The Wall Street Journal identified a lack of checks and balances as “the most glaring red flag in the Madoff scandal” and recommended that investors pay close attention to the levels of internal and regulatory oversight their financial advisors receive.

AMG National Trust Bank is subject to stringent regulation and examination by the Office of the Comptroller of the Currency, a bureau of the U.S. Department of the Treasury. In addition, AMG routinely submits to rigorous financial audits and operational reviews by experienced, knowledgeable and reputable accounting firms. AMG has a full-time compliance officer on staff who reports to an audit committee consisting of independent members of AMG’s board of directors. AMG is well capitalized and has Federal Deposit Insurance Corporation insurance on bank deposits.

Annual audits and reviews independently verify a number of safeguards critical to the security of assets held at AMG; specifically:

• The separation of client assets held in securities accounts from corporate assets and independent confirmation of client-owned securities held at third-party custodians,
• Appropriate accounting for client assets and reporting of the assets to the client,
• The existence of, and adherence to, policies and procedures, including dual control over client assets,
• Detailed due diligence on recommended outside investment managers, brokers, and custodians,
• The scrupulous protection of client privacy.

Member FDIC

Investment products: Not FDIC insured • No bank guarantee • May lose value

In recessionary times, many investors jump out of the volatile stock markets and run for the perceived safe haven of the bond markets. But you should be aware, fixed-income investments are not risk free.

Fixed income investments are fixed in the sense that if the bond is held to maturity, the bond’s yield is the expected annual return to the investor, and the issuer will repay the principal at maturity. However, interim price volatility can be extreme for a number of reasons, such as the inverse relationship between bond prices and interest rates, a change in the bond’s credit rating, and the liquidity of the bond.

In addition, the potential for default by the issuer may result in a loss of principal. While relatively higher yielding bonds seem attractive, there is no free lunch. If a bond has a higher yield than its peers, this generally indicates that there is greater risk of default.

AMG National Trust Bank guards against these risks by first examining the financial strength of the issuer. AMG takes a conservative approach to fixed income investments by understanding risks and not chasing outlandish returns.

With proper management, bonds might be considered the safer allocation in the portfolio. Nevertheless, investors must be aware of the risks associated with fixed-income investments and use a conservative approach.

On February 27, 2009 the Bureau of Economic Analysis (BEA) released its preliminary estimate for fourth quarter real GDP. It shows a 6.2% annualized rate of contraction, considerably worse than the 3.8% downturn of January’s advance estimate. A revision to the estimated change in inventories was the largest factor in the downward revision to real GDP. Revisions to consumer spending and net exports were also material. The silver lining is that the revised inventory figure implies future changes to inventory stocks will be less of a drag on real GDP in the first half of 2009 than previously anticipated. New data indicate greater ongoing deterioration in private business activity than in other sectors, but recent budget legislation implies that increases in government purchases of goods and services will accelerate. The net result leaves our near-term outlook for real GDP about the same as anticipated in the March Notes on the Economy.

Background
The BEA’s advance estimates of the National Income and Product Accounts (NIPA) for fourth quarter 2008 indicated that total inventories grew slightly, boosting the annualize rate of change in real GDP by 1.3 percentage points. The preliminary estimate shows that inventory stocks were, instead, pared back. Since the shrinking of inventories took place more slowly than in the third quarter of 2008, the effect of inventories was still positive, albeit much reduced, adding 0.2 percentage points to the change in real GDP.

Estimates for consumer spending and net exports in the fourth quarter also had sizeable revisions. The advance estimate indicated an annualized decline of 3.5% for consumer spending. The preliminary estimate shows a decline of 4.3%, as consumer spending for nondurable goods and services weakened substantially late in the fourth quarter. Thus, the negative impact on real GDP was revised to 3.0 percentage points from 2.5 percentage points. Likewise, the estimated contraction in exports was revised from 19.7% to 23.6%, while there was little change in the estimate for imports. As a result, the impact on real GDP from net exports was changed from a positive 0.1 percentage points to a negative 0.5 percentage points.

Other revisions to the major sectors in the NIPA were of little effect on real GDP. Minor downward revisions to the level of business fixed investment were offset by higher estimates for homebuilding and government purchases.

Looking Ahead
Cuts to inventories will be a major drag on real GDP during the first half of 2009. The revision to the estimate for the change in inventories was not entirely unexpected. Prior to the publication of the advance NIPA estimates for the fourth quarter, we projected that the change in inventories would push the annualized rate of decline in real GDP down by 0.5 percentage points. Since the preliminary estimate still shows a positive contribution to real GDP, the implication is that businesses remain well behind in their efforts to bring inventories back in line with sales. New figures for December inventories confirm that inventory-to-sales ratios are considerably elevated. However, the downward impact on our projections for real GDP is reduced by roughly the amount of the difference between the advance and preliminary estimates for inventories.

The downward revision for consumer spending is cause for concern. Although retail sales increased in January, this does not signal that a bottom is at hand. Consumer sentiment expressed in University of Michigan and Conference Board surveys plummeted in February. Based on weekly unemployment claims data, we anticipate that payrolls shrunk by more than 700,000 in February and that the unemployment rate, which was 7.6% in January, will close in on 8.0%. So consumer spending will probably still be down about 4.0%, or so, in the current quarter before bottoming out in the second quarter.

