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2012: Many Challenges But Opportunity as Well

The new year has come upon us and we must force ourselves to deal with the uncertainty as well as the opportunities that confront us as investors. Our job at FLI is to present the reality that we see coupled with the paramount responsibility of helping you protect your capital. Reality has to take front stage as we live in a world consumed with leaderless developed countries facing huge economic issues. We are living through the agony and frustration of political paralysis in our great nation as well as throughout Europe. Politicians intoxicated by rhetoric and uncompromising inflexibility are thus far failing to address key issues that challenge our social and economic well being.

Meanwhile, many well run businesses have for the most part purged their wasteful ways of the past and become lean economic dynamos. They have accumulated cash and driven operating margins and profits to all time highs. The unintended consequences of this corporate prosperity is a dearth of hiring and a reluctance to constructively use this corporate largesse to more rapidly grow our economy. They have good reason to be reluctant given little visibility on GDP growth, tax policy and new regulations that are paralyzing decision making. While they wait for the political fog to lift, dividends and share buybacks are constructively used by many companies to reward shareholders to keep them in the game (this has really helped our Dividend Growth strategy). Also, a modest amount of strategic and financial acquisitions are taking place. This too represents opportunity for lucky shareholders.

This fog and uncertainty has resulted in a volatile and undervalued stock market in our opinion. At the same time quality bonds offer little return and appear overvalued. Inflation could be a problem if governments print money to bail out huge indebtedness. This is a legitimate worry. At the same time, housing remains depressed resulting from over supply, tight lending, and weak household formations as young unemployed live with their parents. Weak housing means construction workers remain unemployed which in years past represented a meaningful component of overall employment. However, there are small signs of improvement and hope. Couple this with real concerns about our national debt, deficit and impending financial failure of both our Social Security and Medicare systems, and no wonder many Americans are afraid to invest and question the sincerity and effectiveness of our elected officials.

The hope is that while we as a nation struggle to work out these issues, our economy benefits from robust growth in the emerging powerhouse of China and other developing countries. However, can we rely on a country whose human and corporate rights are limited and where its government controls and mandates economic growth? Maybe, but who knows for how long.

So, what do we do as investors? Hiding under our covers is not a good option. Remaining cautious and somewhat optimistic is the preferred way to proceed in our opinion. Don’t give up on America because we are a country of resilient people ultimately motivated by a heritage of freedom and an enviable and irrepressible entrepreneurial spirit. Thus we must have a practical wealth strategy that recognizes our many challenges but embraces our history of success irrespective of political knuckleheads on both sides of the aisle.

You have heard of the top ten ideas from a famous late night program. Here we would propose our top twelve ideas for your 2012 wealth management strategy:

Have a reasonable goal to achieve an overall investment return that gives you some breathing room above inflation. (We would suggest a net of five percent after taxes with a prudent asset allocation for these times.)
Be diversified in your investment selections with strategies that have reduced correlations so that you capture opportunity irrespective of ugly macro and geopolitical circumstances. And be sure to understand the strategies you invest in and require transparency and reasonable liquidity.
Take advantage of very favorable current tax laws for individuals before the laws expire. It is most likely that prospective fiscal policy will require give ups from both sides of the aisle including somewhat higher taxes.
Be cautious to a larger extent. You are wealthy and you want to stay that way. The world is uncertain and politicians are playing too much of a role as government has become too large. Economic issues relating to deficits, entitlements and the European debt crises need to be dealt with. Now is no time to try and make up for the lean returns of the past ten years.
Initiate defensive equity strategies or add to them as they can provide some upside but should reduce downside in bad markets. Our Dividend Growth strategy has provided our clients with real appreciation and has protected capital in market downturns. Consult with us on your current asset allocation.
Don’t reach for yield in bonds by extending maturities unreasonably or cutting quality and investing in third tier companies or banana republics. Inflation and a slow economy as well as political uncertainty could hurt you. Also, despite fiscal improvement in many states, municipal bond integrity is being litigated as to the full faith and credit that in the past generally assured repayment of bonds. Invest in quality bonds.
Rely on a diversified asset allocation to protect you from uncertainty while affording you the opportunity to participate when markets unexpectedly improve. None of us have a crystal ball and equity market upturns happen when least expected. Remember that gains achieved in equity markets typically happen in a small number of big market-moving days. You can’t afford to miss them.
Review all aspects of your insurance planning. Assess your need for long term care insurance as well as medical evacuation insurance from remote travel locations (American Express offers very little in our opinion). These along with a review of traditional life and property and casualty insurance should be considered periodically. Utilizing the large lifetime gift exclusion as well as low interest cost loans can help fund life insurance policies that could be quite valuable in estate planning. We can help as we are experienced in these areas.
Review your annual spending to assess its relationship to your earnings capacity. Personal deficit spending is no better than our country going further into debt without a plan of remediation. Proposed increased taxes and those that are part of Obamacare (higher cap gains taxes) will reduce after tax income and must be considered in how much you can spend without incurring debt or eating into principal. We live longer lives and must have sufficient capital to provide our quality of life as well as keep pace with creeping inflation.
Prudent wealth planning and an honest annual assessment of your wealth plan will let you have greater peace of mind leading to sleeping better at night. In addition, you will be better equipped to face whatever challenges we must endure – both those we know about and those we can’t project.
There are many stresses in the world we live in. Some we can control and others are beyond our influence. In order to endure these, whether they be financial or personal, one’s health needs to be constantly attended to. Take the time to do this so you can enjoy life with the best possible quality that is available to you. Although we are not doctors or therapists, we are here to listen and try and help. We do have access to some fine doctors and hospitals should that be needed. And stay in good physical shape as it is one key to living a better quality life.
I am sure that we forgot something that you or we should consider. We are there for that as well given all of the unexpected that can occur.

