The dramatic and almost instantaneous drop in stock prices on Thursday of last week has made investors curious on a number of levels. We thought we might be able to shed some light on this unprecedented event.

Our most recent information and research suggests that the dramatic decline in stocks was driven by investor panic coupled with the today's rapid electronic trading. There is no evidence that there was foul play in markets or that one large institutional investor made a trading error. Markets had recently traded significantly to the upside and were due for a pullback. The negative sentiment coming from Europe was just the trigger that set markets into a tailspin. It is unlikely that any trades from that day will be reversed given that there has yet to be any proof of foul play.

We have often expressed that fast moving, dramatically declining markets can be unfriendly to stop loss orders since stocks get sold into significant weakness. However, our strategy is to mitigate this risk by placing stops only on certain sectors of your portfolio – what we consider to be economically sensitive stocks. Additionally, we are not obligated to place stop loss orders on all the shares you own – we can specifically adjust the stop loss orders to affect a certain percentage of the shares you own depending on the economic and market cycle conditions. This is why we call this process Active Risk Management. As a result of our attention to this risk, we sold only 5-8 ½-share positions, or about 5-7 percent of your equity exposure. We want to remind you that over 90 percent of your stock portfolio is still intact.

No one knows for sure if this recent volatility is the beginning of something worse (we doubt it) but if it is, it’s nice to know we own a little less stock exposure and continue to use stop loss orders on your portfolio. If the dust settles, we also have a list of great companies – now at much cheaper prices – to add back in to your portfolio.

We believe that risk management is central to long-term, successful, investment performance. Stop loss orders are one very effective tool in our arsenal, as anyone who was with us during the bear market of 2007-08 can attest. As we say, "stop losses are not perfect, but they are better than using nothing.” As a team, we feel grateful that we reduced the amount of shares effected by stop losses prior to this one difficult day and that your portfolio was only slightly effected.

Lastly, we want to mention that days like May 6th are very rare – thank goodness. Most importantly, the New York Stock Exchange, along with other global exchanges, has agreed to put curbs and circuit breakers on markets to reduce the risk of this type of market gyration in the future. We look forward to this change.

We hope these thoughts are helpful.

Sincerely,

James E. Demmert
Managing Partner