The weakness in exports was hardly a surprise and the downward revision was not abnormally large for such a volatile series. Imports were off dramatically, as well, due to the overall weakness in domestic demand, and there was little downward revision to the total import figure. As discussed in the March Notes a bounce-back in next exports is probable in the first quarter, before net exports turn into a consistent drag on GDP growth. However, the outlook for the first quarter bounce has been pared back in view of deteriorating economic conditions abroad.

Large double-digit percentage declines for business fixed investment and residential investment are still a sure thing in the first half of 2009. Recent reports for durable goods orders and new housing permits confirm previous expectations. On the other hand Congress wrapped up the budget for fiscal year 2009 with an omnibus bill containing higher budget authority and proposed outlays for discretionary spending than we had previously anticipated, boosting the outlook for growth of government purchases.

The Bottom Line
The first quarter’s decline in real GDP will be in the range of 6.0% to 6.5% annualized, while the contraction for the full year 2009 will top 3.0%.

The Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) has determined that business activity peaked in December 2007, marking the beginning of the present recession—notwithstanding the fact that total economic output, as measured by real GDP, reached its recent maximum in the second quarter of 2008. The NBER is generally recognized as the arbiter for dating peaks and troughs in economic activity, and it uses a number of data inputs in making such determinations. In reporting its decision that the economy is in recession, the NBER cited real (i.e. inflation-adjusted) personal income (less transfer payments), real manufacturing and wholesale-retail trade sales, industrial production, and employment estimates based on the Labor Department’s monthly household survey. Its report noted that all of the forgoing items reached peaks between November 2007 and June 2008. It stated that real GDP (which declined slightly in the fourth quarter of 2007, rose in the following two quarters and then declined again in the third quarter) was ambiguous. The NBER was apparently most convinced by payroll employment, which peaked in December 2007, in selecting a date for the business cycle peak.

On November 25, the Bureau of Economic Analysis released its preliminary estimates for third quarter GDP and related figures. This release revised the advance estimates that had been published in late October. The preliminary estimate for the annualized third quarter rate of decline in real GDP is 0.5%, only 0.2% greater than the advance estimate. Consumer spending fell more steeply than first estimated, 3.7% rather than 3.1%. That took 0.4 percentage points off of the real GDP growth rate, but the cut was nearly offset by a reduction of the estimated decline in inventory stocks. Unfortunately, that change in the composition of real GDP implies greater difficulties for the economy in the immediate future. The larger decline in consumer spending indicates aggregate demand is declining more rapidly than first estimated, while the inventory figures imply that businesses will have to cut back production even faster than expected in order to bring inventories down to desired levels.

Other recently released data confirm an accelerated rate of decline in economic activity. Initial claims for unemployment benefits have climbed, indicating that the payroll employment for November (when released December 5) will show job losses well above October’s figure of 240,000 and probably exceeding 350,000. The Institute for Supply Management reports that its indexes measuring both manufacturing and non-manufacturing business activity continued to decline further into recession territory. The Conference Board’s Index of Leading Indicators dropped 0.8% in October, indicating additional economic deterioration is likely in the near term. The October/November surveys conducted by the various regional Federal Reserve Banks, and reported in the Fed’s Beige Book this week, were decidedly downbeat. For the third consecutive month, all Federal Reserve districts reported weaker economic activity. The silver lining is the report that price pressures have eased and that lower prices, in general, are anticipated for the near term.

With the threat of inflation now virtually nonexistent (and the emergence of deflation a possibility), it is probable that the Federal Reserve (Fed) will cut its policy target for the federal funds rate again. We expect a 50 basis point cut to 0.5% following its December 15-16 meeting and, quite possibly, another 25 basis point cut at the end of January. We also anticipate an additional fiscal stimulus package worth more than $500 billion in the form of new benefits programs, tax cuts, state aid and infrastructure programs likely to be enacted in early 2009. Accommodative monetary and expansionary fiscal policies will provide the needed boost to revive the economy, but it will take time before they have a material impact on production of goods and services, and the delay in fully implementing the Troubled Asset Relief Program does not help.

The decline in real GDP will be deeper than projected in November’s Notes on the Economy. We currently anticipate an annualized decline of about 4.6% in the fourth quarter of 2008 and 3.9% in the first quarter of next year. Weak real GDP growth should resume by the third quarter of 2009, but a turn-around in home building is not expected until the fourth quarter. Considering the NBER’s dating for the peak in economic activity, the current recession will most likely last longer than the previous post-World-War-II record of 16 months for both the November 1973 to March 1975 recession and the July 1981 to November 1982 recession. The decline in real GDP from the NBER’s fourth quarter 2007 business cycle peak through the second quarter of 2009 is expected to be about 1.7%—slightly more than the 1.6% average of the decline calculated between the peak and trough quarters of the ten recessions dated by the NBER since 1948.

Except for the likelihood of an extended low-interest-rate environment for Treasury bonds, notes, and bills, the short-term outlook for investment is little changed by the recent economic news. As reported in more detail in November’s Notes, the main driver for the gross undervaluation of nearly all assets (except U.S. Treasury securities) is the global deleveraging that has taken place since August 2007. One cannot say the bottom in asset prices has been reached or that previous lows will not again be tested. However, it is likely that the actions undertaken by the Fed, the Treasury, and other monetary and fiscal authorities around the globe will soon begin to take hold, and financial markets are due for a rebound from oversold conditions.

The Bottom Line
Economic output will fall rapidly through March 2009 and continue to contract until mid year; recovery in the second half of 2009 will be tepid.