The above twelve points are steps and thoughts we believe each of us must consider. We at First Long Island stand ready to personally help you consider each one of them and assist you in taking whatever actions are required in a well thought out plan. This is incredibly important in today’s complex world.

We wish you a most healthy, happy and prosperous New Year and look forward to serving you in your wealth management needs. We appreciate the opportunity to be your wealth managers. Please call upon us.

Best regards,
Robert D. Rosenthal
Chairman and
Chief Executive Officer

*The forecast provided above is based on the reasonable beliefs of First Long Island Investors, LLC and is not a guarantee of future performance. Actual results may differ materially. Past performance statistics may not be indicative of future results.

Disclaimer: The views expressed are the views of Robert D. Rosenthal through the period ending December 31, 2011, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.

Content may not be reproduced, distributed or transmitted, in whole or in portion, by any means, without written permission from First Long Island Investors, LLC . Copyright © 2012 by First Long Island Investors, LLC. All rights reserved.

Robert D. Rosenthal, Chairman & CEO, and Gretchen Morgenson,
Pulitzer Prize winner and New York Times columnist.

Our recent Thought Leadership series featured veteran New York Times business reporter and Pulitzer Prize-winning writer, Gretchen Morgenson. Gretchen’s book, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon, continues to be at the top of Amazon’s worldwide bestseller list, and recently was named one of the “Best Books of 2011” by Barnes & Noble. FLI clients and friends experienced a highly charged and informative morning with some top line insights such as:

High powered executives, members of Congress and Washington’s prestigious regulatory community laid the ground work for the financial crisis and meltdown that America is struggling to overcome.
Washington elites rigged the system for themselves, became rich and powerful and then “slipped quietly from the scene.”
Early warnings and signs of impending doom were virtually ignored or hidden.

Gretchen Morgenson is a business reporter and writes the “Fair Game” column in the Sunday business section of The New York Times, where she also serves as assistant business and financial editor. She was awarded the Pulitzer Prize in 2002 for her “trenchant and incisive” coverage of Wall Street. Prior to joining the Times in 1998, she worked as a broker at Dean Witter in the 1980s and as a reporter at Forbes, Worth, and Money magazines. She lives with her husband and son in New York City.

“Making money doesn’t oblige people to forfeit their honor or their conscience.”
Baron Guy de Rothschild (renowned banking magnate)

Investment Perspective

The third quarter was very difficult with many factors contributing to both uncertainty and fear. The result was a significant downturn in equity markets (S&P 500 -13.9%), and a flight to safety in both U.S. Treasury bonds and gold. However, thus far in the month of October equity markets have rallied sharply (S&P 500 +13.7% as of 10/28/11) and bonds have retreated. (Our defensive equity strategies and bond investments have done well as of this writing for the third quarter and year-to-date.) In addition, social and political strife, reflecting a loss of hope by some, has made its presence known in the Middle East, Greece, and most recently on Wall Street and other major U.S. cities.

