The stock market spent most of June treading water as it worked to solidify three months of consecutive gains. The Dow Jones Industrials and Standard & Poor’s 500 were virtually unchanged, while the Nasdaq Composite managed to climb 3.4%. The market took a more defensive tone, with utilities leading sector performance, posting a gain of 5.1%. The materials sector was the worst performer, posting a loss of 4.9% (source: Bloomberg.com).

Despite the market having rallied 40% from the lows established in March, it remains 40% from its highs reached in October 2007. We have probably come to an inflection point where market prices have completely retreated from the fear of Armageddon and returned to a state of normalcy. The easy money has been made, or in most cases, recovered. Further gains will require a marked improvement in economic indicators as opposed to a stabilization of the rate of decline.

Investors have been skeptical of the market’s torrential advance since the day it began. Many leading economists and market strategists have been equally skeptical of an economic rebound on which future market gains will depend. We believe that much of this skepticism is rooted in a philosophical disagreement with the means by which the government is trying to achieve the end we all desire – an economic recovery. The Keynesian policies the Obama administration has implemented to revive the economy have been widely criticized, and understandably so, because of the deficits they produce along the way. Yet allowing a philosophical rift with these means to bias one’s interpretation of new developments, and maintaining a negative outlook for the economy and markets as a result is self-defeating. A bearish outlook at this stage in the economic cycle simply contradicts logic.

Skeptics point to the fact that we lost 345,000 jobs in May and that the unemployment rate jumped to 9.4%. We would focus on the fact that this is half the number of monthly job losses we had six months ago, and the smallest drop since the credit crisis began last September. Layoff announcements and initial unemployment claims have been steadily declining, and continuing claims saw their first weekly drop since January. While the absolute numbers are ominous, it is the rate of change in the number and the direction it is moving that matters to investors. Today’s numbers indicate to us that we could see job growth before year-end.

Skeptics are quick to remind us that existing home prices are down 18% year-over-year and nearly 27% from their peak, according to the Case-Shiller house price index. New home starts continue to decline and the number of existing homes for sale remains elevated. From our vantage point, existing home prices saw the smallest month-over-month decline (-.8%) in nearly a year, and the fall from the peak has brought home prices back in line with their historical relationship to incomes. The number of homes for sale is now falling, because existing home sales are on the rise at a rate above new listings (including foreclosures). We believe home prices will begin to rise again before year-end.

Skeptics focus on the record plunge in industrial production reminiscent of the 1970s, and on the fact that inventories are on track to decline more in the second quarter than they did in the first. On the flip side of the coin, these inventories must eventually be rebuilt, and while they continue to decline, the Purchasing Managers Index (PMI) for new orders has started to increase. This presages a reversal in the inventory cycle and a significant rebound in production. A case in point is the auto industry, which skeptic or not, most would call a disaster. Chrysler and General Motors have shut down numerous assembly plants, fired thousands of workers, and filed for bankruptcy. Both companies will remain on government life support for a long time. Yet the silver lining most skeptics fail to acknowledge is that auto inventories have fallen so far below an already depressed rate of sales in recent months that auto production is scheduled to surge more than 50% in the third quarter simply to meet current demand. This demand will increase in the fourth quarter as tax incentives kick in from the cash-for-clunkers bill that Congress recently passed.

The stock market historically bottoms coincident with a point in time during which the fundamentals couldn’t look any worse (think bank nationalization), and it now appears that early March was that climactic low. Recessions have historically ended approximately three to six months following the market bottom. Based on this timetable and the improvement in leading economic indicators, we are convinced the recession is now over. The economy probably contracted 1-2% in the quarter just ended, and will likely grow 1-2% in the quarter just begun. The recovery is underway. Only $53 billion in stimulus dollars have been paid out so far from the $787 billion fiscal stimulus package, and regardless of whether we think it is needed or not, the pace will run approximately $40 billion per quarter through the end of 2010. After all, it will be an election year. We believe real economic growth next year will be more than double the consensus expectation of 1.7%.

As incoming data measuring the health of the economy gradually improves, we expect to see the classic revisionist response from leading economists and influential market strategists, redirecting the herd back into the markets and remolding the investor psyche towards an optimistic outlook. A glass now viewed by most as half empty, will eventually be seen as half full. Skepticism is critical to the longevity of every bull market, as it serves as a source of fresh demand for stocks as prices rise higher. There is no better real time measurement of this skepticism than the amount of cash sitting on the sidelines in money market funds yielding less than 1%. Despite the 40% increase in the S&P 500 since March, money market funds still total more than 50% of the value of this benchmark index, which is more than twice the peak levels reached during the market lows of 2002 and 1990. Money market funds have averaged approximately 20% of the value of the S&P 500 over the past 20 years. When this cash hoard eventually declines to normal levels, and negative sentiment capitulates to the bullish side of the aisle, it will be time to temper our optimism.

