At the height of the reality show craze earlier this decade, NBC aired a show in primetime called "Fear Factor" that had contestants perform stunts that appeared frightening or stomach turning.  Most of the challenges involved dangling participants from heights or plunging them into vats of snakes or insects.  Given either innate courage or a strong desire to capitalize on their 15 minutes of fame, most of the show's contestants gamely withstood the challenges without faltering.

Over the past two months, investors have been subjected to harrowing global/economic challenges that threaten to plunge the world into a second financial crisis or global slowdown.  The two most serious threats are the impending restructuring of Greece’s, and possibly other Mediterranean countries’, sovereign debt and the oil spill in the Gulf of Mexico.  The Greek government does not have the financial wherewithal to repay its looming debts without substantial assistance from the rest of Europe, especially Germany.  The issue that concerns the markets is whether or not this sparks a contagion that spreads to larger countries such as Spain and Italy, similar to the way the Bear Sterns' failure eventually infected Lehman Brothers and the rest of the investment banks.

While BP's oil spill is regional in nature, this environmental catastrophe destroys optimistic views of technological progress and mankind's relationship to the ecosystem.  It's a technological triumph that we are able to extract oil from a mile below the ocean's surface, but the spill highlights human frailties.  These weaknesses include the complete lack of contingency planning for what should have been expected emergencies and greed associated with trying to cut costs to wring every last dollar out of the project. 

The spill also highlights our country's complete lack of a coherent energy policy.  Our transportation networks and whole economy depend on cheap hydrocarbons, the majority of which are imported.  Our pursuit of alternatives is half-hearted as NIMBY (not in my back yard) concerns derail efforts to tap alternative sources such as wind.  Similarly, the government streamlines the application procedure process for nuclear reactors, but pulls the plug on developing a safe place to store the waste. 

These events caused the equity markets to shed roughly 12% during the Second Quarter.  Similar to previous downturns, the bond market has rallied pushing the yield on the 10-year US Treasury to below 3%.  These numbers, especially the historically low bond yields, suggest a long period of recession or below average growth.  Why else would anyone buy a bond paying 3% a year that doesn't mature for ten years unless his or her forecast was exceptionally gloomy?

Even given these troubling conditions, we do not believe that this year will devolve into the meltdown the markets experienced in 2008.  Conditions are different now and the economic fundamentals are not as precarious. 

For example, US GDP grew at over 5.5% during the 4th quarter of 2009 and at a rate of 2.7% during the first quarter of this year.  While most growth forecasts have decreased, economists still predict the US economy will grow at a rate of approximately 3% this year.  These trends show that the economy is still recovering and not slipping into another extended recession. 

Further, the global banking system is much stronger than it was in the build-up to the credit crisis.  The large banks had tangible capital ratios of 1.2% (Citi) to 3.3% (JP Morgan) at the end of 2008.  After governmental cash infusions and more importantly very strong earnings due to solid interest margins and trading revenues, banks now have fortress balance sheets with well over 5% of tangible capital.  Lending is also already tight so that the current problems will not induce huge limits on borrowing.

Profits at publicly traded companies are now expanding rather than contracting.  In 2007, profit margins reached a high water mark and expenses were expanding.  In response to the credit crisis and recession, corporations pared work forces aggressively, thus reducing expenses.  This combination of renewed growth plus expense reduction has led to strong earnings.  During the 1st Quarter, earnings at the S&P 500 companies were 51% higher than during the first quarter of 2009.  Analysts expect this rate of growth to slow; however, profits for the second quarter this year are still expected to be 34% higher than last year's comparable quarter. 

Finally, equity prices are very depressed relative to these earnings and cash flow figures.  In 2007 and early 2008, the general price level was significantly higher than it is now with the S&P 500 trading over 20X predicted earnings.  As of June 30th, the S&P 500 was selling for about 12-13X expected earnings.  Stated differently, the earnings yield on stocks (earnings/price) is about 8% compared to 3% for bonds.

The negative news emanating from Europe will most likely slow global growth and the Gulf spill depresses spirits.  However, the domestic economy is still growing as are many emerging markets.  Stock prices are inexpensive and expectations are extremely muted.  Therefore, we view the current market as a buying opportunity rather than a value trap. 