The cause of much of this fear and uncertainty can be attributed to the following factors:

European debt crises resulting in concerns about global banking and sovereign defaults
Economic pundits predicting another domestic recession reflecting continued deleveraging
Political paralysis in Washington relating to our deficit resulting in the downgrade of U.S. debt
Concerns about the pace of growth in China
Fears about domestic inflation
The growing economic plight of our middle-class
High domestic unemployment and under employment
New domestic regulations that continue to hamper business expansion

There are probably others, but these seem to be the most troublesome. However, there continue to be some very favorable factors as well:

U.S. domestic corporate profits continue to grow and have reached record levels!
Domestic corporate balance sheets remain flush with cash and lower levels of debt
In our opinion, valuations for many domestic companies are cheap (11 to 12 times 2012 earnings) assuming there is no double-dip recession (continues to be our view)
Dividends for many quality blue-chip type companies continue to grow
Our banking system continues to get stronger despite headwinds
Retail sales and industrial production continue to improve despite slow GDP growth

The above positive and negative factors are highlighted daily in the press leading to a schizophrenic equity market. Short term investors, high frequency traders, and hedge funds are exacerbating the market volatility. Seemingly knowledgeable market experts speak of recession and market declines adding to investor fears. Some renowned hedge fund managers are down 30% to 40% thus far this year. The multi-hundred point intraday swings in the stock market have once again led to outflows from equity markets and abnormally high cash on the sidelines earning virtually nothing. However, in our view this continues to represent an opportunity for long term investors, who can wait out the uncertainty, and take advantage of certain company share prices that we believe are on sale. Some of these bargain priced companies have dividend rates twice that of the yield of a ten year treasury bond.

We recognize that at a time when politicians are failing to address serious economic and social issues through meaningful compromise, it can be frightening to investors. Demonstrators and liberal politicians want to make us feel that making money is not only not noble, but greedy and dirty. However, it would be a mistake to forget that one can invest with conscience as well as a goal of making money, as Baron de Rothschild suggested. We believe that much of the monies we invest support growing businesses with innovative ideas, new products and hopefully contribute to improving employment. As investors, we must recognize that despite being criticized for being wealthy as well as facing a potential higher tax burden, we could face another threat, inflation. This threat requires us to withstand market volatility and make sound investments to ultimately make enough money to maintain our standard of life and financial security. It is true that stock market returns have been unkind over the past decade, however there are numerous examples of companies whose stock prices have thrived despite the many uncertainties we have discussed (McDonald’s and Apple as examples). In addition, there are numerous companies whose share prices have languished, but have increased dividends on a yearly basis giving us a growing cash return (e.g. Microsoft). At the same time, despite talk of deflation, core inflation continues to modestly rise. We must stay ahead of that, especially given the money printing that has been used to avoid the recent threat of financial Armageddon.

So, how do we invest in this deleveraging and confusing environment yet still sleep at night? We would be foolish to suggest that the European debt crisis, high unemployment, political paralysis, and consumer and government deleveraging is going to just fade away. We can, however, somewhat insulate ourselves from these legitimate concerns by directing you to defensive equity strategies that we believe will result in reasonably good returns over time as a more meaningful part of your asset allocation. This is particularly appropriate for us as wealth managers whose first priority is to preserve your capital (while outpacing inflation). It also permits us to participate in equity returns when some of the black clouds dissipate and investor flows return to stock markets. We continue to believe that more of your asset allocation should take advantage of our strategy that benefits from growing dividends, from strong mostly global companies that successfully build market share. Many of these businesses are benefiting from evolving countries where there aren’t debt problems and boast a surging middle-class representing new customers for the companies we invest in.

Our relatively new Dividend and Growth strategy (growing dividends), continues to dramatically outperform its respective benchmark by over nine hundred basis points respectively on a net basis as of September 30. As of this writing Dividend and Growth has a net return of slightly more than nine percent. The strategy is in our defensive equity category, providing a lower risk way to invest in equities. This strategy invests in companies with consistently growing dividends and reasonable earnings growth. It relies in part on a cash earnings stream as part of its overall return. If equity markets turn much higher, it won’t do quite as well on a relative basis. However, this type of strategy has demonstrated an ability to preserve capital during severe market downturns. We believe it makes more sense than keeping large sums of money in cash (earning a negative real return) or crowding into an overvalued bond market where any inflation leading to an increase in interest rates will result in a loss of “real” capital. And for those investors who have too much exposure to traditional equities, you should feel more comfortable allocating to a defensive equity strategy.

