The next few days we are going to see political theatre that could be greater than Shakespeare’s plays. Some have asked us not to talk about politics, but at times like this, it is politics that is driving the market lower. We believe the market will be very volatile over the next few days with more risk on the downside than on the upside. Eventually the debt ceiling will be raised, as it has to be. The problem with this situation is twofold: 1) the drama in Washington is impacting the economy because of the uncertainty it is causing amongst investors and business owners, and 2) even though the short-term ramifications are important, long term structural changes to our entitlement programs are much more important for future growth.

Uncertainty: We have talked in previous market updates about why we believe many companies and individuals are holding cash. The main reason has been because of the uncertainty they have about the future. Items such as healthcare costs, taxes, regulations, and other issues are points of uncertainty we have previously addressed. Now we have the added uncertainty of the US going into default. With the economy growing at a snail’s pace, uncertainty like this can be the impetus that may cause the economy to pull back. A small downward adjustment in consumer spending will cause our economy to contract. Our economy did well under both Clinton and Reagan. Why? The rules of the game weren’t changing as rapidly or significantly as they are today and confidence was high. We believe our economy won’t truly take off until confidence is restored.

Structural Changes: This is not a red or blue issue, but a black and white one. If structural changes are not made to Medicare or Social Security, we will go bankrupt. There is a demographic tidal wave called the “baby boomer generation” that will be swamping these programs over the next 15+years. Any debt deal that does not adjust these programs may give a short-term reprieve, but will not help us in the long run. If these programs were reformed, some of the anxiety associated with our spending levels in this county would be resolved.

As you know, we have been concerned about the “risk” in the market place. Although the debt ceiling is one of the things we are worried about, there are other items that give us more concern, such as the problems in Europe, sluggish US economic growth, rising interest rates in BRIC countries, and several others. Even though the headlines are about the US debt ceiling, which may be the impetus for a market correction, the other factors we are watching are getting worse. Europe has tried twice to fix the Greek crises in the past 60 days and it is no longer in the headlines. However, the problem is not over and we contend it looks to be getting worse. Both Spain and Italy have seen their interest rates rocket in the past month and, while they did retreat temporarily, are back to their recent highs. Not only is this costly for those governments trying to fund their deficit, but rates for consumers have shot up as well. Interest rates usually go up in a strong economy, not a weak one. Italian 10-year interest rates have gone from slightly over 4.5% to almost 6% in the last two months. If that happened in the US today, that would mean that a current 30-year mortgage rate of 4.75% would jump to 6.25%. This would not be good for our economy and this type of interest rate movement isn’t good for the Italian economy. We don’t want to be pessimists but contagion has started to spread, and it is at the cost of world financial markets. Feel confident that we are watching all the concerns expressed in this update and will act appropriately.

Sincerely,

Your THOR Team