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These thoughts were originally shared with our private clients at the end of April. They are now being shared, unedited, to stimulate discussion of these issues and are considered general in nature and not specific investment advice. Please feel free to contact us and share your comments with us. Additionally, please pass this along to other people who might be interested. Barry Strudwick

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"No Free Lunch"

Its hard to believe that just 6 months ago the stock market was testing 11,000. After the indignity of the S&P credit downgrade, fear of a market collapse was widespread. Despite the consensus angst, we counseled owning stocks was the correct strategy as the prevailing concerns were primarily emotional and not economic. As most people fled to the sidelines, we predicted a 25% plus pop in the stock market should the dark clouds of emotion lift. With the first quarter of 2012 now on the record books as the best in over 15 years, our prediction and positioning has paid off. Going forward into the election year, we still see more upside on
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email : Webview election year, has paid off. Going forward into the: QT Report 2Q2012 we still see more upside on stocks and feel more strongly than ever that the bond markets are a dangerous bubble that is set to burst.

As the election year progresses, we see still more upside potential. However, it is important to keep in mind that our high equity allocation is a defensive strategy based on a small group of select stocks that are fundamentally undervalued relative to bonds. Despite the rally, now is not the time to go stock crazy. Not only is the recovery fragile, but more importantly the Fed is sailing in uncharted waters and must figure out how to unwind three years and $5 trillion Dollars of stimulus. This makes an extremely overvalued bond market appear to be very vulnerable. This isnt just a casual observation, but a huge red strobe light signaling a bubble in the bond markets. Bernankes attempt to control both short and long term interest rates is both unprecedented and very dangerous. Having coerced long-term interest rates below the rate of inflation, the Fed has sparked a bond issuance bonanza of historic proportions. Corporations are issuing 10 year bonds at 2.5% while inflation is closer to 5%. When you can borrow at below the rate of inflation, you are effectively getting paid to borrow. We dont fault corporate CFOs for taking advantage of the cheapest credit in history; its the logical thing to do. But as Milton Friedman once said Theres no free lunch, so who is going to pick up the tab for this extended binge? The odds are that Middle America will get stuck once again and wont even know it. Why? Somebody is buying all of these bonds and a good number are ending up in retirement accounts across America where prudent men are investing "conservatively." When rates revert to normal levels to reflect actual inflation (and they will, as sure as the sun rises) the retirement plans owning these bonds stand to lose 20% or more. The scary aspect is that the bubble of ultra-low rates could burst almost overnight, whip-sawing bond investors in the process. It wont take a major event for the markets to come to their senses. Yet few people appear to be concerned. In The Fed We Trust? Not us! Last quarter we commented that a flood of foreign money seeking a safe haven was a major factor contributing to a stronger U.S. Dollar and very low U.S. interest rates. This has been an unexpected windfall aiding Bernanke. This has also allowed Congress to dawdle yet another year away without budget cuts, or even a budget, for that matter. Without these foreign inflows, interest rates in the States would already be under upward pressure. Should these flows reverse and return home, America will need to pay a much higher price to finance our growing National debt. More importantly, International funds flows are all beyond Bernankes control, thereby making the Feds promise to keep rates low through 2014, sounding hollow and more like wishful thinking.
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email : and more like wishful thinking.Webview : QT Report 2Q2012

