Dear Clients and Friends,

Your copy of Caves & Associates’ Market Review for the first quarter of 2009 is enclosed, or you are viewing this mailing via the Internet. The first quarter continued the extreme volatility of 2008. Notwithstanding a steep run-up starting March 9 to end the quarter, results for global equities were significantly negative for the quarter due to earlier sharp declines in January and February. International stocks again underperformed U.S. stocks, primarily due to currency losses caused by continued strengthening of the U.S. dollar. U.S. government bonds and non-government, investment grade bonds had about breakeven results due to the upward drift of interest rates. Alternative strategies had mixed results that were only modestly negative overall; they ranged from stock-like losses to moderate gains. Given losses on stocks in the range of 10%-15% for the quarter, comparatively better results for bonds and alternative strategies helped to buffer the total portfolio return for a broadly diversified investor.

The backside of the Market Review provides global returns for the first quarter of this year and for twelve months ending March 31, 2009. The global returns provide reference points against which to judge results for your investment accounts. For the quarter, diversification was beneficial as various global stocks and bonds generally did not move in lockstep as they had in the fourth quarter of 2008; behaviorally, investors seemed more rational, being selective about their selling rather than indiscriminately selling everything.

The “Economic Review and Market Perspective” providing a longer-term interpretation of current data is normally presented only at mid-year and yearend. Nonetheless, a condensed version is enclosed or you may review it via the internet.

As you know, Caves & Associates discourages focusing much attention on short-term results because a broadly diversified portfolio is structured for the long-term. As we often state, there is no way to completely eliminate short-term risk from an investment portfolio. As you review the performance data, think in terms of markets (plural), not “the market.” You will notice that typically at least some part of your portfolio is providing positive results. Further, we continue to believe that a disciplined investment approach emphasizing diligent fundamental research, a generally buy-and-hold approach, cost minimization, and rebalancing will provide sound long-term investment returns. Finally, it is crucial to maintain adequate cash reserves to avoid forced portfolio liquidations at cyclical market lows, bearing in mind that such lows are unpredictable.

What’s Below

• General Perspective and Commentary
• Recap of Major U.S. Economic Stimulus Programs
• Commentary on Performance, Results for Alternative Strategies, and Portfolio Math Redux
• Outlook Update
• Timely Topics and Blog Department on Hiatus
• A Key Reminder from Previous Communications

General Perspective and Commentary

You are undoubtedly aware that for the past eighteen months, worldwide economic activity and financial markets have been under extreme downward pressure. This has been mostly due to the decline in U.S. home values, the related devaluation of the mortgage securities market, and the fairly rapid unwinding of excess use of leverage globally. These problems have been exaggerated because of the interconnected nature of the global credit markets.

De-leveraging generally involves shoring up of the balance sheet, whether personal or institutional. Thus, it has necessitated asset sales to raise capital and/or pay down existing (excess) debt. First, extensive asset selling by cash-strapped financial institutions and consumers has put extreme downward pressure on prices of all types of assets, including even high quality assets. Second, precipitous price declines and huge volatility have combined with unprecedented negative financial and economic news to cause a major flight to safety by increasingly risk adverse investors. Finally, U.S. consumers, whose profligacy has been responsible for much of global growth this decade, have been forced to significantly curtail spending, which has had a major ripple effect on the world economy.

Some people are searching for a light at the end of the tunnel or are listening for a bell that indicates we are at the bottom of the current bear market. Unfortunately, the signs that point to a turnaround and future prosperity are not readily evident at the moment. This was also the case with prior recessions, even those that were relatively deep. Bear in mind, financial markets have historically bottomed, on average, six months in advance of economic recoveries. Furthermore, equities on a historical basis have tended to rebound sharply from bear market troughs. See the Updated Outlook for further discussion.

We have discussed our concern about market volatility in previous correspondence. With the usual uncertainty about future outcomes, investors should develop and maintain a plan that has the potential to work over more than one scenario. We believe broadly diversified asset allocation is such a plan.

