The environment for investing today is like a war zone. It is not whether one diversifies that matters any more; it is HOW one diversifies that will make the difference.

1.
Our Investment “War Zone”
To Our Friends of Silver Oak,
As I listened to the economic news after the second quarter
ended, I was struck with how many global “flare‐ups” we
are experiencing in this financially embattled world. In case
you have not thought of it in these terms, let me assure you
that we are indeed in a type of war zone.
I’ve read that a war is won by focusing on the winning of
Joel Framson & Eric Bruck, many battles. While we feel confident that we have been
Principals winning the battles, we have the scars to prove that we’ve
been through minefields. And the battles continue.
Silver Oak
has been recognized Each of these financial and economic battles has a root
by Financial Advisor
cause. In this quarter’s letter, we intend to share with you
Magazine our view of the landscape and our own plan of attack.
as one of the fastest
growing advisory Unemployment
firms in the nation.
There are a lot of people out of work ‐ perhaps not a
Silver Oak Wealth
revelation, but a key strategic issue that we must
Advisors, LLC understand. We don’t do justice to the problem by merely
“Mastering
stating the unemployment rate dropped from 10% to 9.5%.
the complexity In fact, the government’s broader measure of
of wealth…” unemployment which includes people who have stopped
looking for work stands at 16.5%.
The Wall Street Journal on July 2nd noted, “About 6.8 million
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people have been out of a job for more than 27 weeks. This
more...
month, despite a 190,000 increase in the working age
population, the number of people in the labor force
dropped by 652,000.” The Los Angeles Times on July 2nd
wrote, “In fact, the percentage of the overall working‐age
population that is in the labor force fell last month to 64.7%

2. ‐ near a 25‐year low.” It will take until at least the middle of
the decade to lower the unemployment rate to a more
normal 5.5% to 6%, according to an article in the Huffington
Post.
The middle of the decade translates to about 2015. What
happens in between now and then? And how much longer
than 5 years might it take to get back to a “normal”
unemployment rate, since we are adding virtually no new
jobs at present?
This is a problem. Our times of prosperity, and
coincidentally the times when our stock markets were
rising, have been based on the American consumer doing
what they do best – consuming. What happens to
corporate profits when the consumer is out of work?
Unfortunately, there is less discretionary money available
for buying “stuff.” A lot of products just don’t get sold.
Companies that are selling fewer products need to figure
out how to remain profitable. So they cut back on inventory
– that’s smart. But they also cut back on employment – and
that hurts. Yes, we read that productivity is up; however,
it’s really a translation of the fewer employed are producing
the same amount of goods. And that’s NOT good.
Bank lending and easy credit
With housing prices rising rapidly over the last decade,
everyone wanted to buy houses and flip them, making huge
profits overnight. Even my barber was doing it. My wife’s
nail person was probably doing it. Everyone was doing it.
The banking system was all too happy to accommodate.
Credit was easy to get. No job? No problem. Who cares
since Wall Street was able to package these loans into
derivative products that everyone around the world wanted
to buy. Who wouldn’t? No risk and high returns provided
an intoxicating cocktail for investors.
The banks, therefore, did not need to keep any of these
dubious loans on their balance sheets. They had no risk.
There was no recourse. We were buying these mortgage
products as “investments” – as were the Chinese, the
Italians, the French, the English – well, you get the picture.
The pendulum is now swinging in the opposite direction.
That change has critical meaning for what lies ahead.

3. 1. Bank lending criteria are still extremely tight.
Money is still sitting in the bank vaults or in
accounts at the Federal Reserve earning the banks
more (and safer!) income than they could earn if
they made loans.
2. Housing prices have come crashing down
(remember the consumer who is out of work and
therefore not buying homes unless the government
gives them a tax credit) and are still falling.
Collectively, the asset valuations held by banks took a major
hit. This has triggered any number of further complications
that resulted in banks failing, or needing a government
bailout, or just plain not lending.
We now see the ingredients fomenting and leading to a
possible vicious cycle. The banks are not lending, home
prices are down so homeowners can’t refinance to pull
money out, and consumers are increasingly out of work
longer so they are not buying new homes or qualifying
under the new strict requirements.
And more to the point, the out of work consumer no longer
has that pool of home equity to tap into which, in the old
days, supported continued consumer spending. Lower
spending translates to lower corporate profits and
eventually a lower stock market valuation.
U.S. Dollar
When the dollar is weak, it is easier for our corporations to
export products. A strong Euro will permit those lucky
Europeans participating in their common market to buy lots
of relatively cheap goods. In measuring our economy,
strong export sales help to increase our Gross Domestic
Product (GDP).
However, as the U.S. government creates liquidity by
printing the trillions of dollars needed to bail out our banks
and corporations, it creates deficits. Big deficits make us
seem less credit worthy. The Chinese, among others, get
worried and want a higher interest rate to continue buying
our bonds. With these deficits building, the dollar begins to
look even weaker. This weakness is typically good for
exports and, therefore, good for GDP growth.