This is not the only challenge Bernanke is facing. Unwinding several trillion Dollars in stimulus has simply never been attempted before. The Fed will need to deftly shift from Quantitative Easing to Qualitative Squeezing without stalling a fragile recovery. Lets face reality: everyone already knows T-Bills at 2% dont reflect anywhere near our actual rate of inflation. Why should the smartest investors in the world accept a negative real rate of return for the privilege of owning US Dollars? Investing knowingly at a loss is irrational and when the bond market becomes rational again, the world bond markets will demand a premium be added onto the current market rates to reflect the future expectations of inflation. Such a rise could be devastating. How bad? For every 1% increase in interest rates, bonds prices will fall by about 7%. So if T-Bill rates rise to 5% from current levels, weve just defined a 20% fall in the bond markets. A 7% T-bill could result in a 35% plunge in the bond markets. As investors, its important to recognize this current instability and stay positioned ahead of the possible consequences. One alternative is to hide under a rock and buy a CD. But, this strategy implemented last fall, it would have missed the entire rally. What we see as a smarter play, is to own the stocks of large companies with solid cash flows and pristine balance sheets. Many of these are also taking advantage of the distortion in interest rates to borrow billions while the window is open. Companies like J&J, Microsoft and others who dont need the cash are borrowing simply because its absurdly cheap. Even though they already have billions in cash reserves, they are issuing bonds to stockpile even more cash to acquire other companies or at a minimum retire their own stock. For every winner in bonds, there will be a loser. While big companies will profit handsomely, the big losers will be the Middle Class whose retirement plans will get devastated by a combination of higher interest rates and a devalued U.S. Dollar. Sadly, no act of Congress was required to approve this massive wealth transfer which is already in motion. America is now at a crucial crossroad between Free Market Capitalism and Central Government Planning. Over the next 6 months, the upcoming Supreme Court decision and the presidential election will tilt the direction America will follow for the next decade. Some say the role of government is to provide a balance between the survival of the fittestof pure capitalism and a more civilized risk free society. This balancing act has suddenly become more difficult. Why? Politically, the entitlement giveaways were rationalized by the belief that the American pie would always be growing in order to support ever growing levels of debt. The worst recession in 75 years means the American Pie (and tax collections) isnt growing fast enough to pay for the promised benefits. The illusion of the Baby Boomers retiring
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email : Webview : QT Report 2Q2012 enough to pay for the promised benefits. The illusion of the Baby Boomers retiring on Golden Pond is now unraveling. At the National level, the battle over Obama Care has put a spot light on battle between providing civilized benefits and the Middle Class who fear their retirement nest eggs will be confiscated to pay for others benefits. The real irony is that few realize the massive currency debasement already underway will rob their retirement plans just as surely as a tax declared by Congress. The only way to mitigate this is an investment strategy which protects against a falling Dollar and rising interest rates.

So where does this all leave us? Over the next 90 days the Supreme Court will likely strike down at least part of Obama Care. While this will not fix our broken healthcare system, the reduction of uncertainty should be positive for the stock market. If we had to handicap the races right now, we see Obama maintaining the White House with the GOP gaining control of both the House and Senate. Politics aside, over all this is a favorable environment for the financial markets. However, the sustainability of the Feds sleight of hand on interest rates is very much a wild card. Can Bernanke hold the beach ball under water until after the Election? If Bernanke loses his grip on interest rates, an entirely different scenario emerges. A spike in interest rates would put the election spot light clearly on economic issues which would be negative for Obamas re-election chances but also for the financial markets. If rates start to readjust, we will need to re-access the impact on even cash rich stocks. With this as the backdrop, here is our take on how to invest over the next several months. 1) We are currently allocated over 70% to equities through our core domestic Fortress stocks (about 50% ) plus additional holdings (20%) in energy and natural resource holdings. The balance of our allocation is 15% in hard assets such as gold, oil and commodities and the remaining 15% in cash. 2) Recall our prediction last October when we said stocks were severely undervalued and poised for a potential surge of 25% or more. We still see stocks as undervalued but more importantly we see stocks as having strong defensive qualities relative to the overpriced bond market. Global stocks with pristine balance sheets are also a hedge against the falling Dollar. 3) Our stock holdings remain primarily a defensive strategy. And, this is not a strategy based on a recovery sparking growth potential in stocks. Well continue to focus heavily on ultra-large cap companies with huge cash reserves which should provide a cushion in the event of a market correction. Other qualities we like to see
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email Webview : QT Report 2Q2012 provide a cushion in the event: of a market correction. Other qualities we like to see is a corporate culture of acquisition and also a willingness to buy back their own stock in the open markets. We prefer both of these uses of cash over paying dividends. Companies, who have strategically acquired companies over the past 4 years will profit when the recovery eventually returns. If there are fewer shares outstanding, so much the better on an earnings per share basis.