We believe that the unprecedented amount of fiscal and monetary stimulus, combined with the record number of policy actions on a global basis, collectively support an S&P 500 valuation of 1200, which implies a 30% rise from current levels. Healthy corrections of 5-10% along the way should be welcomed, as they will provide the cement necessary to sustain the advance. The sectors that should drive this advance will be those most levered to economic growth. We expect the technology, consumer discretionary and financial sectors to maintain their leadership positions into the third quarter, followed by the industrials, energy and material sectors. We expect more defensive sectors such as healthcare, staples, utilities and telecommunications to lag the market through year-end.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

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PDF version of the Market Outlook

Stocks soared for a third straight month in May as the green shoots that have taken root begin to blossom. We see a bright light at the end of the tunnel most believed was leading to another Great Depression just several weeks ago. The Dow Jones Industrials (+4.1), Standard & Poor’s 500 (+5.3%) and Nasdaq Composite (+3.3%) all finished higher, led once again by the financial sector, which posted a gain of 13.1% (source:Bloomberg.com).

The herd mentality to sell financial assets from November of last year through February of this year was overwhelming. Bearish pundits held center stage, drowning out the voice of rational thought. Our sorry excuse for mainstream media, pouncing on the sensational rather than focusing on the sensible, did its best to make dire straits look apocalyptic. Lawmakers displayed oft-used and long-mastered skills of finger pointing and blame dodging. All the while, prudent investors like Warren Buffet were buying the very same assets the herd was looking to sell. Yet even after a 35% rally in the stock market from the March lows, there are more pundits that dismiss this recent rise as a sucker’s rally than embrace it as a new bull market. The only reason investors might dismiss a soaring stock market is that they are not participating in it, which begs the question, who is the sucker?

Despite the unpopularity of the outlook, and the risk of being trampled by the herd back in March, we opined that, “If investors keep looking in the rear view mirror for direction, they will be run over by an oncoming train in the form of $4-5 trillion of cash earning less than 1%. Investments viewed as safe havens today could be disasters in the not too distant future, as Treasury yields rise and asset prices inflate.” To question the current rally indicates a misunderstanding of the basis for the decline that began in earnest last September, as well as the mechanics of the market that drive asset prices higher. Stock prices declined rapidly after the bankruptcy of Lehman Brother due to the forced selling that ensued when credit availability collapsed. Fear accelerated and deepened the decline. As credit markets began to thaw and confidence in the financial system was gradually restored, the flight to safety reversed course. Money is the gas that fuels the engine of economic growth and inflates asset prices. The Federal Reserve opened the floodgates to the supply of money in response to the credit crisis, and most foreign central banks followed its lead. If money equates to gas in the tank, then interest rates are the accelerator, and central banks have the pedal to the metal, with rates now below 1% in many countries around the world.

We are now in the early stages of a global upturn in economic activity that is nearly as powerful as the decline instigated by collapsing credit markets last fall. From our perspective, all that is still up for debate is the speed and slope of the recovery. Consumer confidence, a leading indicator of consumer spending, is at an eight-month high. Both existing and new home sales appear to have bottomed, and the relationship between home prices and median income has returned to its historical average. Auto and retail sales are gradually improving, albeit from historically low levels, and trucking activity is picking up, indicating that businesses have begun to rebuild inventories.

As the fear and forced selling of recent months abate, investors will be looking for a rebound in corporate profits to push stock prices higher. The fact that consensus expectations are extremely low is a positive. We believe that profits will surprise to the upside as the economy begins to grow again, but for reasons not commonly discussed. When the economy contracts and corporate revenue declines, businesses lay off workers in order to reduce labor costs and protect profit margins, but they usually do so with a lag. This ultimately leads to a decline in profits that far exceeds the fall-off in revenues. When revenues do improve during an economic recovery, companies are equally as slow to rehire, which is the main reason that employment gains are a lagging indicator. As a result, the acceleration in profits can far exceed the growth in revenues. This dynamic is more likely to occur in the financial sector than any other.

Stress test results for the nation’s 19 largest financial institutions were released last month, revealing that regulators are as asleep at the wheel today as they were when the credit crisis unfolded. The loan loss assumptions used to conclude that banks needed to raise billions in additional capital were completely absurd, yet most banks met the necessary requirements by month’s end, and are now applying to repay the loans they received last fall. Meanwhile, the traditional banking business has never been more profitable, and reductions in head count to reduce expenses have nearly run their course. We believe earnings could potentially soar as the year progresses.

An unanticipated source of these future profits is likely to be a reversal of losses banks were forced to take in the past that never materialized. The toxic assets that the Troubled Asset Relief Program (TARP) originally intended to purchase last October remain on bank balance sheets. As their market value declined, these unrealized losses reduced bank profits and the capital on which banks lend. The Treasury is now in the process of launching a new government program, called the Public-Private Investment Program (PPIP), to enable investment firms to purchase these assets. Good luck! These toxic assets, which total nearly $2 trillion in face value, are predominately residential mortgage-backed securities, and many are now rising in value from the depressed prices that banks were forced to mark them to at the end of March. The banks no longer have the need to sell, but instead have an incentive to hold on. As market values for toxic assets continue to realign with the actual losses on loans held in the securities, banks will reverse prior losses and book gains moving forward. Perhaps this is why Bank of America is attempting to nullify the government guarantee on more than $100 billion in securities they acquired in the purchase of Merrill Lynch.

