Coe Capital Management, LLC

1st Quarter 2008
Economic Summary

The first quarter of 2008 marked a difficult time for the economy: housing continued its slump, credit markets lost liquidity, employment suffered, and the dollar remained weak. On the positive side we saw an active Federal Reserve Bank that cut interest rate targets and actively stepped in to buoy the credit markets.

Housing continued its historic decline in the first quarter; pricing was down by 8.2% year over year in February on existing homes and down 3.0% on new homes. The falling prices increased foreclosures driving existing inventories to nearly 10 months. The high foreclosure rate put the large banks in a tough position. Generally, banks made the loans, packaged them as securities, resold them to investors and made more loans but, with the high default rates they were unable to sell their loans. Forced to keep their underperforming loans tied up capital, banks reduced the number of loans and this tightening eventually dominoed through the entire credit market.

Without ready access to capital businesses became more conservative and we saw this begin to show up in the employment numbers where the four week average in initial employment claims rose to 2 1/2 year highs and, as of March, we lost 232,000 jobs and the unemployment rate was at 5.1%.

The Federal Reserve Bank made several moves to ease credit and help the economy. First, the Fed continued aggressive rate cutting, lowering Fed Funds Rate to 2.25% (down from 4.25% in December of 2007). Then the Fed undertook an action not seen since the depression by extending financing to investment banks. Finally, the Fed also made an intermeeting discount rate cut of 75 basis points.

The aggressive rate cutting drove the dollar to record lows against major currencies which should increase exports, hopefully offsetting some of the negative affect of the housing slump.

To ease credit market tightening, the Fed started accepting the lower quality, collateralized debt obligations for collateral at the discount window. This significantly freed up bank capital. The outcome of the actions continues to be uncertain but we would anticipate them to result in improved credit markets towards the middle of the year.

Market Recap

Coming off the worst quarter in the past 5 years to say that things have been interesting would be quite an understatement. We have seen some difficult down days with the S&P finishing down 9.44% for the quarter and the international indices dropping as well.

The negative sentiment towards the market began late last year and the market has remained volatile with a downward trend; multiples have contracted, and the economy has stalled. This can be attributed to a tightening of credit, causing the economy to slow and confidence to drop, leading to companies underperforming expectations which impacts the overall market. The positive side comes with lower rates that will eventually flow through the economy and allow it to expand again. It generally takes about six months to see interest rates start to have an impact.

Strategic Comment

The subprime issues have severely hit the financial sector, however, we have taken several actions in the past few months to position our portfolios: (1) we are underweight in the financial sector; most portfolios have less than 10% financials vs. the S&P which is around 17%, (2) the positions we have taken in the financial sector are strong with minimal credit risk: one of our holdings is JP Morgan which we believe gained significant competitive advantage with its proposed acquisition of Bear Stearns. Our analysts estimate that the deal could add as much as $1B to earnings once fully integrated. Another financial position we have in our more conservative portfolios is New York Community Bank which has limited sub-prime exposure and which benefits from the lower Fed funds rate, given the structure of their balance sheet.

As mentioned in prior letters, we have also continued to maintain positions in multinational companies (e.g., P&G – which derives approx. 58% of its revenues from overseas). Finally, we have continued to diversify portfolios away from strictly domestic equities with the inclusion of some international companies (e.g., ABB – an international, utility infrastructure provider) and some REITs (e.g., HCN – a healthcare property developer).

As with basketball, we believe that teamwork, intelligence and diligence are required to achieve long-term investment objectives. While successful stock selections can be extremely satisfying, the real path to investment success can be found in establishing and adhering to a solid game plan. Once you have outlined your investment plan two of the most important things are: diversification and timing the market.

Market Timing

By market timing we mean remaining disciplined and avoiding the crowd mentality. Supremely rational investors take the even more advanced step of acting against the consensus and adjusting portfolios to long term targets by purchasing the down and out and selling the stars. It pays to reflect on the opportunities that developed out of some historic lows (see inset).

Diversification

Studies show that a large percentage of overall portfolio gains can be achieved simply through diversification3. In fact, institutional investors have been operating diversified portfolios for some time [i.e., Yale University’s endowment credits diversification for its record beating markets indices for the past 17 years]. Once called “the only true free lunch”, diversifying a portfolio into different asset classes (e.g., Domestic Equities, International Equities, Fixed Income, Real Assets and Alternative Investments) allows investors the ability to reduce the overall risk of their portfolio while maintaining the same targeted returns.

As mentioned above, most portfolios already have some elements of diversification however, developments in financial products have created more opportunities to add diversification to your portfolios. As Mark Twain once said "the secret of getting ahead is getting started. The secret of getting started is breaking your complex overwhelming tasks into small manageable tasks, and then starting on the first one." Expect to see some different names in your portfolios in the coming year. We also encourage you to contact us so that we fully understand your financial picture as we add greater diversification to our portfolios.

Sources: All facts and statistics represented in this letter are credited to articles in Barron's, The Wall Street Journal, Bloomberg, Investor's Business Daily and The Chicago Tribune.

The S&P 500 Composite Index with gross dividends reinvested into the index is an unmanaged index that is generally considered a representative of the U.S. Stock Market. "NASDAQ" Index is a market capitalization-weighted index with gross dividends reinvested into the index is designed to represent the performance of the National Market System which includes over 5,000 stocks of the U.S. Stock Market. The Dow Jones Industrial Average is price-weighted average of 30 actively traded blue-chip stocks, primarily industrials including stocks that trade on the New York Stock Exchange. Individuals cannot invest directly in any index.

Securities offered through Ladenburg Thalmann & Co. Inc. Member NYSE/NASD/SIPC