While BP's oil spill is regional in nature, this environmental catastrophe destroys optimistic views of technological progress and mankind's relationship to the ecosystem.  It's a technological triumph that we are able to extract oil from a mile below the ocean's surface, but the spill highlights human frailties.  These weaknesses include the complete lack of contingency planning for what should have been expected emergencies and greed associated with trying to cut costs to wring every last dollar out of the project. 

The spill also highlights our country's complete lack of a coherent energy policy.  Our transportation networks and whole economy depend on cheap hydrocarbons, the majority of which are imported.  Our pursuit of alternatives is half-hearted as NIMBY (not in my back yard) concerns derail efforts to tap alternative sources such as wind.  Similarly, the government streamlines the application procedure process for nuclear reactors, but pulls the plug on developing a safe place to store the waste. 

These events caused the equity markets to shed roughly 12% during the Second Quarter.  Similar to previous downturns, the bond market has rallied pushing the yield on the 10-year US Treasury to below 3%.  These numbers, especially the historically low bond yields, suggest a long period of recession or below average growth.  Why else would anyone buy a bond paying 3% a year that doesn't mature for ten years unless his or her forecast was exceptionally gloomy?

Even given these troubling conditions, we do not believe that this year will devolve into the meltdown the markets experienced in 2008.  Conditions are different now and the economic fundamentals are not as precarious. 

For example, US GDP grew at over 5.5% during the 4th quarter of 2009 and at a rate of 2.7% during the first quarter of this year.  While most growth forecasts have decreased, economists still predict the US economy will grow at a rate of approximately 3% this year.  These trends show that the economy is still recovering and not slipping into another extended recession. 

Further, the global banking system is much stronger than it was in the build-up to the credit crisis.  The large banks had tangible capital ratios of 1.2% (Citi) to 3.3% (JP Morgan) at the end of 2008.  After governmental cash infusions and more importantly very strong earnings due to solid interest margins and trading revenues, banks now have fortress balance sheets with well over 5% of tangible capital.  Lending is also already tight so that the current problems will not induce huge limits on borrowing.

Profits at publicly traded companies are now expanding rather than contracting.  In 2007, profit margins reached a high water mark and expenses were expanding.  In response to the credit crisis and recession, corporations pared work forces aggressively, thus reducing expenses.  This combination of renewed growth plus expense reduction has led to strong earnings.  During the 1st Quarter, earnings at the S&P 500 companies were 51% higher than during the first quarter of 2009.  Analysts expect this rate of growth to slow; however, profits for the second quarter this year are still expected to be 34% higher than last year's comparable quarter. 

Finally, equity prices are very depressed relative to these earnings and cash flow figures.  In 2007 and early 2008, the general price level was significantly higher than it is now with the S&P 500 trading over 20X predicted earnings.  As of June 30th, the S&P 500 was selling for about 12-13X expected earnings.  Stated differently, the earnings yield on stocks (earnings/price) is about 8% compared to 3% for bonds.

The negative news emanating from Europe will most likely slow global growth and the Gulf spill depresses spirits.  However, the domestic economy is still growing as are many emerging markets.  Stock prices are inexpensive and expectations are extremely muted.  Therefore, we view the current market as a buying opportunity rather than a value trap.

Stephen Strasburg, a pitcher for the Washington Nationals, signed the richest rookie contract ever in August 2009 for $15.1 million over 4 years.  As hard as it is to believe, he’s underpaid.

Starting pitchers pitch once every five days and their start dates are known in advance.  It’s logical to assume that any jump in attendance for the pitcher’s start is due to the pitcher, unless there are other extraordinary events (such as a promotion like hat day or visit from a popular team like the Yankees).

Strasburg has pitched three home games for the Nationals against standard teams.  There’s been a jump of 16,000 tickets sold for each game with average ticket prices of about $31.  This means Strasburg generates almost $500,000 in incremental revenue for each start.  Add in concessions and parking for each ticket holder and the additional revenue tops $1 million.  And most of the ticket revenue is straight profit since the tickets are already printed and the seats are already made.

More revenue is generated through merchandise sales- Strasburg tee-shirts go for $25 and replica jerseys $100- and the big gold mine is increased TV ratings.  Ratings for his first start were 3 times the previous high.  High ratings mean high advertising dollars, and advertising dollars can dwarf ticket sales.