4) Bonds overvalued? For the past 50 years bond yields were always higher than stock yields, but right now the reverse is true, even after the recent run-up. Clearly bonds are too expensive and very vulnerable. While higher rates could stall a recovery and cause a stock market correction, the yields on our stocks and their high cash reserves should offer price support in an overall market correction. 5) T-bill rates in the neighborhood of 2% are clearly too low. Despite the flood of money that continues to flow into the bond markets, the risk/return ratio of owning either government or corporate bonds is extremely unfavorable and should be avoided at this time. Mark our words; the U.S. bond market is a bubble waiting to burst. When the inevitable occurs (interest rates rising to reflect the actual rate of inflation), bond holders could see double digit losses. These will not be temporary as bond prices will not rise unless interest rates fall again, who wants to be on that? Wed rather weather a short-term connection with high quality stocks, than suffer a long-term loss in bonds. 6) Early warning? In a period of 2 weeks in March the yield on the 10 year T-Bill surged from 1.95% to 2.45%. This is the type of interest rate movement that can roil the markets. Despite Ben Bernankes best intentions, a prolonged era of ultra-low interest rates is simply beyond his ability to deliver. 7) GE is a good example of our Fortress stock holdings. GEs balance sheet is impeccable with cash having increased from $61 billion to $131 billion since 2007 and the yield at 3.4% is higher than most bonds. Yet GE is still selling at less than 50% of its peak value in 2008 (a great combination of defensive qualities with upside potential.) GE continues to make a massive shift away from the financial services sector and over towards energy infrastructure with a recently announced joint venture to build 500 natural gas fueling stations. Tiny compared to the 159,000 gas stations, but its a start. This could be a long term growth sector, which creates U.S. jobs and moves us away from Middle East Oil. 8) Berkshire Hathaway is also in a very solid defensive holding with strong upside position. The stock is still cheap (down 20% from 2008) but Buffet has taken advantage of the depressed market values over the past 4 years and his massive
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email : Webview : QT Report 2Q2012 advantage of the depressed market values over the past 4 years and his massive cash flow to make a number of significant investments which are a bet on America. When these new assets start earning, the EPS will explode. The acquisition of Burlington Northern is a wager on higher energy prices and a growing economy as $4 diesel makes trains more competitive than trucks. The nice thing about railroads is they aint building anymore of them. Berkshire Hathaway was held back last year by global catastrophes hurting its insurance operations, but these will smooth out over time. Berkshires large holdings in the financial sector should also pay off as the recovery gradually takes hold. They have huge positions in J.P. Morgan, Wells Fargo, and Bank of America. Berkshire is now also the largest holder of IBM which is their first tech investment ever.

9) Another one of our Fortress holdings has been Cisco Systems which is positioned for a dominant position in the booming arena of Cloud computing. While we could over complicate Ciscos strategy with tech jargon, Cisco is basically selling the pick and shovels in the Cloud computing gold rush. It has massive cash flow and over $45 billion of cash on the balance sheet, CSCO is a solid store of value relative to the overvalued bond market. Despite this, CSCOs stock market value has dropped by $50 billion since 2007! Go figure. Over the past 6 months the stock has rallied from $16 to $ 19 and has gotten as high as$21. We see the stock as still very undervalued with huge cash hordes and stable cash flows which gives us the defensive support. We like to see this environment. 10) Another beneficiary of the stock market rally has been Microsoft which has popped 33% in the past 6 months. After this recent run up, it has finally moved ahead of where it was 10 years ago, but is still below its 2007 peak. MSFT also has an incredible $26 billion of annual free cash flow which it has been using to acquire a dominant position in the world of cloud computing. With over $30 billion in cash reserves, we look for MSFT to continue to make strategic acquisitions as it assembles a cloud computing juggernaut. Again, we like the combination of a very cheap stock, huge cash reserves and strategic acquisitions as we patiently wait for the mood of the world to improve. 11) Has real estate finally hit bottom? It feels like we are bumping along the housing sector bottom but a robust upturn is unlikely because of a lack of buyers who can fund a 20% down payment. We should also mention 25% of all homeowners are trapped with under water mortgages at an average of $85,000 each. Still, money can be made as the sector restructures. We got in early through our position in Toll Brothers whose Gibraltar subsidiary has aggressively partnered with funding sources to acquire development quality land at distressed prices. This is a great strategy and the stock is up 65% since last fall. While the stock is still 50% below its
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email : Webview : QT Report 2Q2012 strategy and the stock is up 65% since last fall. While the stock is still 50% below its all time highs, Tolls market cap is back to its 2007 levels, so its likely close to an intermediate full value. We will continue to hold at this time as wed like to participate in some of the upside from their acquisition strategy.

