September 15, 2012

To Infinity and Beyond

On Thursday September 13, Ben Bernanke and the Federal Reserve announced what 99% of Wall Street was already expecting, a third round of Quantitative Easing known as QE3. However, we think the surprise came in its unexpected content. Under the new plan, the Fed will now make monthly purchases of $40 billion in mortgaged-backed securities in addition to the central bank already buying $45 billion in long-term bonds as part of Operation Twist through 2012. The Fed also said on Thursday that it sees benchmark interest rates staying near zero through mid-2015 vs. its prior forecast of late 2014. This announcement sent the S&P 500 soaring as high as 1474.51, closing at 1465.77 a high for 2012. It also took the S&P 500 to the most overbought levels in over 2 years. Investors should understand the Federal Reserves role as stated by the chairman, consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Fed intends to help Main Street as well as Wall Street via the wealth effect. The hope is that higher home and stock prices fueled by QE will make consumers feel wealthier, by giving them the confidence to buy things. Mr. Bernanke further states that, if the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-back securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. This will also be tied to the rate of unemployment. Therefore, this third round of easing is not QE3, it is QEnfinity.

As mentioned earlier, the latest news by the Fed was enough to send the S&P 500 to new highs for 2012 and to the most overbought levels by some technical measures. With this sudden market surge, we can expect some profit taking, and a retracement to the 1440 area would not come as a surprise to us. A normal pullback, combined with a sideways trading market, would help eliminate some of this overbought market status.

The question that now comes is, if the S&P 500 is trading at the most overbought levels in 2 years, how is Compass addressing this in the model portfolios? In our last two editions of Compass Points we noted: Thus far, we have the caution flag raised, but have not abandoned investments in favor of cash. Quite the contrary! We have spent much of the summer researching ideas that are either extremely undervalued in our opinion or investments that have a low correlation to the equity markets for which we expect to see a rally. Three such investments made in our portfolios have been natural gas, low duration bonds, and gold.

Investments that have a low correlation to the equity markets combined with great relative strength can be very helpful in markets conditions like we currently have. Take for example our August 21 investment in the Market Vectors Gold Miners (GDX) ETF for our brokerage model portfolios.

From August 21 through yesterday, the S&P 500 has rallied 3.72%, while the spot price for Gold and the Amex Gold Miners Index gained 8.3% and 15.7% respectively during the same time frame. While we are not invested in Gold directly nor the Amex Gold Miners Index, this type of outperformance shows that while we remain cautious, the rest of the portfolio may not have to work as hard to provide competitive returns while keeping risk in mind. With mixed economic numbers being reported, the European Crisis in the headlines, and the presidential election right around the corner, we can expect further market volatility. We know the Federal Reserve has a clearly stated agenda and we are reminded of the old Wall Street adage, dont fight the Fed. We will continue to look for low correlation and undervalued investments that we feel offer good relative strength to our portfolios and will keep our reps and investors informed.

We appreciate your confidence and trust! Best Regards, Robert D. Yarosz Director, President The Compass Asset Management Team Thomas W. Rendl, Jr. Lead Portfolio Manager

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