Over time, the excitement over Strasburg will fall.  But even if his starts generate 10,000 more tickets, they are worth about $600,000 in tickets, concessions and parking.  Add in merchandise and TV ratings (which increase for both home and away) and they’re approaching $1 million.  Over a full season Strasburg will make about 30 starts, with 15 at home.  Suggesting he earns his entire $15 million contract in one season.

CEOs are also signed to contracts with multi-million dollar compensation packages, many times over what Strasburg is to make.  It can be difficult to determine whether their compensation is justified.  We know Apple’s market cap fell by billions in 2004 when it was revealed that Steve Jobs had cancer, suggesting that he’s worth billions to Apple.   If something were to happen to Warren Buffet, one would think Berkshire Hathaway would also fall.  But most companies do not have a singular driving force that is worth millions, even if they’re sometimes paid that way.  We know that Strasburg is earning his keep.

The People's Bank of China issued a statement on June 19th that it would allow its currency (the Yuan) to appreciate against the dollar and other currencies.  This statement of principle, without any specifics regarding the mechanism, caused a brief rally in the markets which fizzled out shortly thereafter.

China has pegged its currency to the US Dollar at an artificially low rate.  This exchange rate provides a boost to China's exports to the US and Europe since consumers here and abroad are able to buy more goods with fewer Dollars and Euros.  China needs a strong export economy to support the massive migration from its countryside to its cities.  Without manufacturing jobs to employ these migrants, there would be massive social unrest. 

The US government has been lecturing China for years to allow its currency more leeway to appreciate.  Our trade negotiators hope that a stronger Yuan will benefit our exports and thus increase our manufacturing as Chinese exporters become less price competitive.  At the margins, a stronger Yuan will benefit companies such as Nike, Microsoft and 3M that have established businesses in China since their goods will be relatively less expensive than under today's rates. 

However, we do not believe a stronger Yuan will have a tremendous impact on our trade with China.  China's manufacturing and exports are so strong because of the low wages that Chinese workers garner.  According to a US Bureau of Labor Statistics report from 2007, the average manufacturing worker in China earned $0.81 per hour or 2.7% of the $30 per hour earned by the average domestic manufacturing employee.  Chinese wages are rising as evidenced by labor strikes at Japanese auto plants which produced significant wage concessions.  Regardless of these increases, China's labor price advantage will persist and not change the balance of trade from its current equilibrium.

At one point, the equity markets plunged almost 9% last Thursday before rebounding to close down about 3.25% for the session.  The wild swings were reminiscent of the fall of 2008 and March of last year when panic selling drove the market down significantly.  The sell off extended to Friday and the S&P 500 closed down about 7% for the whole week erasing all gains in the market year-to-date.  There are a few rationales for last week's panic and a great deal of unknowns.

The market has appreciated dramatically from its trough last year.  From its low on March 9, 2009 until last Wednesday's close, the S&P 500 had appreciated by over 70% without any corrections along the way.  As we know, common stocks are volatile and returns are never linear.  Therefore, the market has been due for a correction for quite some period.

Part of the crisis that gripped the market during 2008 and early 2009 was due to credit problems at large financial institutions.  Many assets (especially sub-prime mortgages) were over-valued on the books of the world's largest banks.  The banks then refused to lend to businesses and each other since they were basically afraid that their counterparties would go bankrupt and not make good on their loans.  This credit crisis froze markets and caused a deep economic recession.  To counteract this contraction of credit, central banks around the world  lowered interest rates drastically and governments guaranteed loans so that financial institutions would start lending again.  During this process, governments borrowed aggressively and basically transferred financial debt to their own balance sheets.  This proactive move eased the panic and has helped markets in many different areas rebound.

The European situation is scary because weak sovereign nations such as Greece do not have the financial strength to pay back the debts that they have incurred.  At the same time, the population is rejecting any fiscal restraints and violently rioting suggesting that the political will is not strong enough to deal with the problem.  Greece is a small country and only represents about 2% of Europe's economy.  However, the market reaction suggests that the contagion could spread to other countries such as Spain, Portugal, Ireland and Italy which are larger and whose default could seriously threaten the stability of the European Economic Union. 