There are always issues to be concerned about on the investment landscape. The deficit spending necessary to restore economic growth and battle the deflationary spiral has led to a decline in the value of the dollar, and in turn a rise in oil prices. We believe we are witnessing a repeat of last summer, when institutions used commodities as an asset class to drive crude oil to an all-time high of $150/barrel. The volume of unregulated trading in commodity derivatives is surging, and commodity prices across the board are on the rise, despite supply-and-demand fundamentals that are not supportive of such a substantial move. This has led to a rise in gas prices that will likely continue, pinching disposable income for consumers. Other notable areas of concern are the additional job losses that will result from the downsizing of the auto industry this summer and the recent rise in long-term Treasury yields that has pushed mortgage rates back above 5%. At this stage we do not think these issues will derail the recovery.

It has long been said that investors should “sell in May and go away,” because the summer months usually lead to dismal market returns. The fallacy in this line of thinking is that the market has performed well above average during periods when leading economic indicators are improving, as they are today. This year is reminding us more and more of 2003, a period during which the Federal Reserve had lowered rates to 1% and dramatically increased money supply, and the market continued to throttle upward. Our upside target for the S&P 500 remains 1200 for 2009. So long as the pundits and the investors that follow their lead continue to question the advance, we are confident it still has further to go.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

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PDF version of the Market Outlook

The stock market continued its ascent, which began in early March, despite a healthy dose of skepticism from bearish investors, and a consensus view that still believes the worst is yet to come. The Dow Jones Industrials (+7.3%), Standard & Poor’s 500 (+9.4%) and Nasdaq Composite (+12.3%) all finished the month with impressive gains, and financial stocks (+22%) once again led in terms of sector performance (Source: Bloomberg.com).

The world is focused on the probability of a swine flu pandemic, but there is another one already here. The pandemic infecting the investment public is one of fear and bewilderment. The majority of investors, led by the same parade of misguided, book-touting pundits that dominate the airwaves, continue to focus on lagging indicators like the unemployment rate and the year-over-year decline in home prices. This is as futile as the federal government’s attempt to gauge the preparedness of our banks for a worsening economic outlook with the political sham they call a “stress test,” more akin to testing the levees in New Orleans one day after a 100-year flood. Meanwhile, there is an economic recovery underway! There is no better evidence of this reality than the most important leading economic indicator we know of — the stock market. The market lows achieved earlier this year have given birth to a new bull market, with the averages having now recovered approximately 30%, sending the bears into hibernation.

A handful of keen economists have identified what are being called “green shoots” in economic activity. We believe these green shoots have deep roots in what will lead to growth by the third quarter of this year. We have maintained that a significant percentage of the unprecedented contraction in global economic activity was abnormal, in that real demand that existed for goods and services was stifled by a forced contraction in the supply of credit. Now that credit is being restored, we believe we are on the cusp of an equally unprecedented resurgence, leading to one of the sharpest recoveries on record that few see coming. We have seen meaningful month-over-month increases in retail sales, vehicle sales and consumer confidence, but the most important development thus far is the improvement in the global Purchasing Managers Index (PMI) for manufacturing and services companies. This survey, now at a five-month high, is a broad measure of business activity that leads the upturn in industrial production. The unsustainable liquidation of inventories in the first quarter that led to a 6.3% decline in economic growth will inevitably lead to restocking, which should result in economic expansion this summer, marking the end of the recession.

There are improvements on the housing front as well. We rang the alarm with respect to the housing bubble in December 2005, pointing to the initial month-over-month declines in median home prices and existing home sales, while the masses were still reveling in the annual price increases that continued until the summer of 2006. We now see similar developments, but in a different light. Two leading home-price indexes report that median home prices have risen month-over-month for two consecutive months, and we believe prices may be bottoming in the most distressed markets. New home inventories have rapidly declined to a level not seen since the early 1970’s, leading us to the conclusion that both existing home sales and new home starts have bottomed.

We think the next catalyst for higher stock prices will come in the form of better than expected employment data. The unemployment rate may be the figure that catches all the headlines, but it is the weekly unemployment claims number that more accurately predicts a change in trend. The steady decline in layoff announcements indicates to us that claims may have peaked. If this is true, then the market will be taken by surprise with a significant decline in one of the upcoming monthly job loss reports.

This is not to say the coast is all clear. We will continue to see job losses this summer from vehicle supply firms when General Motors shuts down production for nine weeks. The deterioration in commercial real estate will likely continue well into 2009. The number of foreclosures and losses on consumer loans will continue to mount. Yet it is the rate of change that matters to markets most, not the absolute numbers, and we believe the positives will gradually outweigh the negatives. The skeptics will soon fan fears of inflation as the economy reflates, and while inflation has been a nemesis for stock prices in decades past, we are starving for it today, for inflation is a byproduct of growth! Few remember the last deflationary period this country experienced, like the one we are faced with today, because it was in the 1950’s. This was a period during which inflation was good for stocks.

