FIRST QUARTER, 2010

THE ECONOMY: (MODEST) POSITIVE GROWTH REGISTERED IN SEPTEMBER QUARTER. CONTINUED SLOW GROWTH LIKELY THROUGH THE FIRST HALF OF THIS YEAR AS PRIVATE SECTOR SPENDING EXPECTED TO REMAIN AT LOW LEVELS

Consumer spending represents approximately two-thirds of Real Gross Domestic Product (Real GDP). The private sector (consumers and businesses) has been de-leveraging: reducing spending; paying down debt; and strengthening balance sheets. Businesses are operating at low levels of capacity due to the sluggish economy, and have minimized building of plants. This is likely to accelerate next year as the rate of overall economic activity picks up. Consumers had overextended their borrowing through a combination of mortgage defaults, diminished spending activity, an increase in savings rates, and a shift toward value and away from luxury products. This group is not expected to be a major impetus to macro-economic growth in 2010. We believe that the jobs/employment picture will improve towards the end of this year and into 2011 (see discussion below). Therefore, it is likely that consumer spending patterns will improve. As a result of the combination of improved balance sheets in the private sector and higher rates of Real GDP growth in 2011, we project that both consumers and businesses will make a more positive contribution to overall economic activity next year.

A major factor that will contribute to a broad based improvement in our economy will be a downturn in unemployment through job creation. There are three stages in the employment cycle to achieve an increase in jobs. Stage one - contraction, which has been completed. Stage two - leveling out. The economy and employment must stop contracting. But a combination of slow macroeconomic growth and the use of part-time workers limits the rate of increase in permanent full-time jobs. Our country’s economy is in this stage right now. Stage three - business sales achieve high levels. This fuels increases in permanent full-time jobs that are needed to handle the higher level of activity. We are of the opinion that our economy will enter this stage around September of this year.

Real GDP rose at a 2.2% annual rate in the September quarter of last year after having declined by 0.7% in the previous quarter. Important contributions to this reversal were improvements in the following: personal consumption, federal government spending, investment in inventories by businesses, output of motor vehicles, fixed residential investment, and exports. Some offsetting negatives were an increase in imports (which is a subtraction from Real GDP) and a decline in nonresidential fixed investment. Other economic variables of note include:

• Personal consumption expenditures increased 2.8% in the September, 2009 quarter, after declining 0.9% in the June, 2009 quarter.
  
  
• A major positive swing took place in residential fixed investment - there was an 18.9% gain in the September, 2009 quarter, compared to a 23.3% decline in the June, 2009 quarter.
  
  
• Motor vehicle output added 1.45 percentage points to third-quarter 2009 gain in Real GDP, up from a much more modest addition of 0.19 of a percentage point in second-quarter2009.
  
  
• Exports also experienced a major positive change, gaining 17.8% in September, 2009quarter after declining 4.1% in June, 2009 quarter.
  
  
• Equipment and software rose 1.5% in the third-quarter 2009- that sector declined 4.9% in second-quarter 2009.
  
  
• Federal government spending posted a positive change of 8.0% in the third-quarter, although this was down from its 11.4% increase in second-quarter 2009.
  
  
• The change in business inventories contributed 0.69 of a percentage point after reducing the June, 2009 quarter results by 1.42 percentage points. Some negative sectors were:
  
  
• A decline in nonresidential structures of 18.4% in the September, 2009 quarter (the decline was 17.3% in the June, 2009 quarter).
  
  
• Spending by state and local governments decreased 0.6% in third-quarter 2009, after a gain of 3.9% in second-quarter 2009.
  
  
• A major upturn in imports to a 21.3% increase from a decline of 14.7% in second-quarter2009.
  
  

As expected, there was a modest gain in Real GDP in the September, 2009 quarter. We estimate that quarterly results for the first-half of this year will also show modest gains in Real GDP growth - a continuation of the economy’s pattern during the second half of 2009. For all of 2010, we estimate a gain of 2-2% in Real GDP, and we project an acceleration of Real GDP growth in 2011. Since there is currently a lot of excess capacity in the factors of production (a high level of unemployment and a low level of plant utilization), inflation is likely to be muted this year. We estimate that the Consumer Price Index will increase by 1-2% in 2010. Improving economic conditions could put some upward pressure on Treasury and corporate bond yields during the latter part of this year and into 2011.

THE STOCK MARKET: STRONG REBOUND FROM LAST YEAR’S LOW PERSISTED INTO DECEMBER QUARTER AS OUR ECONOMY TRANSITIONED TO POSITIVE GROWTH IN THE SEPTEMBER, 2009 QUARTER

During the December, 2009 quarter, the Standard & Poor’s 500 Industrial Average (S&P 500) increased by 5.5%. This put a nice finish on a year that began with a decline of 25.1% into early March, followed by a vigorous rebound of 66.7% to the 2009 high in late December. For the year as a whole, the S&P 500 was up 23.5%. Investor psychology improved as signs of an economic upturn developed and Real GDP turned positive in the September, 2009 quarter. Demand for equities is expected to remain firm this year as the economic recovery gains a solid footing. We engaged in some trading activity for our clients during last year’s final quarter. Stocks of two retailers were acquired, we instituted purchases in the technology sector, selectively made purchases in the education sector, and also continued to make purchases in the credit card processing sector. On the sell side, we eliminated positions in the agricultural commodity sector. The current position of the total managed assets of Harold Davidson & Associates’ client port- folios is as follows: cash & cash equivalents - 8%; government bonds - 1%; municipal bonds - 10%; corporate bonds - 5%; bond mutual funds - 6%; common stocks - 27%; equity mutual funds -15%; real estate equities - 9%; and real estate trust deeds -19%.

