Absolute Return Portfolio Management LLC

First Quarter Re-cap: At year-end, our models indicated the potential for a decline in nearly all asset classes. This led me to comment that the new year may coincide with a peak in all asset classes. Most asset classes enjoyed a strong rally in the very first week of 2006 but since then they have either given up those gains or drifted modestly higher or lower. Though an intermediate-term decline has not occurred, nearly all asset classes pretty much stalled out since January.

After the peak in the equity markets in mid-January, equities have see-sawed back and forth in a very narrow trading range. International markets remain the strongest and we have very recently begun to see rotation from riskier LatAm and Emerging Markets to relatively safer European and Japanese equities. Asia is also moving up through the ranks. Domestically, the leadership has long been in the hands of Mid-Cap Growth stocks. We are beginning to see the baton passing to the Small-Caps, however. There may be more life in this bull market yet!

Bond yields have continued to move higher across all maturities leading to modest losses in investment grade bonds. High Yield bonds have traced out the same path as equities: a quick run in the first week of the year followed by a tame roller coaster ride since.

Real Assets, especially Gold and Commodities have been in a decline since the end of January. Gold shares declined nearly 20% though models have moved back to a BUY and we have begun investing again in gold. We monitor trends in the commodities market using the Goldman Sachs Commodities Index (GSCI) as several mutual funds and an Exchanged-traded fund are indexed against this index. Like Gold, the heavily energy-laden GSCI has been in a decline from late January. Real Estate has been the best asset class of the Real Assets composite. Our models remained focused on the long-term trends in Gold earlier in the year but recently Real Estate has moved up through the ranks. With this issue we begin coverage of the Alternative Energy area as an additional inflation-sensitive Real Asset/ Inflation Hedge investment.

The ever rising interest rate yields bears watching as stocks do compete for capital and higher interest rates draws money away from stocks. Just as importantly, higher interest rates mean consumers cut back on spending and earnings are reduced by higher interest charges.

I've noted in past issues that capital has begun rotating from the higher risk areas such as LatAm and Emerging Markets to the relatively safer havens of Europe and, more recently, Japan. Domestically, we are seeing rotation away from Mid-Cap Growth towards blue-chips and, more recently into the Small-Cap. This rotation to Small-Caps is a more bullish trend for the equity market outlook.

While Mid-Cap stocks had been the leaders for over a year, which is quite long by historical standards, I am beginning to see a decisive rotation to small-caps. This is a good sign that the bull market might have some life left in it. I am much more impressed recently with the Market Breadth Models that analyze the Small-Cap area as compared to the Mid-caps and I suspect that our Domestic Equity Allocation Models will soon recommend a switch from Mid-Cap Growth to Small-Caps should the later continue its winning ways.

Related to Small-Caps, I am also seeing an improvement in the Micro-Caps. Given the lack of depth and liquidity in small and micro-cap stocks, it is more likely that institutions will be buying across the board with less regard for any style bias (growth vs. value). Likewise, we may opt for a more generic Small-Cap ETF and a Micro-Cap ETF.

Sentiment Models for the Treasury Bond Market show some of the lowest levels of Bulls that I have seen in many, many years. Additionally, in reviewing the Commitment of Traders Reports this weekend for Bonds I note that the smart-money Commercial traders are carrying among the largest long position in bonds I have ever seen - a huge bet that long-term interest rates are near a peak! Similarly, the less-sophisticated (and frequently wrong) Large Speculator and Small Trader categories are making substantial bets on a continued decline in bond prices and for interest rates to continue higher.

It's time to begin looking for an intermediate-term trend change in bond prices from down to up. We'll wait for the trend models to give us the AOK to buy but forewarned is forearmed.

Goldman Sachs Commodity Index (GSCI) - Intermediate- term Model remains on a SELL from early February. Crude Oil is the key here and it has yet to build a solid uptrend.

Real Estate - REITs remain on a BUY and have improved to the top spot among the Real Assets. I noted last week the overbought technical condition warning against investment in REITS. We've now seen a modest pullback of several percent and I am looking for a point to jump on (assuming our short-term trend models remain on a buy).

Alternative Energy - In this issue, I am adding Alternative Energy to our Real Assets (Inflation hedge) coverage using the Wilderhill Clean Energy Index (WCEI) as a benchmark. Recently, a new exchange traded fund, PBW, makes investment in this area possible. My research shows that this benchmark is highly correlated to our Real Assets Composite showing it to be a good investment addition to the other inflation sensitive members of the Real Assets complex. Many very bright analysts are seeing a fundamental shift higher in the demand for crude oil globally which may drive prices higher in the energy complex and lead to much needed investment into renewable sources of energy. As prices within the energy complex go up, I expect to continue to see the WCEI move higher too. Intermediate and Short-term Trend models are on a BUY.