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Pinnacle e-Letter

First Quarter 2008 Investment Overview
By Mac Johnston, Senior Portfolio Manager, Pinnacle Advisory Services

Continued stress related to falling real estate prices, credit market disruptions, and the weakening dollar caused the S&P 500 to decline 9.45 percent during the first quarter of 2008. U.S. commodity prices soared, stoking fears of high inflation combined with little-to-no GDP growth. The credit markets continued their cycle of fear, and this resulted in continued dislocation across the bond markets and Bear Stearns' collapse. However, the Federal Open Market Committee (FOMC) cut interest rates aggressively from 4.25 percent to 2.25 percent and has started to stabilize some areas of the bond market.

Economic Outlook

Our investment committee's outlook for the rest of 2008 has improved, and we expect 1Q earnings to be positive except for financial and consumer-related stocks. Unless economic conditions deteriorate, we are near the end of the easing cycle with only another .25-.50 percent in rate cuts likely. We believe:

• The worst is over for the credit markets.
• Real estate will continue to be weak well into 2009.
• The yield curve will flatten during the balance of the year and the dollar will rally, causing commodity prices and inflation to subside.

Our S&P 500 earnings estimate growth rate continues to be 5.5 percent for 2008, making our price target for the S&P 500 1420. This would translate into a 7 percent return for 2008 and a 14 percent rally from the current market levels.

Portfolio Strategy

Because the stock market was volatile as expected during the first quarter, our investment committee upgraded the quality and lowered the volatility of holdings in the portfolios we manage.

• Overweight: Technology, healthcare, utilities/telecom
• Underweight: Financials, consumer discretionary
• Recent sells: Peabody Energy Corp, American Express, Dish Network, Texas Instruments, Financial Select SPDR
• Purchases: Alcoa, Dow Chemical, Becton Dickinson, Home Depot, National Oilwell Varco, Colgate Palmolive. Added to our position of Citigroup.

We believe the U.S. markets are poised for a recovery and improved growth later in the year. We are looking to make purchases in consumer discretionary and financials as the economy improves.

Return to the May 2008 e-Letter