Over the weekend, the European Union agreed to extend loans to countries such as Greece that come under pressure and face default on their obligations.  The loan package reached a staggering total of close to $1 trillion.  This news has brought about a rally since the fears of a breakup in the EU are greatly diminished over the near term.  However, long term there does not appear to be a mechanism in place  to prevent countries from borrowing beyond their means.   The credit quality of government debt both here and abroad will remain a vital concern until real constraints on spending are put in place. 

The panic selling during Thursday's decline also caused unexplained malfunctions on the exchanges as prices gyrated wildly.  The majority of shares traded are processed by high frequency trading platforms which are designed to execute at the best available price, but are not designed to halt trading during abnormal markets. Therefore, if the volume of buying falls, selling will continue even at lower prices as long as the price is the best available. These trading programs increase market efficiencies by guaranteeing best execution, but can amplify volatile markets. Please note that while we trade electronically, we do so with direct oversight. We ensure that bid-ask spreads are within our price targets and that there is enough liquidity to handle our order. We did not sell shares last Thursday as we saw spreads widen and liquidity on the buy side fall. We knew Procter & Gamble was worth more than the $39 per share.

While we will monitor these developments with vigilance, we believe that the strength in the US economy and corporate profits will not cause a repeat of the 2008 crash.  The economy is growing now at a rate of over 3% per year and most economists expect 2nd Quarter growth to be as strong or stronger than in the 1st Quarter.   Lost in the negative news last week, the jobs report showed that the expansion in the labor markets is getting stronger.  Payrolls increased by 290,000 during April  and revised numbers for February and March suggest that 39,000 and 230,000 jobs were created during these months respectively.   Finally, earnings season has passed and the majority of companies have produced very strong profits.  Roughly 3/4 of companies produced earnings which exceeded analysts expectations.  Additionally, those earnings were 45% higher than during the 1st Quarter of 2009.  Given this positive economic and earnings backdrop, we do not believe the heavy selling last week portends the beginning of another crisis for the US markets. 

The growth of the Internet and increased disclosure requirements for businesses and individuals has unleashed a vast amount of information that was previously semi- private into the public domain.  Aside from the significant efficiency and transparency gains, this information has been a bonanza for scam artists and fraudsters as the number of potential targets for these criminals has expanded exponentially.  Unfortunately, our firm’s corporate identity has been a victim of this trend and our current efforts have not been able stem the abuse.

Many years ago there was a Wall Street brokerage firm that shared the name "Laidlaw" though the founder was no direct family relation.  This firm enjoyed a solid reputation as a broker dealer and investment management firm.  Over the years, however, the name has been usurped by a broker dealer, Laidlaw & Company, that uses extremely aggressive sales techniques.  Based on feedback that we receive through the phone and email, it appears that some of the brokers that work for this firm are telling their existing or prospective clients that they actually work for our company, Laidlaw Group, and not Laidlaw & Company. 

Typically, we receive complaints from individuals that representatives from Laidlaw & Company have pitched their investment products to these individuals over the phone.  The complainants usually ask us to tell so and so from our company to stop harassing them with phone calls.  One complaint received through our website indicated that the prospective client "did not appreciate being called a (insert profane term for male anatomy) when I state that I am not interested in the call at this point.”

The level of fraud appears to have increased in intensity recently.  One of Laidlaw & Company's brokers, directed a prospective hire to list that she worked for both Laidlaw & Company and our firm on her LinkedIn (professional social networking site widely used throughout the country) profile.  Needless to say, no such person has ever worked with our firm.  Unscrupulous brokers are using our transparent business model and clean compliance history to engender confidence in them and in turn to sell their investment products to Laidlaw & Company’s customers. 

Our efforts to stop this continuing corporate identity theft have been unsuccessful.  Our industry group, the Investment Adviser Association, put me in contact with someone at the SEC who works in the inspection office.  This individual indicated that his only recourse has been to work with the United Kingdom's regulator, the Financial Service Authority, to end the impersonation.  As of this writing, nothing has happened, even though a case has been opened at the SEC for the past two years or so.

We are contemplating changing our company name.  This measure would prevent the other firm from continuing to tarnish our reputation.  So if we send out a notice that we have a new name and brand, it is not because I am not proud of having my name on the door.  Rather, it may be a more elegant solution than spending countless hours in time and legal fees to force the fraudulent Laidlaw & Company to cease and desist.