12) In addition to our Fortress stocks, energy, natural resource stocks and commodities account for about 15% of our total strategy, this is a significant reduction from several years ago when our allocation to these hard asset holdings was over 35%. The reduction is largely due to two factors. First, in a global recession demand for commodities drops which means supply outstrips the ability to store more inventories. The supply glut leads to price cutting. Second, for the last several years we have been forecasting a stronger Dollar (not perpetually weaker) due to the Euro and Mid East crises. Commodity prices fall when the Dollar rises. In this environment, we will continue this lower than normal weighting and keep an eye on the direction of the Dollar and the geo-political factors at play. Volatility in rates will argue for an increase in our allocation here. Long term we like commodities but short term were under-allocated. 13) Four buck gas at the pump has the evening news all a titter and could impact the election. However, the reality here is that this could be much worse if not for the strength of the Dollar which has dampened the impact. Over the past couple of years, we have not been overly bullish on the commodity of Oil itself (5% of most accounts), but rather have opted to increase our energy exposure by investing in oil and gas exploration stocks (2.5% of most accounts). Our positions in the oil patch are up 10% YTD. Exploration stocks have greater upside potential than the pure oil in the event that political instability picks up in the Middle East. As we all know, the Middle East could ignite in a nano-second. 14) While on the topic of political instability and hard asset investments, our holdings in Strategic Rare Earth Minerals (2.5% of accounts) are up 18% YTD while paying a 5.5% dividend. These 17 strategic minerals are essential for our high tech economy and China controls 97% of the supply. Recently the WTO has brought action against China which has raised prices. This is a very volatile sector and the political unrest in China could make it even more so. While wed normally be inclined to increase holdings here, the uncertainty in China gives us reason to pause. 15) The nuclear sector has rebounded by about 15% in the 1st quarter, but it still has a long way to go to recover from last year when the Japanese tsunami caused the entire sector to meltdown. Certainly rising oil prices and unrest in the Middle East can help the sector, but as importantly, the U.S. has recently approved construction of the first two new reactors in over 30 years. While

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email : Webview : QT Report 2Q2012 recently approved construction of the first two new reactors in over 30 years. While there might be life left in the sector, we remain negative overall and will continue to look for an appropriate exit point. In the meantime, the sectors 11% dividend yield provides downside protection.

16) As weve commented on before, U.S. companies are collectively sitting on $2 TN of cash with 80% of this outside the United States. Why arent companies investing this potentially stimulative stash? This has nothing to do with patriotism and everything to do with common sense. Three factors are at play right now: excess capacity, high tax rates and low borrowing costs. Companies dont need to build new plants right now because global demand is weak. A tax savvy CFO also wont want to incur a 30% tax to simply bring money into the U.S. to hold it in a checking account. The red hot U.S. bond market provides another reason not to bring the money home. Why would a company ever voluntarily pay 30% in taxes if you could easily borrow money in the bond markets at 3%? Thats a 10 year break-even point. This money will stay offshore until global demand picks up enough so companies need to expand and interest rates rise enough to make paying the taxes a worthwhile trade off. The alternative is a tax holiday. This is a stimulus which would not need to be unwound. 17) For the better part of 50 years Washington intentionally pumped up the real estate sector through tax incentives (like home mortgage interest rate deductions) and legislation that encouraged massive debt creation (Fannie Mae & Freddie Mac). When the bubble burst in 2008, not only did $7 trillion of Americas wealth disappear, but simultaneously millions of people lost their jobs and their household cash flow. Too bad Ben cant wave a magic wand to instantly retrain the millions of people who grew up working in the over-sized real estate sector. You cant just put an iPad into a sheetrock hangers hands and exclaim Welcome to the Digital Age! Hype and new age enthusiasm aside, since digital jobs which can be anywhere in the world, the tech boom will help few of the millions who lost real estate jobs. ApplesiPad is riding high, but its created 200,000 jobs in China not Chicago. The U.S. economic policy needs to create geographic specific jobs which fit the skills of these displaced workers. What types of ventures are uniquely suited to create jobs in America? Until Washington figures this out, unemployment will remain high. Our two cents worth? Create a natural energy policy and put people to work building the infrastructure to convert from gasoline to natural gas and other similar projects. These jobs would be geographic specific and match the skill sets of the displaced workers. 18) Were still in a very deep economic hole; the good news is that its just not getting any deeper at least for now. People who have deferred purchases for over 3
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getting any deeper at leastemail : now. People who have deferred purchases for over 3 for Webview : QT Report 2Q2012 years are starting to spend again and purchase things like cars. Sales numbers are up to an annual pace of 12.5 mm cars, stronger but still well down from the record year of 2007 where production hit 17 mm which was inflated due to cheap credit. 19) Well let the quants figure out the sustainable level of auto sales but our guess is that were likely back to normal a pretty normal level. Color us bullish on the auto sector over the next several years as the front seat becomes a cockpit with the convergence of Internet technology, information and entertainment. And I remember when I couldnt understand why people needed electric door locks on a car. 20) Why are entrepreneurs so important? In the classic creative destruction cycle, invisible innovators outside of large companies are in a cycle of constant experimentation introducing new technologies. While 99.9% of these innovations fail to gain any traction, those that do succeed start to displace large companies whose corporate cultures typically resist change. As one person said Elephants can dance, but rarely well. Look at the battle between Amazon and Best Buy. Historically, one of the advantages of the U.S. versus the rest of the world was that our economic eco-system encouraged this flow of ideas which were implemented by a flow of capital. However, there is startling evidence that our capital formation ecosystem is dangerously polluted and new companies are not being created. Who wins the next election can influence this trend. 21) It has become very difficult for new companies to gain access to capital from the stock market through IPOs. One of the likely causes is too much government regulation. Who in their right mind would take a company public and become subject to the witch hunters of the SEC? The result is that the Elephants who have huge cash flow are gobbling up the entrepreneurs who can get access to capital without going public. Look at the acquisition history of our core Fortress stocks like GE, Microsoft, Cisco and J&J. The number of acquisitions of this small group of companies alone rivals the entire IPO market from 2011. While this is good for these companies, it is likely not good for the economy as it concentrates economic power into a core of ultra large companies. We will invest to take advantage of the trend by investing in very large companies, but it is a symptom of a serious problem in our system. 22) What will be the next big idea to create domestic jobs not just eye popping digital fortunes for a handful of Zuckerbergs? This is the mojo that America has to regain. Why is Austin Texas creating jobs at 10X the national average? This is the