The markets lead us to believe the economy is at an inflection point. We stated last November that while investors were embroiled in the most devastating financial crisis in modern history, they were at the same time being handed the investment opportunity of a generation. We went on to say we may be embarking on one of the best five-year periods for U.S. stock market performance in history. I imagine most still think us foolhardy. Our upside target for the S&P 500 this year is 1200, which would be a 30% rise from today’s levels, marking the point at which the credit crisis ensued last September. We expect the road to be bumpy, with several corrections of 10% or more along the way, but unlike last year when rallies were opportunities to sell, corrections will be viewed as opportunities to buy. Trillions of dollars remain on the sidelines earning negligible returns that provide ample fuel to meet our target.

The sectors that suffered the worst declines last year were those most levered to economic growth. Should the economy be at an inflection point, these are the sectors that should emerge as the best performers in 2009. We believe more defensively oriented sectors like healthcare, consumer staples and utilities will lag this year, while those more levered to an improvement in the economic outlook like technology, industrials and consumer discretionary will lead. The most controversial sector is clearly the financials, yet we think they have the potential to lead the market higher throughout the year.

The public has been led to believe by lawmakers, pundits and fear-mongering analysts that our banking system is insolvent and that some of our largest financial institutions must be nationalized. How then could our nation’s largest banks have reported profits in the billions during the first quarter of the year? The skeptics, in denial of their own flawed analysis, blamed these profits on a boom in mortgage refinancing, an explosion in net interest margins and improvements in asset values resulting from mark-to-market accounting. Evidently, it is fine to mark down the value of assets that banks hold, but it is an accounting gimmick when they mark them back up. As for mortgage refinancing and growth in net-interest margins, this is what banks do! Questioning their profits on this basis is like saying the only reason the Yankees lost their home opener is because the other team scored more runs. We think bank profits will continue to rise as deposits increase, loan volume increases, asset values rise and loan losses gradually level off. The potential upside from valuation levels more consistent with insolvency is significant enough to result in financials being the best performing sector in 2009.

Eleanor Roosevelt once said, “Great minds discuss ideas; average minds discuss events; small minds discuss people.” It is no wonder that popular opinion is so often misguided, given that the noise we rely on for news, which reverberates 24/7, is usually fixated on events and people that really don’t matter. Successful long-term investing is dependent on developing ideas about trends likely to unfold in the economy and markets over time. These ideas take shape in the form of investments that collectively define an investment strategy, which if soundly grounded, ultimately determine success.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

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Performance History

*Composite inception 10/17/2005

Trailing Total Returns

Fuller Asset Management, LLC (“Fuller Asset Management”) is an SEC registered investment adviser. The Fuller Large Cap Growth Composite Portfolio (the “Composite Portfolio”) represents actual client accounts invested according to Fuller Asset Management’s proprietary investment strategy. The Composite Portfolio invests in individual equity securities with a view toward capital appreciation.

The results of the Composite Portfolio are net the actual Fuller Asset Management investment advisory fees charged to the client accounts within the composite, brokerage commissions and other expenses. Fuller Asset Management’s investment advisory fees are described in the disclosure statement of Part II of the Form ADV which is available upon request.

Accounts within the Composite Portfolio are held with different custodians so they are subject to different commissions and other charges. In addition, withdrawals and deposits, and account size among other factors creates variations in performance among accounts within the Composite Portfolio and also in comparison to the Composite Portfolio.

The results of the Composite Portfolio include dividends and other earnings. Comparison of the Composite Portfolio to the Russell 1000 Growth Total Return and the S&P 500 Total Return is for illustrative purposes in relation to the potential performance of large capitalization stock only and the volatility of the Russell 1000 Growth Total Return and S&P 500 Total Return may be materially different from the volatility of the Composite Portfolio due to varying degrees of diversification and/or other factors.

Past performance of the Composite Portfolio may not be indicative of future results and the performance of a specific individual client account may vary substantially from the composite results above, in part because client accounts may be allocated among several portfolios. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable.

PDF version of the Market Outlook

The stock market surged more than 20% last month following a public relations blitzkrieg by Ben Bernanke, Timothy Geithner and President Obama. The Dow Jones Industrials (+7.7%), Standard & Poor’s 500 (+8.5%) and Nasdaq Composite (+11%) all finished the month with impressive gains, and the financial sector (+17%) led the charge. (source:Yahoo finance). We have witnessed five stock market rallies of 10% or more since last November, including the most recent, but each of the previous four left investors empty-handed. We see two key developments underlying the latest upswing that sets it apart from the others, leading us to believe it has much further to go, and could mark the birth of a new bull market.

Yet most investors still can’t see the forest through the trees. The amount of misleading and inaccurate fear-driven noise disseminated on a daily basis by politicians, market pundits and journalists is overwhelming for the average investor. Most are unable to digest this stew of one-part fact, one-part fiction and lots of opinion in an effort to think clearly about events past and present. It is even more challenging to predict the future.

The Congressional outrage over AIG bonuses is a prime example of the political deflection practiced by lawmakers in their effort to divert the public’s attention away from the root cause of the current crisis. They know that the dog-and-pony show some call the main-stream media will cover the bonus issue relentlessly at the expense of everything else. We are as disgusted as everyone with the $165 million in bonus payments to AIG executives, but we are more enraged over the billions in bailouts required to allow this company to make good on its legally binding contracts to other firms that were speculating on credit default insurance, and thus avert a catastrophic meltdown. If the public wants answers, then they should read the Commodity Futures Modernization Act passed by Congress in 2000 and hold lawmakers accountable.

