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INVESTMENT STRATEGY Ideally I would always invest in stocks for the long-term and have low turnover. However, it is very important to closely analyze intermediate-term potential economic cycles and resulting stock market problems or positives. In October 2007, I became increasingly concerned regarding several potential economic problems. I believed that one of these potential problems was high housing prices, and the increasingly speculative financial instruments that had evolved in this segment of the economy. As a result, I began implementing a strong “defensive investment strategy” for the Reynolds Blue Chip Growth Fund by selling equities held in the Fund and raising the cash position. The beginning of the implementation of this defensive investment strategy coincided within a few days of the intermediate top of the stock market in October 2007. I began purchasing equities for the Blue Chip Fund in March 2009, as I believed that the prices of many high quality equities had declined to attractive long-term buying ranges and the massive amount of stimulus that was being implemented worldwide would be a positive. The beginning of the implementation of this more “normal investment strategy” also coincided within a few days of the intermediate bottom of the stock market. Economic Discussion The U.S. economic recovery that started in mid-2009 has continued so far in 2011. The U.S. economy is growing, but at a lower than ideal rate. For example, growth of 3% or better is needed to begin meaningfully reducing unemployment which is at 9%. In the last two months the economy has been growing faster than was forecast a few months ago. U.S. Gross Domestic Product (GDP) is estimated to have expanded at an inflation-adjusted annual rate of 2.5% in the quarter ended September 30, 2011 helped by stronger than expected consumer spending and business investment. Americans spent more on services such as health care, restaurants and finance. This is the most robust quarterly performance in a year and eased anxiety that the recovery may be stalling. U.S. GDP is forecast to expand at a 2.2% rate in the quarter ended December 31, 2011. U.S. GDP increased at a 1.3% rate in the quarter ended June 30, 2011; at a 0.4% rate in the quarter ended March 31, 2011; at a 2.3% rate in the quarter ended December 31, 2010; at a 2.5% rate in the quarter ended September 30, 2010; at a 3.8% rate in the quarter ended June 30, 2010; at a 3.9% rate in the quarter ended March 31, 2010, at a 5.0% rate in the quarter ended December 31, 2009; and at a 1.6% rate in the quarter ended September 30, 2009. Prior to that, the economy decreased for four consecutive quarters. For the next six months the outlook remains for good but less than ideal growth accompanied by high unemployment, modest inflation pressures and no change in the Federal Reserve policy on the federal funds rate. The economy will continue to be characterized by large fiscal deficits. The Fed completed the second round of economic stimulus in June 2011. The Fed recently began “Operation Twist” by purchasing longer term maturity Treasury Bonds and selling shorter term maturity Treasury Bonds. This tends to moderately lower longer term interest rates. This should add a moderate amount to economic growth. There are some current and potential economic and investment negatives at the present time including: (1) hiring continues cautious and unemployment at 9% is still high, more than two and one half years after the economy started growing; (2) high oil prices including higher gasoline prices continue to negatively affect economic growth, although prices have recently declined; (3) mortgage rates are low, but mortgage credit is still somewhat tight; (4) federal, state and local government spending remains weak; (5) inflation, while modest, continues to creep upward; (6) the U.S. deficit needs to be reduced; (7) there are major economic problems with some individual Euro-zone countries such as Greece, Italy, Ireland, Portugal, and Spain which may spread to other countries; (8) the European Commission recently lowered its Euro-zone forecast for 2012 to 0.5% from 1.8%; (9) the Euro-zone economy may slip into a recession in the near term; (10) Euro-zone problems and uncertainties may continue for some time; and (11) economic problems in Europe may negatively affect U.S. economic growth. Some current and potential economic and investment positives are: (1) the Conference Board’s confidence gauge and the Thomson/Reuters/University of Michigan index of consumer sentiment recently improved; (2) consumer spending, which accounts for about 71% of the economy, has recently increased; (3) manufacturing demand and output are showing gains; (4) capital spending on equipment and software has been increasing; (5) employment and payrolls are increasing although at a modest rate; (6) there is modest growth in commercial and residential construction; (7) near term energy costs including gasoline have recently decreased; (8) there has recently been a modest increase in new home sales; (9) productivity has recently increased; (10) there has been an increase in the willingness of companies to commit capital as evidenced by the increase in merger and acquisition activity; (11) the economy has grown in the last eight quarters through the September 30, 2011 quarter and growth should continue in the near term; (12) growth in the service sector is broadening; (13) businesses have been able to use the credit markets to strengthen their balance sheets; (14) short-term interest rates remain low helped by a low Fed Funds rate; (15) long-term Treasury rates have fallen in response to the problems in Europe; (16) many companies reported revenue growth, not just earnings growth from cutting expenses in the most recent quarters; (17) European leaders agreed to expand a bailout fund; (18) the European Central Bank (ECB) recently cut its benchmark interest