4. But a funny thing has happened. Europe has an even bigger
unemployment problem than we do and their
governments have also needed to print money to bail out
their economies. European countries made as bad or worse
loans than we did which is causing a number of them to be
on the verge of bankruptcy if not bailed out by Germany.
All of a sudden, the U.S. dollar is the giant in a land of
midgets. For no other good reason than the appearance of
looking more stable than the rest of the world, our currency
is strengthening. That would be good news except that a
strong dollar is not good for exports, formerly one of the
bright spots in keeping our GDP growing.
Recession Fears
When the economy, as measured by GDP, declines for a
couple of quarters, the situation is officially termed a
recession. There used to be warning signs and economic
indicators that might warn us about the onslaught of a
recession. A declining stock market was one. Surveys
indicating weakness in consumer confidence was another.
Rising unemployment was technically an indicator which
happened after the fact, a lagging indicator. However,
continuous entrenched unemployment of the variety that
now masks the true unemployment rate is currently being
referenced and used as another leading indicator.
On the other hand, many other indicators are showing
positive signs. Some are so positive that they have caused
many economists to opine that a V‐shaped recovery is
starting. That should create optimism. However, consumer
confidence polls, representing the majority demographic of
our citizenry, don’t seem to reflect much optimism. There is
obviously a disconnect between the positive signs that the
economy is healing and the negative signs indicating that
businesses are not expanding to create enough new jobs.
The stock market does not like uncertainty. And it certainly
does not like recessions. We are not saying that another
recession is imminent. But we are concerned about the
tank tracks running across Main Street that may portend
that another battle is imminent.
Deflation vs. Inflation
As in any battle, there are two protagonists in this conflict:

5. 1. Our government has printed and pumped trillions of
dollars into the banking system. We are running
extremely large deficits. The national debt, which
we must continue to pay interest on, will continue
to create a significant drag on GDP. These dynamics
often have been a precursor to inflation.
2. Home prices are declining. People are out of work
making it difficult for the labor market to demand
higher wages. The price of everything we buy, with
the possible exception of oil and health care, is
generally stable or declining. Interest rates are
extremely low and the government seems inclined
to keep them low for an extended time. These
dynamics are signaling deflation.
This picture does not look like inflation to us. In fact, there
are signs that deflation might be more likely than inflation.
Deflation is more difficult than inflation for the government
to combat. During deflation, prices decline. Demand is low
and supply is high. People wait to buy goods because they
might obtain lower prices by waiting. Business growth
becomes stifled and unemployment becomes chronically
high.
The last thing Ben Bernanke and our other government
officials want to see is deflation. Inflation they can deal with
through various monetary policy tools. Deflation, as Japan
learned in the past decade or more, is more like guerilla
warfare than a conventional war – the enemy seems to be
everywhere but the weapons to combat them are fewer and
ineffective. This is why, ironically, the Fed has been trying
without success to inflate the economy as a deterrent to
deflation.
Investment Policy Considerations
The investment strategies (our weapons) that we are
carrying to the battlefield are framed by the above issues.
Each of these issues has an impact on our investment
decisions. Viewing them in the context of possible scenarios
enables us to design investment policy in an effective,
comprehensive manner.
The challenge that we all face is that these economic factors
are in a constant state of flux and the outcome in the near‐

6. term is unclear. In conjunction with the G‐7 and G‐20
countries, our government has been waging war on several
of these economic fronts. What might be helpful to our
economy could clearly be detrimental to the interests of
other participants. It is important, therefore, that we follow
various news and media outlets, international politics and
financial implications, and global economic developments
closely because of the potential effect a single event could
have on investments we make at home or abroad.
As we have pointed out, the complexity of the issues being
faced by governments globally is unprecedented. There are
no tried and true solutions. The facts are that each
government is experimenting individually with domestic
solutions while concurrently and delicately weighing the
impact of those solutions on a world that has become
globally interdependent.
From our vantage point and with our world view, we feel
that we are able to identify the challenges, each one
representing a type of hot spot around the world that
demands a peaceful resolution. Yet we also recognize that
some of the proposed resolutions by governments don’t
work and result in a retreat and a regrouping before the
next advance.
The Markets and Our Strategy
The S&P 500 gave up 12.9% during the past quarter, and
was down 16% from its 2010 high in April. On a six month
basis through June 30th, the index has lost about 7%.
International stocks were lower by 13.2% for the first half
of the year as measured by the EAFE index.
Silver Oak Wealth Advisors, LLC continues to maintain a
defensive orientation in our portfolios. As we have
explained, we have created an asset allocation approach
based on the relative risk exposure of various investments.
Our higher risk bucket contains a small strategic allocation
to equities through global managers with mandates to
tactically alter their selections as opportunities arise.
To hedge against all of the potentially globally destabilizing
international economic challenges, we are maintaining an
allocation to gold. We are firmly convinced that allocations
and diversification are not enough in this new era of
investing. It is HOW one diversifies that will make the
difference.

7.
Our overriding investment focus continues to be first on
wealth preservation and income, and then on creating
moderate growth that is designed and targeted to meet the
objectives of our clients. By controlling portfolio risk, we
have been able to keep volatility low while not sacrificing
returns.
As we share our perspectives with you, we are eager to
understand your concerns and how you feel about the
markets. We welcome all or your questions or comments.
Sincerely,
Joel H. Framson Eric D. Bruck
President Principal