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It certainly is a more optimistic time in the financial markets, which is one reason for this note to you. One approach would be to put these messages out only when things are looking tough, but my purpose in more frequent updates is to make available to our members our latest thinking in our stewardship of your retirement assets. This more positive update is certainly an easier one to deliver!

In the case of global stock markets, I want to start off where we left off in our most recent letter to you at the end of the year, just seven weeks ago:

As for equities, valuations remain at attractive levels, with the S&P 500 Index trading at just over 12x the next-twelve months earnings forecasts. Corporate balance sheets remain strong, supported by record levels ($2 trillion) of cash. The rampant pessimism among market participants means that any positive resolution out of Europe may result in large scale allocation towards equities from bonds. Within equities, we like high-quality issues in the U.S. but also increasingly favor emerging markets equities, where valuations, dividend yields, and home country fiscal situations are markedly better than those in many developed nations.

As of this writing, equity markets are up in the 8-10% range since the end of the year, with emerging markets equities leading the way with a 15% return. As of this moment in time, we have been, well, on the right side of things. Certainly, though, optimism (bullishness) has returned quickly. Consider this: since the September 30, 2011 low, the U.S. equity market as represented by the Standard & Poor's (S&P) 500 has appreciated over 20%. What an amazing turn of events and sentiment!

As a fairly interested fan of all sports, and a resident of New York, I have been compelled by the story of Jeremy Lin. For those of you who may have missed it, Lin is the Asian-American, Harvard-educated basketball player currently stirring up an international frenzy. Overlooked in basketball’s draft a few years ago, with little professional experience to speak of, Jeremy has catapulted the New York Knicks to an unpredictable and stunning turnaround on the strength of his individual performance and leadership. In two short weeks, Jeremy has gone from the end of the bench to the front of newspapers and t-shirts everywhere.

Although global markets and professional sports are just two slices of life, I want to lift up a connection. I will personally admit to you that three weeks ago - after watching still another New York Knicks team loss, I gave up - threw in the towel. Like many other fans, I was tired of overpaid, selfish superstars who over-promise and under-deliver on results. I vowed to stop watching at all (although this is not the first time).  After tuning in and watching the unheralded, undrafted, unpredictable Lin lead his team to eight wins in nine games, I, like everybody else, have gotten optimistic again.

Investors, as we have seen, often do the same. Volatile shifts between optimism and pessimism were the theme of 2011. At the end of last year, I tried to describe and capture for you the pessimism in global equity markets. Yes, there is plenty to worry about in the economic and political realm, as we chronicled in our year-end letter. What is also true is that optimism and pessimism on the part of market participants often provide opportunities for those taking a longer-term view.

The question is, in both of these cases, is the rise in optimism sustainable? For markets, confidence in domestic growth and greater trust that Europe can address its debt problems has surfaced. In both the U.S. and Europe, central banks have provided massive liquidity and stand ready to provide more, but we know it will not last forever. Earnings, especially in the U.S., have been strong but the level of upside surprises has begun to level off. Bottom line, although we have taken some money off the table in equities in balanced funds, we still favor stocks over bonds.  As Ned Davis, a strategist we follow closely, says, “At extremes in the market, the crowd is almost always wrong.” But during the move or trend the crowd can be right for a while. We will continue to watch closely on your behalf.

As for Jeremy Lin on the New York Knicks, one observation we would make is that leadership matters, and can be infectious. What has happened with the Knicks is that Lin has made everyone else around him better, and as a result, confidence has returned. Hopefully, political leaders in the U.S. (Congress) and in Europe (those working on the debt crisis) tune in and get inspired. Confidence, competence, and leadership are definitely not the only things (as developed economies still have structural problems to work through), but they certainly matter to financial markets.

We look forward to keeping you informed.  

- David A. Klassen
Chief Investment Officer

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