This legislation was authored by Phil Gramm, endorsed by the likes of Alan Greenspan, Robert Rubin and Larry Summers, passed by members of Congress and signed into law by Bill Clinton. It paved the way for financial institutions to trade derivatives (credit default swaps) without any regulatory oversight. These are the very same derivatives, sold by AIG with reckless abandon to Wall Street firms, for which taxpayers are now paying the price. We hold these financial institutions accountable, despite the legality of their actions, but we place equal blame on lawmakers for building the framework for this disaster. Focusing myopically on an issue like bonuses, in an effort to instigate a populist tirade, is akin to fretting over a hangnail while you are having a heart attack. It has also served to sour investor sentiment and divert attention away from important developments that we believe underpin the current rise in stock prices.

There is no doubt in our minds that the significant discount placed on market valuations to date can be attributed to a lack of confidence, transparency and trust in the financial system itself. Yet we sense a renewed level of confidence contributing to the recent rise in stock prices. The SEC has announced it will reinstate the up-tick rule, which will make it more difficult for short-sellers to pursue bear raids on stocks. Lawmakers are finally addressing the need to regulate the credit default swap market. The Financial Accounting Standards Board will soon be announcing modifications to the mark-to-market accounting rules that have devastated bank balance sheets. These are the desperately needed changes we have been discussing for months, and they are happening!

In concert with this renewed confidence comes a bank plan announced by Treasury Secretary Geithner that we think will be successful. The irony of this plan is its similarity to the first plan introduced by Henry Paulson last October, one that we wholeheartedly endorsed, which intended to purchase toxic assets. The Public-Private Investment Program (PPIP) will partner private institutions with the Treasury to purchase the troubled assets that are eroding bank balance sheets. The Treasury will provide low-cost financing to these institutions, using up to $100 billion from the TARP, to enable them to leverage their initial investment and bid on debt securities that are trading at depressed valuations. This will create a market for these securities that has not existed for months. We also believe it will lead to significant price recovery that will benefit all parties involved. The taxpayer, represented by the Treasury, and the private institutions will realize positive returns from these investments over time. The banks that sell these assets will improve their regulatory capital position, and those that don’t will realize higher market values for similar debt securities they continue to hold. We are not surprised that lawmakers and the media have defined this latest effort as “cash for trash.” Based on that commentary, it is bound to work.

Sustaining the current uptrend will require more than just confidence and a viable plan to fix the banking system. It will require a gradual recovery in economic activity, and we see reasons to be encouraged about this recovery that most do not. It comes as no surprise that the recent market lows coincided with the deepest point of contraction in economic activity, but the rate of decline is moderating. Retail sales are on track to increase in the first quarter of the year, and bank lending to consumers is improving. The decline in home prices and mortgage rates has led to record levels of affordability, and we believe we are on the cusp of a surge in refinancing activity. It is likely that the economy will be growing again before year-end. Focusing on lagging indicators like unemployment and home prices is a recipe for missing a significant percentage of the market recovery. These statistics have historically never improved until well after the economy has rebounded.

Despite what appears to be a trough in the economy, investors continue to pour money into the safe havens of U.S. Treasuries and money market funds with virtually no yield. We believe this could prove very costly in the months ahead. If investors keep looking in the rear view mirror for direction, they will be run over by an oncoming train in the form of $4-5 trillion of cash earning less than 1%. Investments viewed as safe havens today could be disasters in the not too distant future, as Treasury yields rise and asset prices inflate.

We believe we are near the end of an unprecedented period of fear and uncertainty – a period during which at one point General Electric was considered to be a greater credit risk than the country of Vietnam. We must concede that we were unable to anticipate the rapid decline in stock prices that ensued from mid-September through November, but we have refused to capitulate to the doomsday scenario, and thankfully so, as March was the best performing month for the stock market in more than six years. We remain focused on the value of the underlying businesses we own, rather than on the irrational stock price declines that have occurred in recent months. In fact, we welcome the opportunity to buy more shares in these businesses at lower prices in anticipation of increasing future returns. We still see tremendous long-term value in common stocks and virtually all segments of the bond market, with the exception of Treasuries, and remain fully invested with respect to our allocations.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

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Performance History

*Composite inception 10/17/2005

Trailing Total Returns

Fuller Asset Management, LLC (“Fuller Asset Management”) is an SEC registered investment adviser. The Fuller Large Cap Growth Composite Portfolio (the “Composite Portfolio”) represents actual client accounts invested according to Fuller Asset Management’s proprietary investment strategy. The Composite Portfolio invests in individual equity securities with a view toward capital appreciation.

The results of the Composite Portfolio are net the actual Fuller Asset Management investment advisory fees charged to the client accounts within the composite, brokerage commissions and other expenses. Fuller Asset Management’s investment advisory fees are described in the disclosure statement of Part II of the Form ADV which is available upon request.