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email : Webview : QT Report 2Q2012 regain. Why is Austin Texas creating jobs at 10X the national average? This is the model for us to examine.

23) For every Under Armour, thousands of garages across America are filled with boxes of a dreamers cant miss idea. In the best of times funding of new ventures is a slow process, but new job formation in this cycle has been slower than normal for a number of reasons. Uncertainty over U.S. tax rates has limited the flow of venture capital to fund new ideas. When comparing alternatives, potential investors look at their net after tax returns. Obamas higher proposal to raise the capital gains tax rates means new ventures need to pencil in higher projected pre-tax returns to tempt angel investors into a new venture. Venture investors are also reluctant to step to the table right now because they know gun shy consumers arent buying. With fewer buyers, Venture capital feels no urgency to invest for fear of missing a new market. Meanwhile good ideas are withering for lack of funding. 24) This deflationary psychology which freezes up venture investing and consumer spending is not only dangerous, but also difficult for Washington to break. Bill Gross, the worlds foremost bond investor, predicts the cycle of weak spending and investment could last 10 or even 15 years. Overly pessimistic? Perhaps not. Japan has been stuck in this deflationary cycle for almost 25 years. What should be obvious is that the Fed cant simply sprinkle some pixie dust of cheap money to fix this. (Recall Cash for Clunkers) This again supports our decision to invest in Fortress stocks which have the cash reserves and steady cash flows to survive a long and slow recovery. 25) Need another indicator of bonds being over valued? Consider this disparity between stocks and bonds where bonds normally yield more than stocks. Currently, the world wide government bond index is yielding just 0.5% versus 2.7% dividend yield on the MSCI worldwide stock index. Bonds would have to fall by more than 15% to bring this relationship into balance. 26) Maybe Miami can be seen as the barometer of the international funds that flow into the U.S. and also a signal of the real estate market bottom. Miami real estate prices have risen now for 18 consecutive months and local realtors are now predicting a record number of $ 1,000,000 plus sales in 2012. Amazingly, Miamis once massive excess inventory of condos is already gone and over 1,000 new condos were constructed last year. Over 50% of the buyers are foreign born with a big influx of Brazilian money. Its now estimated that there are 300,000 Brazilian residents in Dade County. Were not sure what this means for the rest of the country, but at least one of the hardest hit markets is now recovering. Well need to keep an eye on the Feds moves as we go forward. Our biggest fear
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email : Webview : QT Report 2Q2012 Well need to keep an eye on the Feds moves as we go forward. Our biggest fear right now is the bond market. A crisis here might cause us to rethink our equity allocation.

Barry Strudwick April 3, 2012 DOW 13,199

If you received this letter from a friend, click here to receive complimentary copies of our quarterly Q.T. Report. PS. We really appreciate the referrals and if you have friends who you think might like to discuss investing with us, please let me know.

Strudwick W e alth Strate gie s 12 East Eage r Stre e t | Baltim ore , Maryland 21202 W e bsite : www.noload.com | Em ail: info@noload.com | Phone : 410-727-6444

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