Stocks have made a remarkable recovery during the previous twelve months, as widespread feelings of doom and gloom have been replaced by cautious optimism. Corporate earnings have begun to improve, as businesses better aligned their costs with revenue expectations. While the high rate of unemployment continues to impact consumer confidence, there have been recent improvements in retail sales. As an example, Best Buy reported that its December comparable U.S. sales increased 9.3%, as consumers purchased computers, mobile phones and flat screen televisions. The stronger than expected data from the December 2009 Institute for SupplyManagement (ISM) Manufacturing Index, as well as the increase in the ISM New Orders Sub-Index, portends stronger economic growth for the months ahead. There are, however, some potential headwinds that could impact future economic growth over the next several months. Inflationary concerns related to substantial fiscal spending and easy monetary policies from the Fed have weakened the U.S. dollar, resulting in sharply higher commodity prices (including gold and copper). The health care bill working its way through Congress may also potentially have implications for the stock market, though some of this may already be priced into the market. Moderate economic growth over the next several quarters should support higher stock prices this year, though not at the same level experienced in 2009. We estimate mid to high single digit returns for the S&P 500 index for 2010, with expected further gains in 2011 as the economy continues to expand.

THE BOND MARKET: TREASURY YIELDS EDGE UP AS MARKETS SENSE ECONOMIC RECOVERY

After reaching a recent low of 3.152% on November 27, 2009, yields on the benchmark 10-year U.S. Treasury bonds began increasing as investors believe economic growth in the United States may begin to improve in 2010. Currently, yields on 10-Year U.S. Treasuries stand at 3.8%. Spreads on corporate and municipal bonds tightened considerably in 2009 as investors chased higher yields in a low interest rate environment. Furthermore, investment grade corporate bonds had been trading at substantial discounts to par value during the latter half of 2008 and early 2009. A good portion of the gains achieved in fixed income securities in 2009 came about through security price appreciation, resulting in the dramatic tightening of credit spreads. Going forward, yields on U.S. Treasuries are likely to increase as expectations for economic growth are more widely accepted. Concerns over the potential negative effects on the dollar resulting from substantial U.S. fiscal deficit spending may also result in Treasury yields increasingthroughout 2010. A weaker dollar negatively impacts foreign holders of U.S. government debt, possibly necessitating higher Treasury yields to attract foreign capital.

Harold Davidson & Associates is of the opinion that interest rates are likely to edge higher as the year progresses. Consequently, more attention will be focused on shorter maturity, higher coupon corporate and municipal securities (with emphasis on national municipal bonds). We will continue to emphasize issues with solid fundamentals.

REAL ESTATE: IMPROVEMENT IN AFFORDABLE HOUSING SECTOR SALES LEAD REAL ESTATE RECOVERY

Real estate continues to recover for affordable housing, with lender foreclosure resale activity now accounting for 39.1% of Los Angeles sale activity, down from the high of 56.7% last February. There is increased investor activity in this sector with roughly 19% of sales attributable to non-owner occupied transactions, and 24% of all sales last month were cash transactions. FHA guaranteed loans are driving the sales process at this time, with 38% of all home sales in California being financed with FHA guaranteed loans.

We expect continued slow stabilization in affordable housing, with instability in mid-range to higher end housing throughout this year due to lack of affordable financing options in the higher end housing markets.

SUMMARY & CONCLUSION: MAJOR ECONOMIC DISASTER AVERTED IN 2009. TEPIDIMPROVEMENT EXPECTED THIS YEAR, TRANSITIONING INTO A MORE POSITIVE 2011

During the first few weeks of 2009, ongoing investors’ fears of a major financial and economic meltdown caused a severe continuation of the preceding bear market. There was a sharp decline through early March of 2009. But several programs instituted by our Federal government, along with actions taken by the Federal Reserve Board and the Treasury Department, improved market stability and investor confidence. This intensive effort served to stave off the looming disaster, and investor psychology improved significantly. As a result, the stock market mounted a significant rally and the S&P 500 closed 2009 with a gain of 23.5%.

An economic recovery of modest proportions is estimated to take place this year. Therefore, the stock market will likely digest its recent vigorous rebound during the next several months. We expect that equities will move higher during the latter part of 2010 in anticipation of better economic conditions in 2011.

CLIENT REFERRALS

We greatly appreciate the referrals of new business that we continue to receive from our clients.

"'Economic Outlook & Investment Perspective' is designed to serve as a regular forum for the discussion of pertinent economic and market issues that are of concern to individual investors. However, this newsletter is not, and under no circumstances is to be construed as giving financial or investment advice and/or as an offer to sell any securities. harold Davidson & Associates, Inc. and its officers and employees may have an interest in some or all of the investments, industries or securities, mentioned herein. The information set forth herein has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and does not purport to be a complete analysis of the investment, industry or security involved."