Client Letter 4Q11

January 11, 2012

To Our Clients:

Last year was, in no uncertain terms, a tumultuous one for investing in common stocks.  Investor psychology was quite negative and US Treasuries and Municipal Bonds greatly outpaced stocks.  The natural questions to ask are: what caused this to happen, and will it persist into 2012?

Looking back on the year, Greece’s economic problems ballooned into a full-blown sovereign debt crisis, which, after spreading to Spain, Italy and France, caused stock prices to fall across the globe.  In addition, investor confidence was further rattled by a record level of worldwide catastrophe losses, including the Japanese earthquake and Thailand floods, as well as the downgrade of the United States’ prized “triple A” credit rating by Standard & Poor’s during the summer.  Another major negative was the failure by governments and elected leaders, both here and in Europe, to enact well-conceived long-term solutions to encourage economic growth.

These issues resulted in excess volatility in stock prices.  By way of perspective, there were, according to The Wall Street Journal, 37 days during 2011 where the Dow Jones Industrial Average gained or lost at least 200 points.  Also, between August and December, the difference between the intraday trading highs and lows for that index averaged nearly 270 points, which is a very large trading band.  Finally, there were many days in which 90% of all stocks traded in the same direction.  Fundamental company analysis is less helpful when price correlation reaches such high levels.

Generating above-average returns was nearly impossible in such an environment and performance fell short of our expectations.  This being said, we proactively harvested losses to offset already realized gains to ensure tax efficiency.  In addition, your portfolio benefitted from the inclusion of several high-quality dividend-paying stocks which performed very well during the year.

Our best performing holdings for 2011 included Exxon, McDonald’s Corp, and Verizon, which provided total returns ranging from 18% to 35%.  McDonald’s was actually the top performing stock within the Dow Jones Industrial Average.

On the flip side, there were some core names that failed to rebound following the market’s correction which commenced during the summer.  One stock, Hewlett Packard reported several earnings disappointments, abruptly changed its strategy and fired its CEO for the second time within a year.  We lost confidence in HP and subsequently sold the stock to preserve capital.

Two other underperformers for the year were MetLife and Peabody.  MetLife fell with its peer group of large multi-national financial institutions, amidst rising fear that Europe and its banking system would experience substantial credit losses.  Thankfully, markets have settled and MetLife shares remain quite attractive even after gaining 10% thus far during 2012.  Peabody’s share price drop resulted from a slowdown of coal purchases by China and changes in domestic demand due to the availability of cleaner fuels, namely liquid natural gas.

Looking forward, we begin 2012 with a sense of optimism about the long-term growth potential of common stock investing, utilizing Train, Babcock’s conservative time-tested investment approach.  Although the year ahead may be similar to the year gone by, we are encouraged by three things:

o       First, although Europe appears to have entered a recession, the United States has not fallen victim to a “double-dip” and, in fact, manufacturing activity has expanded and other economic measures (housing, employment) have recently trended positively.

o       Second, stock prices have held up over the past eight weeks, even in the face of negative news, and numerous stocks within Train, Babcock client portfolios have rebounded since the New Year began.  In fact, CSX, MetLife and Peabody have returned more than 9% thus far in 2012.

o       Third, our conservative base case calls for stocks to return 5% to 10%, assuming modest GDP growth, continued improvement in US employment and additional stabilization in the single family housing market.

Against this backdrop, we seek to deploy your assets into attractive growth stocks prudently and over time, when price opportunities present themselves.  While macro-economic risks still linger, namely that Europe’s problems could drive a global economic slowdown, the risk of that playing out has lessened.

Please note that we have recently updated our website, www.TrainBabcock.com, to both provide you with transparency about our investment philosophy and process, as well as introduce you to the entire Train, Babcock team.

As always, please do not hesitate to contact us should you have any questions or concerns.

The Partners of Train, Babcock Advisors LLC