The results of the Composite Portfolio include dividends and other earnings. Comparison of the Composite Portfolio to the Russell 1000 Growth Total Return and the S&P 500 Total Return is for illustrative purposes in relation to the potential performance of large capitalization stock only and the volatility of the Russell 1000 Growth Total Return and S&P 500 Total Return may be materially different from the volatility of the Composite Portfolio due to varying degrees of diversification and/or other factors.

Past performance of the Composite Portfolio may not be indicative of future results and the performance of a specific individual client account may vary substantially from the composite results above, in part because client accounts may be allocated among several portfolios. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable.

PDF version of the Market Outlook

The stock market is digesting a worst case scenario for the economy that could see unemployment rise to 10%, home prices fall an additional 15-20% and the recession last through year-end. February, a terrible month for stocks, ends the worst six-month period for the market since 1932. The Dow Jones Industrial (11.7%), Standard & Poor’s 500 (11.0%) and Nasdaq Composite (6.7%) all finished the month with losses (source: Google finance). No one knows if the recent retest of the November bear market lows will hold or press lower. We do know that markets bottom on very bad news, and that they eventually turn up on news that is still bad, but less so than expected. The point at which dismal expectations fall below the grim reality we face will mark the turning point.

President Obama is embarking on an ideological shift to Keynesian policies at record speed in an effort to end this recession and restructure the American economy. The American Recovery and Reinvestment Act contains $789 billion of tax cuts, spending initiatives and investments in healthcare, education, energy and infrastructure. This stimulus plan hopes to create or save millions of jobs, boost economic growth in the second half of this year and address the structural deficiencies in our economy that will save money over the long term. The theory is that government spending will encourage consumers and businesses not to defer purchases and investments based on fears about the economic outlook. There is no doubt that no stimulus at all would lead to a deflationary spiral that would further retrench spending and investment. The stimulus should add 2-3% to economic growth in the second half of this year and end the recession, but the debt burden will soar.

The Obama Administration’s Homeowner Affordability and Stability Plan will use $75 billion from the $700 billion Troubled Assets Relief Program (TARP) to modify conforming mortgages for families that are current on their payments, but at risk of foreclosure in the future. The plan targets 3-4 million homeowners in hopes of reducing the foreclosures that are driving down home prices, and it offers cash incentives to lenders and borrowers to encourage participation. Aside from the moral hazard issue of helping some and not others, this program could reduce foreclosures by as many as one million.

The Financial Stability Plan introduced by Treasury Secretary Timothy Geithner fell way short of expectations due to its lack of specifics and his lack of charisma. The plan proposes a “stress test” for our largest banks to determine if they will be well capitalized should the economy worsen, but the results won’t be revealed until April and no one knows what measuring sticks will be used. The plan also proposes new programs to allow private investors to borrow from the Treasury and the Fed at low interest rates, allowing private capital to purchase assets. The problem here is that they will only allow private investors to purchase the highest quality debt, not the toxic assets for which there is no market. They still don’t get it! They must address the downward spiral in toxic asset market values in order to halt the negative feedback loop that is strangling credit availability.

Lawmakers and the media have vilified the banks and demonized the toxic assets that burden their balance sheets, thereby inflaming public outrage – The banks won’t lend! While the banks are culpable, they hardly deserve all the blame. The system is to blame, and we are all a part of the system. The toxic assets are taxpayer liabilities in the form of home loans, car loans, real estate loans and credit card loans. Who is to blame for their toxicity? We blame irresponsible borrowers, loan originators, investment banks (that no longer exist) and banks that bundled the loans into investment securities, rating agencies that glorified the credit ratings for profit and our lawmakers that defanged and under-funded the regulatory bodies established to prevent this from occurring. There are also innocent borrowers with wages that have not kept pace with the rising cost of healthcare, energy and education expenses. The banks are a part of the problem, but they are now our only solution.

So why are banks not lending despite all the taxpayer funds they have received? The belief that loaning money from the TARP would help them lend was flawed from the start. Nearly 50% of our credit came from the securitization market, which shut down following the bankruptcy of Lehman Brothers. Banks would originate loans, bundle them into investment securities and sell them to replenish their capital in order to make new loans. Now there is no market for these loans because investors can’t borrow and in some cases must liquidate what they previously purchased. This is constantly driving down the value of the existing loans that banks hold for investment and relentlessly eroding the capital they use for new loans. The Treasury has simply been filling the void with taxpayer funds all the way down. Yet lawmakers demand the banks lend, while regulators tell them that if they do, they will require more capital. It would be helpful if the public were better informed.

The mark-to-market accounting rule instituted in November 2007, just before real estate prices started to collapse, is the most significant contributor to capital destruction, yet the government refuses to address the issue for fear it may be viewed as favoring the financial institutions that they blame for the crisis – politics! Do we force a homeowner that is current on his mortgage to increase his down payment if the value of the home falls below the mortgage? It is equally as absurd to force banks to take losses on loans that are performing, just because there is no rational price for that loan in the marketplace. End mark-to-market accounting!

