“The key to making money in stocks is not to get scared out of them.”
Peter Lynch

Investment Perspective

Life has a way of injecting reality into our good time. The first quarter was a great period for investors, but one should never annualize investment returns after one good quarter. The second quarter ending June 30th reminded us that volatility caused by an ugly Europe, fiscal problems, higher unemployment, and political paralysis can appear at any time. Despite all of this, the quarter ended down only modestly for many equity strategies, overcoming an earlier sharp downturn. Of note, our dividend growth strategy achieved modest gains for the quarter, outpacing the general market that was down about 2.8%. Bonds also made modest gains in the quarter, but we remain skeptical about bond returns going forward. The important result is that our fixed income, defensive equity and traditional equity strategies are meaningfully positive thus far for the year!

At our recent seminar at The Garden City Hotel (please see our website (www.fliinvestors.com) for a summary) Jason DeSena Trennert, co-founder of Strategas Research Partners (a macro research, advisory and capital markets services firm), and Bob discussed, in an interview format, four big issues facing us as investors:

1. The European Debt Crisis (both sovereign and banking)
2. The upcoming elections (Presidential and Congressional)
3. The fiscal cliff (tax increases and mandatory spending cuts)
4. Investment strategies that make sense for the world we live in

We also touched upon the impact of China slowing as well as other potential problems including possible decreases in both corporate margins and productivity. Additionally we discussed Iran and its pursuit of a nuclear bomb as well as our chronic and debilitating unemployment situation.

The bottom line is that we still have a lot of unsolved problems, the solutions to which depend in some part on politicians here, and in Europe and China. This is not a pleasant thought. However, on the brighter side, American businesses both here and abroad have huge cash balances and very strong balance sheets. Our greatest resource just might be the strength of American business as well as the natural resources that remain abundant in our great country (especially natural gas and oil). Of course, we have to encourage the use of that cash and those natural resources, and that requires our politicians in Washington to remember who they represent. Consider that the cry for QE3 to help our economy is only a repatriation of excess cash away in terms of possibly putting to work as much as a trillion dollars. Both sides of the political aisle would have to cooperate and find a constructive way to put the money to use while also raising tax revenue from its repatriation. In our opinion, this will happen in time and that would be a positive for equities and our economy.

So not a lot has changed since our last letter except that those investors who stayed the course in our defensive and traditional equity strategies have maintained some real gains year-to-date after inflation to show for the risk they took. We believe that improved earnings and attractive valuations for many companies, (as well as low yielding bonds and cash), support the equity markets. All of our equity strategies are solidly positive for the year and outpaced bonds and commodities through the second quarter. In our dividend growth strategy, all companies that we expected to raise dividends did, and our performance improved versus the S&P 500 by posting a gain for the quarter. Since inception, this defensive equity strategy continues to beat the market despite being less risky than the market. Our FLI Partners Fund (also a defensive equity strategy) also had a good quarter. Prudent asset allocation with a defensive tilt continues to help us navigate the choppy and uncertain times that we live in, while helping us deliver to you a blended return that has more than outpaced inflation this year. Irrespective of the headlines, we focus on quality companies with attractive valuations and strong fundamentals.

Speaking of inflation, it still seems inevitable to us, given the amounts of money being printed here and abroad. However, velocity (circulation and use of that money) remains poor such that the money resides on the balance sheets of banks and in the treasuries of corporations without benefitting the domestic economy. At some point when greater velocity is achieved, we expect that inflation will increase and interest rates will trend up. Bond investments must reflect this possibility and those investing in bonds with long term maturities or buying low quality bonds will be subject to potentially meaningful losses. Of course, we don’t know when interest rates will rise, however we remain cautious in our purchase of bonds and still believe that higher yielding large cap companies are currently a better investment. Our bond portfolios continue to concentrate on shorter duration and high quality.