Investors should not lose sight of the inevitable recovery that follows recession. It is important not to overreact to downbeat economic and financial news, since there is no way to know for sure when the market has truly toughed (or peaked). Market recoveries can occur quickly, without notice, and long before tangible evidence of improvement has occurred. Meanwhile, challenging and volatile market conditions often lead to market dislocations which present opportunities for disciplined, long-term investors. Finally, very major government programs have been and are being implemented in the U.S. and abroad to meet the challenges we face.

Recap of Major U.S. Economic Stimulus Programs

By way of introduction, U.S. programs are generally being executed by either the Federal Reserve Banking System or the U.S. Government through its various agencies, primarily the Treasury Department. Efforts began under the Bush administration and included various bailouts and arranged mergers of financial institutions plus numerous special credit facilities offered by the Federal Reserve. Probably the largest and most notorious program has been the $700 billion Troubled Asset Relief Program (TARP), to be administered by the Treasury Department. Enabling legislation was not particularly specific, and TARP funds continue to be allocated to various needs of predominantly, but not exclusively, financial institutions. For example, in March, recognizing the potential damaging cycle that could emerge, the Treasury Department announced a $5 billion program to aid struggling auto-parts suppliers. The new program will use funds allocated from TARP.

Meanwhile, the U.S. Government has remained actively engaged in the financial sector to assist those companies it considers too big to fail. The beleaguered insurer, American International Group (AIG), reported a loss of $61.7 billion for the fourth quarter, the largest in corpo¬rate history and, as a result, will receive its fourth bailout. AIG will receive up to $30 billion in additional federal assistance from TARP. At a recent Senate Finance Committee hearing, Neil Barofsky, who is in charge of overseeing the government’s bailout efforts said that so far the U.S. has committed nearly $2.98 trillion towards stabilizing financial companies and rescuing domestic auto makers.

The American Recovery and Reinvestment Act of 2009, promoted heavily by the new Obama administration and signed into law by the President February 17, 2009, is intended to provide a $787 billion stimulus to the U.S. economy. The Act includes $281 billion in tax cuts to individuals and businesses; $308 billion in discretionary spending for transportation, housing and urban development, and education; and $198 billion in direct spending programs such as Medicaid, unemployment compensation, and COBRA subsidies. On March 11, 2009, The Wall Street Journal published a forecasting survey that indicated economists are divided over the expected effectiveness of the bill and whether it is big enough.

The Federal Reserve has been actively engaged in developing the Term Asset-Backed Loan Facility (TALF) and is prepared to expand the program to as much as $1 trillion. The TALF is intended to assist the credit markets in accommodating the credit needs of consum¬ers and small businesses by facilitating the issuance of asset-backed securities (ABS) and generally improving the market conditions for ABS. Just as mortgage-backed securities (MBS) provided a secondary market for home loans and facilitated high loan volume, ABS operate in relationship to consumer, student, and small business loans in the same manner. Specifically, the Federal Reserve Bank of New York will lend up to $200 billion, initially, to eligible owners of certain AAA-rated ABS backed by newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans. The U.S. Treasury Department will provide $20 billion of credit protection to the Federal Reserve in connection with the TALF.

Further, the U.S. Government recently announced an initiative called the Public-Private Investment Program (PPIP), which is designed to address both the legacy loans and legacy securities (mainly MBS) clogging the balance sheets of financial firms. Using $75 to $100 billion in TARP capital and capital from private investors, the PPIP is expected to generate $500 billion in purchasing power to buy these legacy assets – with the potential to expand to $1 trillion over time. Specifically, the PPIP will purchase real estate related loans from banks and securities from the broader markets in an effort to increase the flow of credit and expand liquidity.

