Quarterly Newsletter: July 2009

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Capital Markets
After one of the greatest drops in history, markets rebounded in the 2nd quarter. Beginning March 9th, equity markets rose strongly for two months. While growth slowed in June, the S&P 500 was up 15.9% for the quarter and 3.2% year to date. Small Cap, International and Emerging Markets were up over 20% for the quarter

Most observers believe that this bounce was one of relief that the financial system remains viable—rather than the start of a classical recovery. Significant problems remain in the economy as job losses continue and corporate earnings suffer.

The consensus view is for the economy to recover late in 2009 or 2010.

Asset Management in the New World Economy: Searching for Real Return

The free-fall in the stock market seems to have subsided for now. While markets remain fragile, fear and panic have been replaced by quiet resignation in the financial world. In the last eighteen months, we saw the US and global financial systems move dangerously close to total collapse as the highly leveraged, overvalued financial assets in the system plummeted in value.

Looking back, it seems unbelievable that those overpriced mortgage securities were being purchased without more scrutiny as to the underlying value. But all stocks and other securities were being bid up without caution. We know that's what happens in all overheated markets–investors get carried away and lose perspective. But this time seemed different in an important way: our regulators–the Federal Reserve, Treasury, SEC and ratings agencies–didn't grasp the magnitude of the risk of the unchecked leverage.

Now, the US and other nations are struggling with how to shore up their economies through governmental stimulus programs and new regulations. Politics aside, everyone seems to agree that steps had to be taken to save the system. So facing multi-trillion dollar deficits and potentially huge inflationary pressures in the future, what's an investor to do in this environment? We see four key principles going forward:

Lower Return Expectations
The double digit stock returns of the 20th century will be extremely difficult to achieve in the coming years. The growth economy of the past was driven by several macro trends: economic globalization, a freely spending US consumer, growing industrial efficiency, the knowledge explosion through technological advancements and productivity gains. In the absence of predictable new waves of productivity gains…together with probable high deficits, inflation, higher taxes and a thriftier US consumer, sustained future growth seems problematic.

This isn't to say that stock returns will be negative; investors should continue to capture an equity premium for taking the risk of stock investing. But without friendly economic winds at our backs, investors should plan for lower returns than we've been accustomed to. For planning purposes, a compound return of 6% to 8% for equities is likely a reasonable range.

Reduced Equity Exposure
While stock returns should be superior to those from fixed income investments, lower returns dictate that investors consider lowering their equity component from past levels. Because most portfolios are already lower than the pre-crash levels, it may be a good idea to adjust to these new levels. Asset allocation is always investor specific; however, many Arbor clients are now ten percentage points below equity targets from two years ago and expect to adopt these as the new, lower equity targets.

Hedge for Inflation
While inflation in the future is uncertain, there seems to be a relatively high probability that the US and other world governments will be funding deficits by printing money. In this environment, prices may be under significant inflationary pressure. Investment portfolios should include assets which recognize this prospect.

• Keep fixed income maturities on the short side
• Own some hard assets, such as commodities
• Consider Treasury Inflation Protected Securities (TIPS)
• Consider Floating Rate Bank Loan funds

Watch Investment Costs and Taxes
Fees, expenses and taxes are always important, but even more so in a lower return environment. Our investment approach is to implement tax-efficient portfolios with funds that have low administrative fees. Exchange-traded index funds with low administrative expenses are a key part of our investment strategy. Also, our custodial services through Fidelity Institutional Wealth Services provide high value/low cost custody, trading and reporting. Judiciously watching costs and taxes will be important for future investment success.

In Summary
The new investment environment will be different from what we have been used to. New federal regulations, massive deficits and the prospect of inflation will limit growth and make it increasingly difficult to generate real returns from investment assets.

Being realistic is important for planning; lower return expectations are a fact of our new financial lives. But careful management is more important now than ever before. Prudent asset allocation, inflation-aware instruments, low-cost investments and rebalancing to long-term targets are critical to producing real portfolio returns.

Fidelity News
If you have an individual account and an IRA with us, you have received a letter from Fidelity notifying you of changes to Asset Movement Authorization on your account(s). The essence of this letter is that your signature is no longer required to make your IRA contributions from your individual account. At your direction, Arbor will be able to journal your contributions going forward.

Employee News
Please join us in extending best wishes to Emily Hinton Coe of our operations team. Emily and Doug Coe were married in Raleigh on June 6th. We are very excited for Emily and Doug!

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Arbor Investment Advisors, LLC. Please remember to contact Arbor Investment Advisors, LLC if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. Please also advise us if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. A copy of our current written disclosure statement discussing our advisory services and fees remains available for your review upon request.

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