The “wall of worry” continues to garner headlines each day. The problems in Europe continue to plague us and slow the pace of corporate earnings of large multinational companies. How soft the landing will be in China remains to be seen. The high unemployment in the U.S. is showing no signs of improvement. An 8+% unemployment rate is terrible and frustrates so many Americans as well as delaying the needed housing recovery. The continued increase in U.S. government debt is a ticking time bomb that must be addressed after being ignored for the last eight years. Health care also must be addressed through revisions to the new health care law that was just ruled constitutional. Providing care to almost all Americans is a noble mission; but it must be accomplished in a fiscally prudent manner. Finding a way to deal with Iran before it possesses nuclear weapons is essential. History is marred with madmen like Hitler and Stalin who used their weaponry to murder millions of innocent people. We can’t let that possibility occur again. Thus there remains a boatload to worry about.

However, we remain cautiously optimistic because we do believe that the American people are resilient and are beginning to make it clear to our elected officials (at both the state and federal levels) that it is time to act responsibly on behalf of those they represent. The paralysis which has become Washington sport isn’t acceptable, and everyone sees what’s happening in Europe. The equity markets might just be signaling this as we still have good gains for the year reflecting a still growing global economy. And those who ventured into our defensive equity strategies (both Dividend Growth and FLI Partners Fund) have achieved gains (since the inception of the Dividend Growth strategy) that are much higher than their bond or money market accounts. We urge you to remain properly allocated among our four investment baskets. Remember, we assess your asset allocation each quarter and will continue to make suggestions to you to better position you for the long term.

So, hold onto your seats as we navigate the next six months. There will be both opportunity and volatility. We believe that quality and defensively tilted investing will reward us as investors while letting you sleep at night. Some measure of greater certainty will result from the upcoming elections and hopefully actions of Congress in the lame duck session. We look forward to it and we believe the markets will appreciate it as well. Please call us with any questions you might have.

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

Ralph F. Palleschi
President and
Chief Operating 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 and Ralph F. Palleschi through the period ending June 30, 2012, 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.

Jericho, NY: First Long Island Investors, LLC (“FLII”) announced that Ralph F. Palleschi, President and Chief Operating Officer, was appointed non-executive Chairman of the Board of Directors of Astoria Financial Corporation (NYSE: AF), the holding company for Astoria Federal Savings and Loan Association. Palleschi, a certified public accountant, co-founded First Long Island Investors, Inc., the Jericho-based independent employee owned wealth management firm, in 1983. FLII oversees approximately one billion dollars in assets. Mr. Palleschi continues to serve as President and Chief Operating Officer of FLII.

Download Full Article Here

First Long Island Investors Senior Vice President and Chief Financial Officer of First Long Island Investors Stephen Juchem is Long Island Business News CFO of the Year.

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Clients and friends of FLI Investors gathered for a discussion on navigating the Fiscal Cliff in light of the uncertainty ahead and this year’s political election. Robert D. Rosenthal, FLI Chairman & CEO, and Jason Trennert, Chief Investment Strategist of Strategas Research Partners, shared their insights and predictions.

HERE ARE SOME OBSERVATIONS FROM THE HIGHLY CHARGED CONVERSATION TO KEEP IN MIND FOR YOUR INVESTMENT PORTFOLIO:

U.S. INTEREST RATES & DEBT
The U.S. Government is using short term debt to run the economy. This is an “extremely dangerous” way to capitalize the economy. US debt has gone from $10.9 trillion to $15.5 trillion in the past three and a half years. Yet, the dollar continues to be the reserve currency.

ASSET ALLOCATION
The only chance for positive real return is equities and the real return from bond funds for the next 5 to 10 years will be negative.

GOLD
Gold may continue to “have an underlying bid for a long time.” It’s not as much of a commodity play, as it is an insurance policy.

ENERGY
Oil production is limited by technology and it’s only a matter of time before a major transport fleet, such as FedEx, converts to natural gas.

