerely,

Your THOR Team