A Leading Investment Firm Specializing
in Insurance and Financial Services Businesses

November Can’t Get Here Fast Enough

August 2010- Market Outlook
We emerged from the May/June selloff a bit shaken by the lackluster jobs data given several jobs-dependent positions in the portfolio. Despite these positions we were down less than the S&P 500 during these two months, but saw the subsequent “rally” outpace our July 5.9% return. In this month’s communication we address why we have taken positions geared to an improvement in the jobs numbers, and why a pick-up in jobs immediately boosts the top line of several stocks we hold.

The Nasty Nine: The two graphs below (thank you Barclays) summarize our frustration with the jobs situation. After 12 months into the recovery we expected unemployment to have started a decline towards 7%-8%. Instead we seem stuck above 9%. For perspective on the severity of the current rate, consider that +9% rivals the ’81 - ‘82 recession (left chart). However, as we explain below the challenge for several positions in our portfolio is that mere improvement has not even started to materialize— we remain stuck above 9%. A dig into the data is beyond the scope of a one-pager, but the highlight of our analysis is a wide dispersion around the well-publicized, +9% average after taking into consideration differences in geography, industry, age, education, and race. Understanding the dispersion steered us away from certain jobs-geared stocks, and towards others.

Divided We Stand Until November: It is an enormous understatement to point out that the current administration would like a pick-up in jobs before the November elections. On the other hand, the Republicans may not lose sleep if improvement fails to materialize within the next several months, and dare we go so far as to suggest that prior to elections there may (may?) exist a disincentive to even whisper that pockets of improvement are masked by the +9% “average” quoted in the press. Regardless of short-term wishes, once November passes it’s a safe bet both parties will move towards common ground on the employment issue. This common ground would be a positive for our portfolio, as we explain below.

Stocks and Jobs: We’ve selected several group benefit stocks that provide retirement accounts, health insurance, disability insurance, etc. for small/mid-sized, industrial/service-oriented companies. The selected employee benefit stocks in our portfolio immediately see a pick-up in revenue when existing clients (not even a need for new clients) add employees to the payroll. As soon as someone is hired, additional insurance premiums and retirement dollars begin to flow to the employee benefit company, which, in turn, immediately drives the top line. As a sign of the times, our stock selection specifically steered away from a group benefits company with a client focus on municipalities. How the world changes: the municipal focus was previously valued in a recession given the protection from payroll downsizing.

If you have questions regarding the financial services sector, or would like to discuss our investment approach, please contact us at the phone number below, or visit our website. (www.PhiloSmith.com)

E. Stewart Johnson
Portfolio Manager

Performance through July, 2010

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Stamford, CT 06901
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