The Fed and Treasury continue to jawbone the markets with talk of programs designed to purchase all assets, other than the ones that are troubling the economy (toxic assets), in a dire attempt to protect taxpayers dollars. If they refuse to revoke the absurd mark-to-market accounting rules that are hemorrhaging bank balance sheets, then the government must purchase the troubled debt securities that are destroying credit markets and hold them to maturity. Those experienced in these markets tell us that current prices now imply unrealistic default rates that exceed those of the Great Depression. They are undervalued! It is one or the other, and the longer they wait, the more damage that will be done to the markets and the economy, and the longer it will take for recovery. The Treasury and Federal Reserve proclaimed that they would buy troubled assets in October 2007. Since then they have attempted everything but that in an effort to appease misguided lawmakers and an uninformed and infuriated public. The Obama Administration must have the political will to break this negative feedback loop or the impact of economic stimulus will be muted.

Should our banks be nationalized? The king and queen of doom and gloom, economist Nouriel Rembini and analyst Meredith Whitney, have gained fame (and likely fortune) over the past year exclaiming that our largest banks are undercapitalized and insolvent, the shares are worthless and the government should nationalize them. This has obviously fueled tremendous fear and driven stock prices into the ground. The statistics don’t support their claims. A bank’s health is measured by weighing its assets or capital relative to its liabilities. This ratio (called Tier 1) is considered healthy when it exceeds 6%, and it accounts for the quality of the assets and liabilities a bank holds. The four largest banks all had Tier 1 ratios at year end of approximately 8-12%.

It is also difficult to claim insolvency when the revenue these banks earn, net their expenses and realized losses on loans, results in positive cash flow. The net losses they incur are a result of unrealized, mark-to-market accounting charges and accounting provisions for losses that have yet to occur. It is cash flows and asset values that determine the value of a bank. In the most recent quarter ended, a quarter that saw the greatest contraction in economic growth (6.2%) since 1982, Citigroup announced losses of more than $12 billion. The “loss” resulted from nearly $8 billion in mark-to-market losses on investments they hold and $6 billion on provisions made for potential loan losses in the future. (source: Citigroup press release Q4 2008). These are accounting losses and have no impact on cash flows. The major disappointment with Citigroup management is that they succumbed to the pressure of the skeptics who demanded a far more draconian measure of assets relative to liabilities. This more stringent ratio involved converting the government’s $25 billion of preferred shares to common shares and amounts to nothing more than an accounting change. Now taxpayers own common stock in lieu of preferred stock that was paying an 8% dividend. This move may silence critics in regard to the bank’s capital levels, but it drastically diluted common shareholders, and it places taxpayers in a position to profit purely from capital gains.

We believe our banks are solvent, well-capitalized and will not be nationalized. The decline in share prices down to levels not seen since the early 1990’s may give pause to this claim, but banks were not subjected to mark-to-market accounting at that time. We believe the irrational market prices on debt securities will reverse their decline when toxic assets are inevitably purchased. This should reverse the mark-to-market losses on these assets and dramatically improve bank balance sheets as we move forward.

The recession is global and the plunge in consumer net worth is unprecedented as all asset prices decline. Inflation is negligible as demand continues to weaken. We still believe home prices will bottom this year. Governments around the world have implemented massive stimulus and central banks continue to lower interest rates. At some point, these actions will inflate asset prices. A rise in asset prices will reverse the negative wealth effect and demand for goods and services will recover.

What is the point of owning common stocks at Depression-era valuations in the face of one of the worst recessions we have had since World War II? If this recession turns into a depression, then selling stocks at today’s levels may be a good idea, and the most sensible alternatives would be cash or Treasuries. Despite the stock market (S&P 500) recording its worst year in 2008 since 1931, we do not see another Great Depression, and there are no other comparable statistics. The two longest recessions since World War II both lasted 16 months. We have now officially been in recession for 14 months. Should this recession end this year, regardless of how swift the recovery, we believe that common stocks will outperform other asset classes over the next 3-5 years, regardless of whether the recent November low holds or not. We are focused on owning companies over this period that will benefit from the inevitable recovery of the credit markets and the deficit spending by the federal government designed to transform our economy in the years ahead.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

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PDF version of the Market Outlook

The stock market finished the month of January at the lower end of a trading range established approximately 8% above the bear market lows reached last November, as Congress deliberates the size and structure of the economic recovery plan and the Obama administration determines how best to deploy the second $350 billion from the Troubled Asset Relief Program (TARP) to revive credit markets. The Dow Jones Industrials (-8.8%), Standard & Poor’s 500 (-8.5%) and Nasdaq Composite (-6.2%) all suffered significant losses (source: Google finance).

Financials led the market decline in January based on the belief that the entire system is insolvent. Recent share price declines along with fourth-quarter earnings reports would seem to validate this assessment. Despite historic efforts by the Federal Reserve to lower interest rates and increase money supply, the banks refuse to lend. The decision made by former Treasury Secretary Paulson to inject capital from the TARP into banks has been a complete disaster. We were told the money would be used to lend to consumers and businesses, thereby unclogging credit markets, but it has instead been used to meet what can best be described as margin calls on the declining value of “troubled assets” – the same troubled assets that the TARP was designed to buy. These so-called troubled, toxic or bad assets are loans extended to consumers and businesses prior to the recession that sit on the balance sheets of financial institutions.