THE EUROPEAN DEBT CRISIS
The fiscal authorities in Europe cannot continue to spend money they don’t have. The U.S. is extraordinarily different; it is the only place in the world where people want smaller government—“you will never see a Greek protestor calling for smaller government.”

Hope you will join us at our next event!

Jason Trennert
Managing Partner — Chief Investment Strategist

Jason Trennert is the Managing Partner and Chief Investment Strategist of the Strategas Research Partners. He has been ranked consistently by Institutional Investor magazine as one of the top Strategists on Wall Street. A keen market observer, known for giving “good copy,” he is a regular guest host on CNBC’s “Squawk Box” and “Bloomberg News.” He is the author of the popular investment book, New Markets, New Strategies, published in 2005 by McGraw Hill. Prior to founding Strategas, Mr. Trennert was the Chief Investment Strategist and a Senior Managing Director at International Strategy & Investment (ISI) Group. He has an M.B.A. from the Wharton School at the University of Pennsylvania and B.S. in International Economics from Georgetown University.

“We must build dykes of courage to hold back the floods of fear.”
Martin Luther King, Jr.

Investment Perspective We had an excellent first quarter for our equity based strategies, both defensive and traditional with gains as high as 17% (net) for our best performing strategy. This was accomplished despite widespread investor fears that continued to prevail from last year. For the most part, our strategies outperformed their respective benchmarks, and we believe we accomplished this while taking less risk, using no leverage, ^* and maintaining the utmost transparency. Our bond portfolios tracked at least as well as their respective benchmarks despite most bonds offering little return and not much value (in our opinion). Our private equity and real asset investments appear to be making progress as well.

Of great importance in being able to accomplish solid results despite ongoing fear, is deploying one’s liquid net worth in a prudent asset allocation. One’s carefully constructed asset allocation among our investment baskets in security; defensive equity; traditional equities; and private investments is the building of our dykes of courage. The floods of fear come daily from the many economic, geopolitical, and political challenges that we face. Our asset allocation seeks to protect us from the emotional decisions that investors often make that tend to hurt their performance.

^* Only our Sterling Stamos strategies invest in funds that use leverage.

Our explanation for the first quarter’s significant gains stems from a catch up to reflect last year’s earnings growth, and the somewhat reduced fear emanating from last year’s economic, political and natural disasters. The Japanese earthquake and related events, our budget debacle and subsequent credit downgrade, predictions of a Lehman-like financial meltdown in Europe,
and a projected double- dip recession were digested/dealt with/or just didn’t happen. Of course some challenges including structural and growing deficits, unacceptable levels of unemployment and anemic domestic growth need to be addressed with reasonable fiscal policy. But that will have to wait until after the election given the selfish nature of our politicians.

We at FLI believe that the economy is somewhat better than many pundits believe based on the financial strength of American business and the resilience and prudence of the American consumer. This is in spite of politicians who have chosen to bicker rather than promulgate constructive fiscal policies relating to addressing budget deficits, overdue tax reform, and impending difficulties with Social Security, Medicaid, and Medicare. This paralysis has contributed to a continued level of high unemployment as existing businesses are slow to deploy capital and hire new employees as there remains too much uncertainty. And overzealous government regulation in many industries including energy have hampered growth initiatives and subsequent job growth.

The unfortunate reality is that we face significant uncertainty from both unknown tax and healthcare policy which severely impact the domestic economy. Tax rates for almost all Americans are set to increase the first of the year as payroll taxes go back up and the Bush tax cuts expire. In addition, our new health care law is being challenged by 26 states before the Supreme Court. Their decision will impact virtually all Americans and most businesses. And by the way, imbedded in this new health care law are tax increases on all forms of investment income. The net result could be a huge headwind to the consumer and business depending on what happens at year-end (we believe some compromise will be made lessening the tax blow).

