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originally shared with ourprivate clients at the end ofApril. They are now beingshared, unedited, tostimulate discussion of theseissues and are consideredgeneral in nature and notspecific investment advice.Please feel free to

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Additionally, please pass thisalong to other people whomight be interested.Barry Strudwick

"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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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 therecovery 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 inflationis 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 actualinflation (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. I t

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 allowedCongress 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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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 positionedahead 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, Microsoftand 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 othercompanies 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 thenext 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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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 Bernankeloses 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. I f 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 assetssuch 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 defensivequalities 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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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. I f 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 thanstock 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 toburst. 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 roilthe markets. Despite Ben Bernankes best intentions, a prolonged era ofultra-low

interest rates is simply beyond his ability to deliver.

7) GEis a good example of our Fortress stock holdings. GEs balance sheet isimpeccable 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 announcedjoint 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 Hathawayis 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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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 therecovery gradually takes hold. They have huge positions inJ.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 theovervalued 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 Microsoftwhich has

popped 33% in the past 6 months. After this recent run up, it has finally movedahead 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 housingsector 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 watermortgages 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 Gibraltarsubsidiary 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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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 holdingswas 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 oilin 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

recentl a roved construction of the first two new reactors in over 30 ears. While


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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 autosector 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 companieswhose 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 eco-

system 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 thesecompanies, 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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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 investorslook at their net after taxreturns. 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. BillGross, 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 estateprices 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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right now is the bond market. A crisis here might cause us to rethink our equity

allocation.

Barry Strudwick

April 3, 2012

DOW 13,199If 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 Wealth Strategies

12 East Eager Stree t | Baltimo re, Maryland 21202Website: www.noload.com | Email: [email protected] | Phone: 410-727-6444

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