We believe the banking system has ample capital and is not insolvent, but every quarter the banks are forced to value or “mark” the loans they hold on their balance sheets as if they were selling them in the market on that day (mark-to-market). Irrespective of whether these loans are performing or not, in an illiquid market laden with tremendous fear and absent any willing buyers, their market value is steeply discounted from fair value or value at maturity. This decline in market value is considered a loss of capital on the balance sheet of the financial institution, and in turn requires maintaining more liquidity as well as reducing lending capacity. As long as financial companies fear lower marks on their assets, they will continue to restrict credit availability and use cash infusions to build reserve capital.

We have confidence that Treasury Secretary Timothy Geithner will be more effective than his predecessor in deploying the second $350 billion of TARP funds by creating a market for troubled assets and addressing the root cause of their trouble – foreclosures. Purchasing debt either through a “bad bank” like the Resolution Trust Corp. or other entity accomplishes two goals. It creates a rational market for these assets that will likely attract private capital and it allows the government to renegotiate the terms on the loans they own to mitigate foreclosures. The actual process of doing this is far more complex than just described, but the initiation of such a program will breed something the markets are starving for – confidence! A change in sentiment can be a self-fulfilling prophecy. If banks see an improvement in the value of the assets they retain, and if they believe government programs are in place to mitigate the rise in loan delinquencies and foreclosures, we think they will begin restore credit availability.

The market is likely to remain range-bound until the passage of an economic stimulus package in coming days, and the potential for an economic and market recovery will depend upon its size and structure. Democrats and Republicans are debating the balance between tax cuts and spending initiatives that will have the greatest multiplier effect along ideological lines as usual, while some would prefer no government involvement at all. Unfortunately, the free market is no longer the arbiter of economic activity. That role is now held by the federal government.

From our perspective, the stimulus must restore confidence in the short-term by addressing state budget deficits and the needs of some 13 million under- and unemployed, but it must also address the structural changes to the U.S. economy necessary to foster long-term economic growth. We are at the end of an era in terms of relying on asset appreciation and debt-induced consumption to drive economic growth. Reducing tax rates at a time we need to borrow money to stimulate growth would be as irresponsible as it was when we initiated wars in Iraq and Afghanistan. We are hopeful that any revision to tax policy comes in the form of credits designed to foster the investment we need to create jobs.

The majority of unemployed come from the construction industry. The Obama administration proposes tapping this pool of ready labor to rebuild our roads, bridges, schools and other infrastructure projects. Yet sustained economic growth is dependent on advances in productivity and efficiency that will require new investments in energy, healthcare and education. We believe the greatest investment opportunities will be found in initiatives to overhaul the nation’s electricity grid in ways that promote renewable energy and reduce America’s dependence on foreign oil.

Hubbard’s Peak will eventually converge with Moore’s Law in the years ahead. Despite the recent fall in oil prices, we believe demand will gradually recover and production will continue to decline. At the same time, we continue to see technological advancements in the amount of energy produced from wind, solar and other renewable sources. We see a coming of age for alternative energy with the establishment of a national Renewable Portfolio Standard (RPS) by the Obama administration similar to the one that already exists in California. As we debate the merits and costs of these initiatives, the oil-rich United Arab Emirates is pouring billions of dollars made in oil into alternative energy, with the intention of maintaining its dominant position as a global energy supplier.

We believe the recession will end during the course of 2009. It is likely that markets will begin to recover in advance (3-6 months) of an economic recovery. Improvements in employment, consumer spending and home prices have not been leading indicators to market performance in past recessions. In the early 1990’s, the stock market bottomed nearly one year before home prices bottomed. Those indicators that historically lead a market recovery are all improving. Central banks around the world are cutting short-term interest rates, money supply is exploding and credit spreads are narrowing. Home prices have declined 25% from their peak in 2006 and continue to fall, but we believe they will bottom in the months ahead. Home price affordability is approaching a record high and the relationship between home prices and median family income is near its historical norm. Yet we will need to see an improvement in credit markets before consumers are able to capitalize on the record decline in mortgage rates.

We live in an age that demands immediate satisfaction, where patience is a lost virtue, especially for those that have seen a significant percentage of their net worth disappear. The internet age has accelerated the speed at which information flows and markets move around the world. Money-market funds are at a historical high relative to the value of the stock market. We do not know what event will ignite this liquidity and re-inflate asset prices in the year ahead, but we do believe it will occur unannounced and that it will be as violent and substantial as the decline that occurred following the bankruptcy of Lehman Brothers in September of last year.

Fuller Asset Management, LLC (FAM) is an SEC registered investment advisor. FAM and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisors by those states in which FAM maintains clients. FAM may only transact business in those states in which it is noticed filed, or qualifies for an exemption or exclusion from registration requirements.

This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. All information presented in this newsletter is believed to be reliable, but no representation or warranty (express or implied) is made or given by any person as to the accuracy or completeness of the information contained herein and no responsibility or liability is accepted for any such information or opinions. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security. Any subsequent, direct communication by FAM with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides.

For additional information about FAM, including fees and services, send for our disclosure statement as set forth on Form ADV from FAM using contact information herein. Please read the disclosure statement carefully before you invest or send money.

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