The S&P 500 gained 53.2% in the 6 months since the March 9th bottom.  Over the same time frame, the NASDAQ gained 57.1%.  These are among the sharpest gains ever recorded for either index (record for the NASDAQ.)  However, the S&P 500 still remains 34.3% below the October 7th, 2007 record high, and the NASDAQ remains 29.02% below the October 2007 high and 59.9% below the March 2000 record high.  YTD the S&P 500 is up 17.0%
 
Bottom line, both indices need to increase by 50% just to get back to the level of October 2007.  We think those levels will be achieved in the next 3-5 years, which implies annual rates of return of 14.4-8.4%.  The long term average return of stocks is 8-10%/year, so our forecast would be straddle the long term average rates of return.  However, the average rate for return in stocks for the current decade is negative 2.3%/year for a cumulative loss of 20.2%.  There have been three other periods of negative ten year returns in the US stocks over the last 200 years.  Each of those periods was followed by a decade of excess returns.
 
Yellow lights on the instrument panel

The experience of the last year made us feel like the pilot of a business jet cruising along happily at 40,000 feet when suddenly one of the plane's engines blows apart.  In moments, every indicator on the instrument panel turns red, the cockpit fills with smoke and the plane plunges 30,000 feet in seconds.  With the ground looming, the pilot manages to transfer enough power to the remaining engine to stabilize flight and regain altitude.  Lights on the instrument panel turn from red to yellow, but making the airport is not yet guaranteed.
 
We review several hundred economic indicators each month and read about 600 pages per week of economic forecasts, trade magazines and opinions of other portfolio managers.  From October 2008 through March 2009, all those resources showed the equivalent of "red" across the board.  Now we're seeing a lot more "yellow."  Of note:
 
Housing - After falling 32.5% from the June 2006 peak, house prices according to the Case- Shiller indices through June 2009 have been stable to slightly higher for four months.  Case-Shiller produces their data with about a two month lag.  Concurrent analysis from Radar Logic showed that June 2009 prices gained 3%, with gains in 23 out of 25 Metropolitan Statistical Areas (cities.) Existing home sales surged in July.  Many of these sales were foreclosure sales, but bottom feeders are out in force.  We have no expectation that housing prices will regain 2006 levels anytime soon. After the 1989 real estate market peak, prices did not recover from a relatively mild 8.3% decline for 8 years.  

Employment - the US unemployment rate more than doubled from the cyclical low of 4.4% October 2006, reaching 9.5% in June 2009.  The July report rate showed a modest decline to 9.4%, and "only" 247K jobs were lost in July, versus 741K lost in January 2009.  If the current recovery matches the "jobless recovery" of 2003-2006, where net jobs gained averaged $142K/month, it could be a decade before unemployment falls below 6%. Economic growth and prospects - US GDP lost "only" 1.0% in the year over year period through June 2009.  The Conference Board's index of Leading Indicators surged to the highest level since March 2003, which marked the end of the last recession.
 
Commodity prices, the dollar and inflation - Commodity prices, which fell 57% in the 7 months
ending February 2009, staged a modest recovery in recent months as demand, especially from emerging economies such as China, picked up.  The US dollar, the "flight to safety" currency during the crisis, sold off recently.  We expect both to settle into a trading range for the rest of the year, with oil trading in a range of $65-$80/barrel.  We're not worried about the dollar falling precipitously against, for example, the Euro, because we expect the US economy to recover faster than Eurozone economies, and interest rates to head higher in the US before Europe.  
 
US Consumer Price Inflation remains negative, so Federal Reserve Policy should remain neutral for the foreseeable future.  The 10 year Treasury bond yield, which drives both mortgage and corporate lending, is stable around 3.5%.
 
Net: as average Americans see the value of their homes stabilize, the security of their jobs assured and the value of their stock portfolios gain, they'll feel more confident about purchases.  Businesses, which cut spending to the bone over the last 9 months, will respond in kind.  However, we're not going back to boom times for a while.  The loss of wealth in the financial crisis will compel the average American to work ten years longer than planned before retirement.  Their #1 priority will be paying down debt and bulking up savings - a long term boost but a short term drag on economic growth.
 
Institutional investors are also rethinking their priorities.  Pension plans and particularly US colleges and universities moved away from traditional stocks and bonds over the last decade, and moved aggressively into hedge funds, private equity, venture capital, commodities, real estate and timber.  When push came to shove over the winter, the trustees discovered that when it came time to pay the dormitory fuel bills, only US equities provided the liquidity needed.  The alternative investment managers compelled endowments to lock up funds for extended periods of time, pay high fees, offered little transparency into the investment process, but only provided, with some exceptions, meager returns.
 
Pace of Regulatory Reform

We're encouraged by the regulatory reforms currently circulating in Washington.  After 15 years of laissez-faire capitalism, politicians and regulators are thinking that those Franklin D. Roosevelt era safeguards were pretty important after all.  Newer investments products such as Credit Default Swaps are moving from over-the-counter to exchange markets.  We'd be happy to see all investment firms, not just traditional registered investment advisors such as ourselves, regulated by the SEC (no more Bernie Madoff's!)  
 
We'd also like certain aggressive hedge funds brought to heel.  We don't think our society can survive if a portfolio manager aggressively shorts and buys puts on a company's stock, aggressively bids up the credit default swaps on that company's bonds, and then puts out rumors that the company is in trouble.  Yes, the portfolio manager made hundreds of millions of dollars but in the process destroyed billions of dollars of other people's wealth (as former employees of Bear Stearns and Lehman Brothers know all too well.)  
 
The key question that must be answered in Washington is, "Do markets exist to serve the capital needs of corporations and the savings needs of individuals, or is it all a game for traders and speculators."  If the latter, we are all poorer.
 
Strategy

In March, we made the decision to take our clients fully invested.  At the time, that decision seemed insane as millions of individual and institutional investors were liquidating their portfolios at 13 year lows for US stocks.  We were confident in our knowledge of stock market history that, after every major sell-off of the last 100 years, stocks always outperformed.  This financial crisis, while severe, did not seem fundamentally different from previous crises.  So far our clients have been rewarded.  The easy gains have already been made, but we're staying invested in anticipation of "normal" returns going forward.