To our clients and friends:

What an interesting, albeit unsettling, time it has been for financial markets. Looking back over the past year, equity markets have experienced over 20 sessions posting day-to-day changes in excess of 2 percent. Compared that to 2006, when only 3 sessions met the 2 percent mark and you get the picture of just how jittery investors are. This past quarter has been flush with events to keep investors on edge; sovereign debt issues, oil spills, financial reform and general concerns about a double dip recession to name a few.

Economic Conditions

Last quarter we summarized the U.S. economy as follows: “The condition of the U.S. economy can be reported succinctly as follows: manufacturing health continues to improve, consumer sentiment remains low, the labor market is struggling but unemployment has stabilized, housing is giving up ground, inflation is tame, and economic growth is poised to moderate after a fairly strong showing in the 4th quarter. And we don’t expect any of this to change very soon.” The simple follow-up this quarter is ditto.

Here in the U.S. our economic recovery has continued at much the same pace that we were experiencing earlier this year. The few modest exceptions are on the employment and consumer fronts. Employment has shown gains this quarter. Recent increases in temp hiring, the average workweek and in job openings point to continued improvement, but not robust activity. On the consumer front, evidence indicates that some have been willing to spend. Helped by some tax benefits, disposable income has grown, those consumers with jobs and are less worried about receiving a pink slip, have pushed retail spending higher and the personal savings rate down. Aside from these areas, our domestic economic picture remains on a path of slow, steady improvement lead by manufacturing and hampered by housing, where a temporary tax credit induced flurry of activity has since turned tail.

Over the past few months, much focus has been on overseas markets, particularly Europe. Pressures steadily escalated as a result of the Greek debt crisis, and concerns of regional contagion. After some time, the EU, ECB and IMF delivered emergency measures to stave off growing financial market tensions. These measures will likely alleviate some of the fear and illiquidity over the short-run, but do not address fiscal problems of member states. To be effective, the emergency package will require severe budgetary consolidation in these countries already facing weak economic fundamentals, and it appears that the region is in for an extended period of weak economic growth. Although the U.S. was at the center of the financial crisis, our recovery appears on stronger footing thanks to quicker and larger fiscal and monetary policy responses, and stronger nonfinancial balance sheets and a smaller reliance on bank credit.

Market Developments

Risk aversion stemming from events mentioned above has driven equities lower, while pushing Treasury rates down substantially. Year-to-date equity markets have moved to negative territory over the quarter. After ending the first quarter with strong gains and moving higher in April, the S&P 500 is now down just over 1 percent for the year. Fundamentally, however, corporate earnings have had a strong recovery which began in the fourth quarter of last year. Removing the positive distortion of financial firms, fourth quarter earnings grew by 12 percent, and that was followed by 30 plus percent year-on-year growth in the first quarter of 2010. While earnings were heavily supported by cost cutting last year, we are now experiencing top line sales growth, a positive sign for things to come. Fundamentally, the U.S. recovery remains on track, and we expect another strong showing in earnings for the second quarter, offsetting some of the recent headline jitters.

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