Finally, the U.S. Government, Federal Reserve, and U.S. Treasury are committed to taking any and all neces¬sary actions to prevent the economy from deteriorating further. The Federal Reserve is on record saying that it will employ all available tools to promote economic re¬covery and to preserve price stability. With no additional room to lower the Federal Funds rate, since it is already at a targeted range at 0.00% to 0.25%, but an ongoing desire to lower interest rates to spur lending and growth, the Fed has resorted to unusual and aggressive remedies such as buying large amounts of Treasuries and mortgage-backed securities. It is too early to tell whether the Fed’s actions will spark a recovery or will simply lead to higher inflation down the road.

Commentary on Performance, Results for Alternative Strategies, and Portfolio Math Redux

We’ll make an exception about focusing on short-term results, partly due to recent unprecedented conditions, to note that our defensive strategies have generally been successful at preserving client capital for future growth opportunities, especially recently. We have increasingly relied on alternative strategies funds. To summarize, they have been excellent diversifiers, have added value since initially incorporated in client portfolios in 2000, and have served us well since a substantial increase in use last December when they were substituted for a portion of the equities allocation in client portfolios.

Over full market cycles, our alternative strategies funds have consistently outperformed a traditional balanced mix of long-only global bond and stock positions. As a group, they have exhibited fairly low correlation with equities. They have generally lagged in bull markets but significantly outperformed in bear markets. Results for the first quarter of 2009 versus equities since a major increase in the allocation to three of our six alternative strategies funds last December are illustrative and summarized below:

Based on the weighted average, the alternative strategies funds outperformed by almost 15 percentage points. It is important to note that this comparison is for a short time period and one which significantly favored hedged strategies. April month-to-date the comparisons would in all likelihood be unfavorable.

In the Timely Topics disseminated in April 2007 (and stored on our website), we included an article entitled The Math of Diversification. The gist of the article was that lower portfolio volatility leads to higher compound annual returns. We would argue that lower volatility from broad diversification, including incorporation of alternative strategies, has been especially critical over the past 18 months, during which time global equities have lost about 50%. Such a loss requires a subsequent 100% positive return (i.e., doubling) just to recover to the beginning point. A lower loss, such as 25%, requires only a 33.3% return, or one-third as much, to recover. In the latter instance, the math for a $100 starting point is (100-25% of 100) + 33.3% of 75=100). Of course, a lower loss “feels much better,” too and inclines clients to hold the course.

Updated Outlook

Our outlook for 2008 was promulgated January 31, 2009. We have noted that 1) our outlook was somewhat more negative than what might be judged the consensus 2009 forecast at the time, and 2) the ensuing reality is typically significantly different from the consensus because the consensus is already factored into prices at the start of the year (this is sometimes described as the various positive and negative expectations being “already discounted” by the market). To summarize, our outlook was very cautious, and we advised capital preservation and a defensive emphasis for client portfolios.

As we head into the second quarter of this year, economic pundits and investors continue to wonder whether the worst is over or whether we are heading for a depression akin to the one the U.S. ex-perienced in the 1930s. A CNN poll on March 17 showed that the number of Americans who think another Great Depression will occur is on the rise with 45% of people questioned saying that another depression is likely. The results of this poll clearly reflect the toll that the financial crisis and lay-offs have had on the public and is consistent with the current low level of the Michigan Consumer Sentiment Index. We would contend that the odds of a depression have never been high, even when the financial markets were in a more dire state during the fourth quarter of 2008. Since then, and even during the fourth quarter, key barometers of credit risk in the economy such as the TED spread, which peaked on October 10 of last year at 4.64%, have improved substantially, suggesting that the financial system has been stabilized to some extent. That is not to say the economy and markets are at all healthy, but a depression appears unlikely.

Looking ahead, like many others, we have concerns about the economy and financial markets. At this point, we do not see a clear catalyst that that would lead to near-term economic and corporate earnings improvement and growth. Our position, like PIMCO’s and others, is that the economy is in a long bottoming process. Also, economic recovery, when it comes, will be L-shaped rather than U- or V- shaped. In other words, recovery will be very protracted and not at all robust for a number of years. Accordingly, in this business environment, corporate profits will take a long time to rebound.