rate by 0.25% to 1.25% to boost growth; and (19) the current valuation of stocks is at the low end of historical ranges. The U.S. economic recovery continues to be affected by a number of secular factors that are altering the pace and composition of growth. The economy in 2011 is being affected by greater prudence and less speculation in lending, high unemployment and less leverage for consumer spending. GDP increased 3.0% in 2010 after decreasing 3.6% in calendar 2009, after no change (0.0%) in calendar 2008, and increasing 2.1% in 2007, 2.8% in 2006, 3.1% in 2005, 3.9% in 2004, 2.7% in 2003, 1.9% in 2002, 0.8% in 2001 and 3.7% in 2000. GDP is forecast to increase 1.65% in 2011 and 2.7% in 2012. U.S. inflation numbers have been helped in the last few years by such factors as: (1) global competition; (2) advances in technology resulting in increasing productivity; and (3) technology innovations that are helping to lower production and distribution costs. Inflation, as measured by the Consumer Price Index, increased 1.6% in 2010 after decreasing 0.3% in 2009, and increasing 3.8% in 2008, 2.9% in 2007, 3.2% in 2006, 3.4% in 2005, 2.7% in 2004, 2.3% in 2003, 1.6% in 2002, 2.8% in 2001 and 3.4% in 2000. U.S. inflation is forecast to increase 1.85% in 2011 and 1.75% in 2012. The World Economy The global economic recovery that started in mid-2009 has continued in 2011. Growth is slowing, but outside of Europe, most economies do not appear to be contracting. The expansion today, except for the Euro-zone, appears to be more sustainable than it was a year ago because domestic demand is better in many economies and accommodative financial conditions remain largely in place in most countries. Recovery is strongest in Asia with China having the strongest growth. However, China’s growth rate has recently slowed to 9%. Other Asian countries are having good growth rates as well. Recovery is also occurring in Latin America and Brazil. Some developing countries in the world have been growing faster than the U.S. in the last few years. Their economies continued to grow faster than the U.S. during the most recent worldwide economic slowdown and their economies are continuing to grow faster. The biggest risk to Euro-zone economic growth is related to the potential sovereign government debt crises that have appeared. Europe needs significant fiscal retrenchment in the next few years which is slowing their economic growth. The Euro-zone may slip into a recession and real GDP may decrease 1% over the next two quarters. The World Economy increased 4.8% in 2010 after decreasing 0.8% in 2009 and is forecast to increase 3.4% in 2011 and 3.1% in 2012. Among “advanced economies”: (1) Japan increased 4.0% in 2010 after decreasing 5.2% in 2009 and is forecast to decrease 0.7% in 2011 and increase 1.8% in 2012; (2) the Euro-zone increased 1.7% in 2010 after decreasing 4.0% in 2009 and is forecast to increase 1.5% in 2011 and 0.5% in 2012; (3) the United Kingdom increased 1.3% in 2010 after decreasing 4.9% in 2009 and is forecast to increase 0.8% in 2011 and 1.0% in 2012; (4) Canada increased 3.1% in 2010 after decreasing 2.6% in 2009 and is forecast to increase 2.2% in 2011 and 2.1% in 2012; and (5) Korea increased 6.2% in 2010 after increasing 0.2% in 2009 and is forecast to increase 3.7% in 2011 and 3.8% in 2012. The biggest developing economies are many times referred to as the “BRIC” economies, which is short for Brazil, Russia, India, and China. China’s population is approximately 19% of the world’s total population of approximately seven billion. Many economists believe that China has a particularly good long-term outlook. In the second quarter of 2010 China overtook Japan and became the world’s second largest economy after the U.S. It is the world’s fastest growing major economy. China was one of the first countries to show a pickup in growth as the recession was ending in 2009 and it helped to lead the world out of recession. China’s strong growth is resulting in policy makers withdrawing record fiscal and monetary stimulus. For example, bank lending has been tightened and interest rates have been raised several times. GDP increased 10.4% in 2010 after increasing 8.5% in 2009 and is forecast to increase 9.1% in 2011 and 8.1% in 2012. India’s population is approximately 17% of the world’s population. It is the world’s second fastest growing economy. India’s economy increased 8.4% in 2010 after increasing 6.8% in 2009 and is forecast to increase 7.3% in 2011 and 7.4% in 2012. Brazil is Latin America’s biggest economy. Brazil emerged from its first recession since 2003 in the second quarter of 2009. GDP increased 7.5% in 2010 after decreasing 0.2% in 2009 and is forecast to increase 3.2% in 2011 and 3.5% in 2012. Russia’s economy grew at 4.0% in 2010 after decreasing 7.9% in 2009 and is forecast to increase 4.0% in 2011 and 3.2% in 2012. Many worldwide larger multinational companies should be well positioned to benefit long-term from worldwide growth. To the extent that some of these companies’ U.S. earnings are growing slower, this could be somewhat offset by their possible stronger foreign earnings. The long-term strategy of the Reynolds Blue Chip Growth Fund is to be structured to benefit from this worldwide growth by investing in many of these leading multinational growth companies. The Blue Chip Fund is positioned to participate in long-term worldwide growth trends through investments in multinational U.S. headquartered companies. In addition, the Fund has investments in leading foreign headquartered companies, whose stocks or American Depositary Receipts (ADRs) trade in the United States. These ADR’s are denominated in dollars and they must use GAAP (Generally Accepted Accounting Principles) accounting to qualify as an ADR. The Blue Chip Fund may hold up to 35% of its assets in ADRs. For more information, please download the latest Shareholder Report. |
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