Meanwhile China’s growth is still strong but somewhat slower than recent quarters. Europe’s debt and banking issues are being dealt with but it is in a modest recession (thus far) resulting from austerity and tax increases (there is a lesson here). The good news is that the powers in Europe are looking to avoid a Lehman-like event. So far so good – and even headlines about Greece, Italy, Spain and Portugal don’t really move our markets as much as they had. However, we continue to be concerned that steps taken to this point are still a temporary fix and include anti-growth austerity. This could present issues down the road. Other  eopolitical hotspots in the Middle East could bring back volatility, especially efforts to stop Iran’s nuclear undertaking.

The good news is the S&P 500 and other benchmarks are at much higher levels than three years ago, but not record levels. However earnings are higher for companies and we believe share prices therefore are more reasonable. This is especially the case given the historically low interest rates being paid on bonds. Corporate balance sheets are much stronger; however the pace of expected earnings growth has slowed. Dividend growth is robust and our Dividend Growth strategy yield is more than fifty  percent greater than the ten year Treasury! Thus we remain comfortable in advising clients to have prudent but reasonable allocations to our defensive and traditional equity strategies. Too much money is in money market funds and bond strategies which we believe will provide negative real returns (after inflation) and will suffer losses if interest rates increase. Skepticism about the market’s gains and ongoing fear continues to cause

this outflow from stocks into bonds and cash. This we believe, as contrarians, is a positive factor.

Commodities are hard to call given the uncertainty of global growth. Gold remains more of an insurance hedge against inflation and global conflict now that financial collapse seems off the table. Real estate, if not overly levered and financed at longer term low interest rates while sporting a good cash on cash return, could be a worthwhile investment (not so easy to find, but we are looking). Private equity also is attractive if you’re willing to endure long periods of illiquidity (you are generally paid for waiting).

The proverbial wall of worry described above should also include high energy costs and a housing market that continues to sputter along (we believe it will get better in the next year). Both particularly hurt the consumer who is still deleveraging. So why do we remain defensively optimistic? The answer is cash, fear, and progress.

The individual and corporate cash on the sidelines, both here and abroad, will ultimately find its way into investment, dividend increases, share buybacks, and acquisition activity. This will bode well for good stocks. The media-driven fear seems to be giving way to the animal instinct of greed. Apple at $600 and paying a dividend, Facebook going public at a hundred billion dollar valuation and old Big Blue (IBM) hitting $200 per share have made those risk takers richer. Given what we believe to be reasonable valuations for both Apple and IBM, even my older relatives would make that risk-on trade. Yet many remain on the sidelines still contemplating an entry point. They will slowly but surely commit as other asset classes provide little or no value and that also will be good for the markets. Despite the legitimate real life concerns that exist, progress is being made by companies in terms of earnings growth, market share gains and product innovation. And even politicians both here and abroad are starting to deal with structural issues that must be solved.

So stay disciplined and nimble by allowing us to work with you on a prudent asset allocation. In the current environment we generally recommend an asset allocation that emphasizes defensive equities, so volatility and fear doesn’t shake you out of the equity markets. In addition, at this juncture we believe that our defensive equity strategies provide better value and yield than most bonds. At the same time you will also have a better chance to make a real return (after inflation) on your core capital. The balance of security (bonds and absolute return) on one side and traditional equities (growth, value and diversified) on the other side of defensive equities should give you a pathway to reasonable long term returns while taking on the level of risk you are comfortable with. Meanwhile you can watch events unfold on our wall of worry with fewer sleepless nights.

You will see from the results in the next section that having been diversified among our allocation baskets of security, defensive equity and traditional equities paid off handsomely this quarter while permitting you to sleep at night. We can’t let fear dictate a policy of accepting below inflation returns.

Best regards,

Robert D. Rosenthal
Chairman and
Chief Executive Officer

Ralph F. Palleschi
President and
Chief Operating 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 and Ralph F. Palleschi through the period ending March 31, 2012, 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.