Some say that valuations are compelling when comparing prices to normalized earnings. While normal-izing earnings could potentially result in very favorable valuations, the challenge has been, and may continue to be, that earnings visibility is low and may not improve materially in the short-term. Further, estimates for operat¬ing earnings have been deteriorating, and financial institution results are potentially suspect now that the Financial Accounting Standards Board has relaxed mark-to-market rules.

It is unclear whether reviving the credit markets, and thus making it easier for individuals and institutions to borrow, will improve the economic and financial environment, and if it does, when that ultimately will happen. Nonetheless, what we do know is that the economic downturn has had a significant effect on the consumer, as evidenced by the Michigan Consumer Sentiment Index, which remains not too far from its all-time low set in 1980. Investor sentiment is also quite negative, as many people hesitate to commit additional capital in a very uncertain environment.

As for global stock markets and near-term strategy, the key question at this waypoint is whether the post-March 9 price increases (described in the accompanying Economic review and Market Perspective) are a mere bear market bounce or are a sustainable rally and the start of new bull market, especially because the upswing already technically qualifies as a bull market (price increases greater than 20%).

We cannot have much confidence in our ability to forecast the future in these almost completely unprecedented times, to be able to answer this crucial short-term question. As reviewed above, we do not expect economic conditions to improve anytime soon. Further, government stimulus programs, though massive, may be ineffective and/or take a long time to achieve material results. Also, it would likely be foolish to rely on a purely statistical analysis, namely, that 12-month results were at such extreme variation from the norm (in statistical language, way more than two standard deviations below the mean) that a sustainable market upturn must have occurred on March 9. Finally, we believe we have identified a reasonable strategy that is working. Thus, we are leaving our 2009 outlook and associated major portfolio strategies unchanged.

As usual, our outlooks are predicated on good fiscal and monetary policy decisions and execution, gradual transitions, and the absence of major external shocks. It can be argued, especially with 20/20 hindsight, that government officials have acted too slowly, inconsistently, and without coordination. Of course, the timing of the growing crisis to generally coincide with a change of administration in Washington has been quite unfortunate for government efforts.

What’s Topical or Timely

We remain committed to continuing education as well as keeping you abreast of information which may have a significant impact on your wealth management. Nonetheless, Timely Topics is not being presented at this time but will return in the future.

The Blog Department

The Blog Department is our occasional expression of opinion. Whereas Timely Topics may involve some disagreement among experts, its primary purpose is to educate in the realms of financial planning and wealth management. The Blog Department ventures into broader topics which may be more controversial. For the time being, the Blog Department is under wraps due to time constraints.

A Key Reminder from Previous Communications

In addition to maintaining broad diversification and discipline, we can’t overemphasize the importance of maintaining adequate reserves for all potential needs to withdraw from your portfolio. Reserves, it turns out, were not needed in the 1990’s and for about four and one-half years from 2003 to mid-2007 because stocks went up steadily. But stocks have now retreated broadly and significantly. That’s when you need adequate reserves because reserves allow us to avoid selling at such inopportune times. Finally, a reduction of personal expenditures increases the likelihood reserves will not be exhausted before financial markets have either substantially or completely recovered.

In Conclusion

We are providing these materials for your information and as a means to stay in touch. We hope you find this information helpful, and we would be pleased to hear your comments and questions. Also, you are welcome to share our views with your family and friends if you think they will benefit. Nonetheless, the information is of a general nature and should not be acted upon without further details and/or professional assistance.

This letter and the enclosures, as well as an overview of our staff, advisory philosophy, and methods, are available on ourr website, www.cavesassociates.com.  We appreciate your referrals and suggest you steer those who might be interested to our website as a convenient and private way to initially make our acquaintance.