These are difficult and confusing times for investors. But we believe we can offer you reasonably safe and diverse ways to make an honest, liquid and transparent return while still focusing on preservation of capital. And despite fear, political paralysis, and policy uncertainty, we believe we can still find an honorable way to protect and grow your net worth with a clear conscience. Asset class diversification with a bias towards defensive equity strategies is called for in this troubling economic and geopolitical environment. And, as contrarians, we believe there are still investment opportunities for those conservative investors that are patient, selective, quality-oriented and don’t give in to the herd mentality following the constant noise of media

We look forward to working with you to craft your asset allocation to navigate these troubled investment waters. Our goal remains preservation of capital with appreciation above the rate of inflation while minimizing risk through greater emphasis of defensive equity strategies and overall diversification. And yes, we know this will help you sleep at night as well. Please call upon us.

Best regards,

Robert D. Rosenthal
Chairman and
Chief Executive Officer

Ralph F. Palleschi
President and
Chief Operating Officer

Merge documents/Lisa/Website Letters/FLI 3rd Qtr 2011 report on funds part one for website

Disclaimer: The views expressed are the views of Robert D. Rosenthal and Ralph F. Palleschi through the period ending September 30, 2011, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.

We feel beaten up as investors. Fears of a double-dip recession, angst over the European debt crisis and the volatility from high frequency trading makes us queasy about equity investing. Fears of inflation make us worry about long term bond investments, and yields on short term bonds are pitiful to nonexistent. Real estate is still a mess with workouts and continued abundant supply of residential housing. It also locks up your capital for long periods of time. The seemingly easy alternative of just leaving money in cash is not a panacea as near zero interest rates mean we earn a negative return when considering that inflation is probably running at the rate of two and a half percent. And to boot, at this time we have little confidence in those responsible in Washington to implement prudent fiscal policy that will improve unemployment, bring certainty to our future taxes, and deal with our country’s growing debt burden.

And if all of that isn’t enough, Mother Nature has punished us with both a direct hit from Hurricane Irene and the shock of a recent nearby earthquake (for those of us in the metro NY area). However, we believe there is a silver lining to all of this. It comes in the form of what we believe is an opportunity to take advantage of the mispricing of high quality larger companies that has resulted from the aforementioned volatility.

We have been in this business for a long time. We collaborate with smart people who have also been doing this for twenty, thirty or more years. We have all lived through scary times both economically and geopolitically. Our country has been challenged before by war, recession, political uncertainty, hyper inflation, and downright pessimism. Yet, when we see great companies selling at distressed prices while possessing stellar balance sheets and global opportunity, we see the potential for capital appreciation. We also see great innovation in this country. Whether it’s the iPad, new drugs combating cancer, cloud computing, or social networking, Americans are alive and well with a resilience which has always been the envy of every other country. This has not changed (although most of us are somewhat down over the circus-like environment in Washington). So, what does the beaten up investor do?

Well, we believe we should try to take advantage of this by not cowering to the herd mentality of running for the hills and hiding in cash and overpriced bonds. History shows time and time again that the average investor sells when overtaken by fear and buys when obsessed with greed. The result is buying high and selling low. This is not a prescription for making money. Today, we believe that prices for many large high quality companies have been mispriced by fearful investors. We believe it makes sense to take advantage of these abundant opportunities. Our views are based upon our belief that we will not fall into recession; we will just experience slow domestic growth. We believe that the pathetic display in Washington will give way to some greater cooperation. We also believe that the strength and leadership of the private sector will protect the integrity of our investments. So, we ask you to work with us to better position you to reap the benefit of what we believe to be good discounted businesses that are available through a prudent asset allocation. This opportunity may take time to be realized (meanwhile you can collect high dividends in some cases) and there will still be volatility. However, fear has set our table with what we believe is an opportunity. We ask you to view the future as an investor with some optimism as great companies to us are on sale or are misunderstood. And, you can access this opportunity through our defensive equity strategies that mitigate some of the volatility, including Mother Nature, that we will be confronted with.

We look forward to discussing this with you or meeting with you in the near future.

Best regards,

Robert D. Rosenthal
Chairman and
Chief Executive Officer

Disclaimer: The views expressed are the views of Robert D. Rosenthal through the period ending September 30, 2011, and are subject to change at any time based on market and other conditions. This is not an offer or solicitation for the purchase or sale of any security and should not be construed as such. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities.