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First Quarter 2009 Review ASSET MANAGEMENT

An Economic and Market Commentary By Michael Obuchowski, Ph.D.

Managing Director, Chief Investment Officer and Director of Research

Michael Obuchowski, Ph.D. Managing Director, Chief Investment Officer and Director of Research

Table 1 FEAM 50 Composite, Russell 1000 Growth Index, Russell Top 200 Growth Index and S&P500 Index performance during Q1 2009

Equity markets started the first quarter of 2009 by continuing the more than 20% recovery that began on November 20, 2008. The rally did not last very long, peaking out on January 6th and quickly reverting to the fear-driven volatility of late 2008, with equity markets retreating more than 20% until reaching the March 9th trough. Similarly to the last quarter of 2008, January shocked many investors with significant declines in the financial sector during the first half of January with deterioration spreading to other sectors during the second half of February. At its lowest point on March 9th, the S&P500 Index declined a staggering 24.63% and the Russell 1000 Growth Index declined 17.58% from the beginning of the year. From March 10th, the equity markets staged an impressive recovery for the rest of the quarter, with the S&P500 Index gaining 18.08% and the Russell 1000 Growth Index gaining 16.33% to end the quarter at -11.01% for the S&P500 Index and -4.12% for the Russell 1000 Growth Index. The large performance difference between the S&P500 Index and the Russell 1000 Growth Index reflected the drastic decline in financial services companies during the quarter (-28.8% decline for the Financials sector) with Industrials as the second worst performing sector at -20.9%. The only sector with positive returns for the quarter was Technology (4.3%), closely followed by Materials (-2.1% decline). First Empire Asset Management’s FEAM50 Large Cap Growth Equity strategy finished the quarter at -1.0%, with our clients benefiting from the relative outperformance of the relevant benchmarks during both January and February. The primary driver of the FEAM50 excellent performance during the quarter was lack of any exposure to the US financial institutions, large exposure to the Technology sector, a large cash position during most of the quarter (20.7% at the end of January and 22.1% at the end of February) and stock selection among all the sectors represented in the investment

Jan. 2009

Feb. 2009

Mar. 2009

Q1 2009

FEAM50 Gross





FEAM50 Net





Russell 1000 Growth Index Russell Top 200 Growth Index









S&P500 Index





strategy during the quarter. The frightening economic numbers continued to pour in throughout the quarter. Continuing declines in company earnings, staggering job losses (742,000 in March alone resulting in over 2 million jobs lost for the quarter), initial unemployment claims above 660,000 and resulting continuing unemployment claims of 5.8 million brought even the most optimistic economists to question their expectations of recovery during the second half of the year and provided the most pessimistic economists another few months in the limelight. Despite the impressive global efforts aimed at resolving the credit crisis and stimulating the slowing global economy, the extended length of the seemingly endless negative news on the economic front resulted in confirmation bias among investors, economists and politicians alike, affecting both their outlook and actions. Confirmation bias is a tendency to search for or interpret new information in a way that conforms to one’s preconceptions and to avoid information and interpretations which contradict prior beliefs. It is hardly a surprise that after six quarters of negative equity markets returns, nearly everybody following the markets displayed clear signs of cognitive dissonance, applying rigorous critical scrutiny to any evidence challenging the idea that the economy might be beginning to turn around and accepting the evidence supporting continuing economic deterioration.

Despite the gloomy economic numbers, we believe the liquidity programs implemented by the Fed and the US Treasury together with the drastic interest rate cuts and the quantitative easing policy that followed eventually have to affect the economy and stimulate economic growth. Most economists agree (especially during their lucid moments) that the economic recovery is driven by credit availability, liquidity and confidence rather than unemployment or GDP numbers. Both unemployment and GDP are lagging economic indicators and, we believe, despite their high emotional load, employment gains and GDP increases are results of an economic recovery rather than its precursors. Considering the coordinated efforts of central banks around the world and a large number of programs designed to prop up the global financial system, months ago we started searching for a set of early economic indicators that could be used to augment our critical thinking skills and assist us in minimizing the emotional and cognitive biases while evaluating the flow of economic data during the current economic malaise.

For more information...

about our investment advisory services, please contact Jennifer Vernier at 631-630-2500, email or write to First Empire Asset Management, 100 Motor Parkway, 2nd Floor, Hauppauge, New York, 11788.

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First Quarter 2009 Review ASSET MANAGEMENT

An Economic and Market Commentary continued...

As I mentioned in our Q4 2008 update, one of the requirements for an economic turnaround is effective functioning of the credit markets. Without functional credit markets, none of the government efforts aimed at increasing liquidity and credit availability to corporations and consumers can succeed. For several quarters, I have been presenting updates on TED Spread, which I believe is one of the best measures of credit market health.

The TED Spread The TED Spread represents the difference between the LIBOR (London Inter Bank Offered Rate) and the Three Month T-Bill rate. The TED Spread is a measure of liquidity and is frequently used as a measure of credit risk. The T-Bills traditionally represent a risk free rate. The LIBOR represents the perception of counterparty risk among financial lenders. Although the TED Spread fluctuates over time, it tends to be much wider during times of financial stress. The size of the TED Spread is measured in basis points and, over time, it is typically close to 50 basis points. In times of stress in the financial system, banks and other financial institutions don’t want to lend to each other as they are not sure they will be repaid. When that happens, the TED Spread will grow from its usual range. When the markets calm down, the TED Spread should return to its historical range. Looking at the TED Spread chart provides a good idea of where we are in the financial crisis (or at least what the perceptions of financial institutions are of each other). Chart 1 presents the TED Spread since the beginning of the current financial crisis. It is easy to see the initial spike in August

Chart 1 - Source: Bloomberg The TED Spread 01/02/2007 to 04/06/2009

2007 right after BNP Paribas announced that it could not value assets in three funds containing US subprime mortgage assets. Since then, despite the central bank efforts, the TED Spread has fluctuated wildly, reaching its all time peak of 463 on October 10, 2008, right after the Lehman Brothers bankruptcy filing and Bank of America’s acquisition of Merrill Lynch. Since the end of the last quarter, the TED Spread has continued its decline, dropping below 100 in the first two weeks of 2009 and staying below that threshold during the quarter, despite the equity markets’ volatility. For more details about the TED Spread’s historical volatility during the current and past financial crises, please see the Q4 2008 update available on our website at The TED Spread’s drop below 100 and its drastically lower volatility during the first quarter of 2009 suggests that the central banks efforts are finally showing some effects and credit markets are heading in the right direction. With that in mind, we keep looking at other early indicators that might provide us with information about where the economy is heading.

The Core Crude Goods Producers Price Index In the Q4 2008 update, I presented the Core Crude Goods Producer Price Index (CCG Index) – one of the best leading economic indicators that provide insight into the earliest stages of capital goods production. Due to the core crude goods’ price sensitivity to shifts in economic activity, the Core Crude Goods PPI is especially sensitive to turning points in economic activity, and is therefore a valuable indicator for those who want to stay ahead of the business cycle curve. Last December, after a steep fall that started in July 2008, the slope of its decline moderated. As one can see in Chart 2, the CCG Index turned slightly positive in January (0.09%), and then moved 1.48% higher in February, thus suggesting that a shift in economic activity occurred as early as January 2009. While searching for other early indicators to corroborate or challenge the results of the CCG Index, we have focused on the very early stages of economic activity. The traditional measures, including the Conference Board’s

Chart 2 - Source: Bloomberg The CCG Index - 03/31/08 – 02/28/09

US Index of Leading Economic Indicators, include a number of measures that are, or at least should be, considered coincident or even lagging indicators, including initial jobless claims, manufacturing workweek length and consumer expectations. In addition to the CCG Index, we have selected five more indicators that we believe are likely to capture very early stages of economic activity:

The Baltic Dry Index The Baltic Dry Index (BDI) provides an assessment of the price of moving raw materials by sea. It covers 26 shipping routes worldwide and is a composite of the Baltic Capesize, Panamax, Handysize and Supramax dry bulk carriers indices. The BDI is published daily by the London-based Baltic Exchange. After a steep decline that started in May 2008, the BDI reached its trough on December 12, 2008, declining from 11,793 to 663. Since

Chart 3 - Source: Bloomberg The Baltic Dry Index (BDI) 03/31/08 – 03/31/09

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First Quarter 2009 Review ASSET MANAGEMENT

An Economic and Market Commentary continued...

December, the BDI recovered to 2,298 on March 10, 2009, declining again to 1,615 on March 31st. While the steady recovery from its lows was very promising, the recent decline might be a sign of normal volatility or a potential slowdown.

The Architecture Billings Index The Architecture Billings Index (ABI) is a leading economic indicator of construction activity, capturing the approximately nine to twelve months lag time between architecture billings and construction spending. The ABI is derived from a monthly “Work-onthe-Boards” survey sent to a panel of AIA member-owned firms. The ABI is published monthly and is produced by the American Institute of Architects’ Economic and Market Research Group.

and Orders (M3) contains a large amount of data obtained from 4,200 manufacturers representing 89 industry categories. Firms with $500 million in annual shipments (plus a handful of smaller companies) are asked for figures on new orders, shipments, unfilled orders and inventories. A new order is considered if it comes with a legally binding agreement to purchase a product for immediate or future delivery. From the large number of available numbers, we have selected two indicators that we believe are most likely addressing the early stages of economic activity.

Chart 6 - Source: Bloomberg The Core Capital Goods Order Index03/31/08 – 02/28/09

Chart 5 - Source: Bloomberg The Primary Metals Index03/31/08 – 02/28/09

The Primary Metals Index Chart 4 - Source: Bloomberg The Architecture Billings Index (ABI) 03/31/08 – 02/28/09

After its recent peak in August 2008, the ABI experienced a steep drop in September, October and November (-11.40%, -10.19% and -7.57%, respectively), moderating its decline in December (-0.29%) and January (-2.35%) and recovering with a 6.5% increase in February. Although the ABI is still significantly below 50, the pace of the decline in architectural billings seems to be moderating. The associated Inquiry Index staged an even more impressive turnaround, moving from 38.5 in December 2008 to 43.5 in January (5.1% change) and 49.5 in February (5.9% change), suggesting the possibility that the ABI might continue on the path to recovery. The Advance Report on Durable Goods Manufacturers’ Shipments, Inventories,

recent peak in July 2008, the Index declined for five of the last six months, with an average decline of 5.28%. In February, the Index moved 7.12% higher, suggesting the possible beginning of a turnaround in business spending.

The Primary Metals Index captures the raw materials being ordered by large manufacturers. The increase in orders for primary metals suggests that industrial production is likely to increase in the near future. After a steep drop since the July 2008 peak of 24,418, the Primary Metals Index moderated its decline in February, declining 0.75% to 13,031 (compared to the 9.73% average decline for the previous six months). While it is certainly too early to talk about a recovery, the drastically slower rate of decline might be a precursor to recovery in the coming months.

The Core Capital Goods Orders Index New Orders of Nondefense Capital Goods Excluding Aircraft (also known as Core Capital Goods Orders) is considered to be one of the best leading indicators of business investment spending. After reaching the

The current economic crisis has very significantly affected the housing industry. In addition, housing is usually considered to be one of the most reliable indicators of future economic activity. Within housing, residential real estate is typically one of the first sectors to turn around with an improving economy.

The Building Permits Index While the ABI targets primarily commercial construction activity, one of the leading measures of housing activity is the Private Housing Authorized by Building Permits Index, provided on a monthly basis by the US Commerce Department’s Bureau of the Census. This index provides information about private residential real estate activity based on the issuance of building permits. While not every permit results in construction, nearly 95% of localities in the US require construction firms to obtain a building permit before any construction activity takes place. After a recent peak in June 2008, building permit issuance experienced a drastic decline for the next six months, with an average monthly decline of 11.4%. In January, the rate of decline slowed to 2.93%, with a 6.21% positive turn in February. Because of its long term reliability as an economic

100 Motor Parkway, 2nd Floor • Hauppauge • New York • 11788 Tel: 631.630.2500 • Toll Free: 888.620.5736 • Fax: 631.622.0168 •

First Quarter 2009 Review ASSET MANAGEMENT

An Economic and Market Commentary

added another tool to our research and critical thinking toolset.

Chart 7 - Source: Bloomberg The Building Permits Index03/31/08 – 04/28/09

indicator, and because of its huge multiplier effect, it is an important index to watch. By some estimates, construction of 1,000 single family homes generates 2,500 full time jobs and nearly $100 million in wages. Despite the home construction business accounting for less than 5% of GDP, its effects are seen throughout the economy, as we have experienced during the recent economic decline. Using these six early indicators, we have

While the economy is still in the middle of a very severe recession, it seems that a positive information flow is slowly making its way into the minds of investors, economists, and even politicians. Because of the cognitive bias described earlier, it takes a long time, and it takes a lot of consistent information for anybody to accept that the positive indicators are valid. Especially during such times as these, it is important to put our emotions aside and focus on exploring the empirical evidence of any potential improvement (or further decline) in the economic activity. Our research and interpretation of the various indices discussed above is one such attempt. Based in part on the information obtained from our research into early economic indicators, on March 30th we have decided to once again fully invest our clients’ accounts following the FEAM50 investment strategy.

of the equity market cycle. We do not expect the GDP or the unemployment rate to immediately turn around, since equity markets are also considered one of the leading economic indicators. We expect the equity markets to lead the early recovery that eventually will result in the GDP becoming positive again, possibly as early as the second half of 2009. We believe the unemployment rate is likely to continue to increase for the next several months. Eventually, we believe both the underemployed and the unemployed will start finding more opportunities as the US economy leads the world out of the grips of recession.

– Michael Obuchowski, Ph.D. First Empire Asset Management

Based on currently available information, we believe that we have passed the bottom

Charts 8-13 - Source: Bloomberg Matrix of early economic indicators- March 2009

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First Quarter 2009 Review ASSET MANAGEMENT

An Economic and Market Commentary

Firm Update During last quarter, we have launched our new, completely redesigned website. The website provides information about our firm, all the different investment strategies we offer and updates of selected media appearances or quotes in financial publications. You can also use the website to sign up and receive notification information about our media appearances, or to be contacted by our professionals regarding our investment advisory services. To access our new website, go to: DISCLOSURES The foregoing letter is qualified by the following notes: 1. The S&P 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation. It is a market value weighted index with each stock’s weight in the Index proportionate to its market value. The Index is one of the most widely used benchmarks of U.S. equity performance. The Russell Top 200 Growth Index measures the performance of the especially large cap segment of the U.S. equity universe represented by stocks in the largest 200 by market cap that exhibit growth characteristics. It includes Russell Top 200 Index companies with higher price-to-book ratios and higher forecast growth values. The companies also are members of the Russell 1000 Growth Index. The Russell Top 200 Growth Index is constructed to provide a comprehensive and unbiased barometer of this larger cap growth market. The Index is completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics.

completely reconstituted annually to ensure new and growing equities are included and that the represented companies continue to reflect growth characteristics. The indices referred to herein are unmanaged and therefore do not have any transaction costs, advisory fees or similar expenses to which a client account would be subject. It is not possible to invest in these indices. The indices are for comparison purposes only. It should not be assumed that a composite will invest in any specific securities that comprise the indices. The composites managed by FEAM may not be as diversified as the indices and may experience differing degrees of volatility. Performance for all indices includes the reinvestment of dividends.

fees paid quarterly in arrears and actual trading and other costs incurred by each account in the composite, which vary based upon the client’s directed broker or custodian. Differences in client trading costs will affect each client’s actual returns. Only clients invested in the FEAM50 composite with balances above $100,000 are included in the performance figures. The amount below $100,000 was not significant and has no material impact on these numbers. 3. Past performance should not be construed as an indicator of future returns or results. 4. This letter is not an offer or solicitation.

2. All net performance figures include the reinvestment of dividends and other income, and reflect the deduction of actual advisory

The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the U.S. equity universe. It includes those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Growth Index is constructed to provide a comprehensive and unbiased barometer for the large-cap growth segment. The Index is 100 Motor Parkway, 2nd Floor • Hauppauge • New York • 11788 Tel: 631.630.2500 • Toll Free: 888.620.5736 • Fax: 631.622.0168 •

FEAM Q1 2009 Update