Our Market Commentary

The second quarter ended with the major stock market averages posting double-digit losses, in what has proven to be the worst first half of the year since 2002. Despite those dreadful numbers, we’re pleased to say that we exited the period ahead of the popular benchmarks.

While certain segments of the economy are in recession these days, most notably the financial and housing sectors, the economy has held up far better than many expected. This is due in part to the Federal Reserve’s aggressive credit stance in the past year and the resulting weak dollar, which has helped to boost U.S. exports. We’ve cashed in on this trend by being overweight in materials stocks, which were among the quarter’s stand-out performers.

Crude oil has continued to move higher, setting one record after another in the quarter and energy continued to dominate the investment landscape. Our stakes in oilfield service providers, contract drillers and integrated oil companies all paid off nicely as a result.

Our approach has always been to not only try to make money in up markets but to protect what you have in weak ones as well. That’s why we’ve maintained a focus on owning only what we believe are high-quality stocks as well as large weighting in hedges that range for ultra-safe companies such as Berkshire Hathaway, to inflation-fighting gold shares to deflation-protecting zero coupon U.S. Treasury bonds.

We now have nine years of verified returns under our belt and you’ll be pleased to learn that our performance during that extended period has placed us at the forefront of the large cap growth managers’ universe as of June 30, 2008 according to Informa Investment Solutions.

Keep in mind that while we’ve had excellent results in recent years, there’s no guarantee our future returns will be as impressive. Moreover, it would not be surprising if we were to suffer a poor quarter or two as trends tend not to move in straight-line fashion. Of course we’ll continue to employ the same tactics that have served us so well over the years, adjusting our holdings to fit what we predict to be changing investment conditions.

Outlook

There’s no ill wind that prevents us from making money, but it remains a constant balancing act. So far, the economy has skirted recession, although the slowdown has been quite painful for some segments. Should it exhibit increased signs that it’s sliding into a deep contraction, we would be inclined to add more protection in the form of zero-coupon bonds and gold shares.

The official inflation rate is running above 4 percent these days and it’s widely acknowledged that the true rate of inflation is much higher. So barring some unforeseen blowup, the Federal Reserve is likely through cutting short-term interest rates for this cycle. Yet given the fragile state of the economy in general and the financial sector in particular, the central bank isn’t about to suddenly reverse and start raising interest rates either.

Mounting inflationary pressure, coupled with a slow-growth environment—hamstrung by high energy costs—are conditions eerily similar to the 1970s. Unlike the ‘70s, however, consumers are saddled with debt, prohibiting the normal prescription for curing the ailment—drastically higher interest rates and an ensuing deep recession.

We’re seeing some demand destruction as a result of higher energy prices. But unless the economy slows markedly from here (and we don’t think it will at this time), and the developing world’s thirst for energy is suddenly quenched, any pullback in energy prices is likely to be short and shallow. So while a decline to $120 a barrel or so isn’t out of the question, a return to the good old days of $60 oil is in our opinion, at best only a very remote possibility.

Despite our bullish long-term view of where crude oil is headed, we would also lighten up on our more leveraged energy plays, such as the oilfield service and contract drilling companies, in the event we see cracks in the global economy.

For now though, the most likely scenario in the coming months is that the economy continues to move ahead at a sluggish pace and the overall stock market remains mired in a trading range. We’re at the bottom of that trading range now and could see a brief rally, but we foresee a sustainable move higher to be some ways off.

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Disclaimer: The specific securities identified and described herein do not represent all of the securities purchased, sold, or recommended for advisory clients, and that the reader should not assume that investments in the securities identified and discussed were or will be profitable. The mention of securities in this letter should not be deemed as a recommendation to buy or sell the securities. Leeb closely monitors the companies held in client portfolios. If a company’s underlying fundamentals or valuation measures change, Leeb will reevaluate its position and may sell part or all of its holdings.