QUARTERLY

Commentary
firSt QUarter 2010

economic overview

The U.S. Economy

The first quarter of 2010 closes out an incredible year of recovery for the markets, yet other economic indicators continue to be mixed at best. A year ago we were all worried that financial Armageddon was upon us; it is remarkable that the Dow is up over 70 percent from the low of 6,547 set March 9, 2009. However, unemployment remains at 9.7%, banks are still very picky about to whom they will lend and the U.S. will have deficits for as far as the eye can see. On the other hand, manufacturing is picking up and the housing market seems to have stabilized, albeit at a much lower level than before. We believe that company anecdotes and economic indicators are consistent with a recovery. GDP (Gross Domestic Product) was up 5.6% annualized in the 4th quarter. The Case/Shiller 10-city index of housing prices is unchanged over the last 12 months, whereas in late 2008 prices were declining 20% per year. Many of our industrial companies are reporting good news, with solid sequential growth. Our 111th Congress has passed two hugely expensive laws, and neither of these seems likely to help our economy. The fall 2008 financial bailout worked, and a more serious economic meltdown was averted. It does not appear that ARRA, the American Recovery and Reinvestment Act passed in February 2009, has had much of an impact. The number of pork barrel projects in this $787 billion legislation was appalling and its effect on job creation has been minimal. Since then, our elected representatives have been consumed by healthcare legislation. Many provisions of the new healthcare bill are costly and have implications for both the overall economy and individuals. For more information, see the healthcare box at the top of page two. It is our fervent hope that Congress does not further interfere with the nascent recovery. Despite our concerns, we note that in many businesses orders and backlogs are improving. Same store sales are up. Even the automakers are reporting good news. We may be early with this call, but we think the next big wave of technology advances is upon us. See the article on page four about Internet video and cloud computing. We are fundamentally optimistic about the U.S. economy and we think the stock market will reward prudent investors.

Inside this Issue

economic overview

: : The U.S. Economy : : Healthcare Legislation Provisions for Individuals : : Asset Management
featUred StocK

: : Akamai (AKAM)
internet technologY trendS

index Performance Dow Jones Industrials Standard & Poors 500 EAFE (international stocks) Russell 2000 (small stocks) Barclays Interm. Gov/Credit Barclays Municipal

Q110 4.82 5.39 0.98 8.85 1.54 1.25

Ytd 4.82 5.39 0.98 8.85 1.54 1.25

: : Video and Cloud Computing

wealth management

: : Roth IRA Conversion Tax Traps

fixed income

: : A Potpourri of Fixed Income Notes

www.nelsonroberts.com | 650.322.4000

While the first quarter of 2010 closes markets, other economic indicators con

top

economic overview (contd)

FiFteen Holdings
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Healthcare Legislation Provisions for Individuals

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With the recent passage of the over 2,700 page Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act, major new taxes and mandates will be imposed. In this issue of the Commentary we focus on individuals; we will cover companies in our July issue. The Medicare payroll tax increases to 2.35% from 1.45% and the self-employment tax increases by 0.9% for singles earning more than $200,000 and families earning more than $250,000. There is a new Medicare tax of 3.8% on net investment income which applies to those in the income categories noted above. Also with regard to Medicare, there is another new 3.8% tax on trusts and estates levied on the lesser of all undistributed net investment income or all adjusted gross income in excess of $11,200. Charitable trusts are excluded. Flexible spending account limit declines to $2,500 from $5,000. Deduction of unreimbursed medical expenses is limited to amounts > 10% of adjusted gross income vs. the current 7.5%. These provisions all go into effect on January 1, 2013.

S&P Small CaP

FaStenal Co.
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VolCano CorP. emerSon eleCtriC adobe SyStemS miCroSoFt CorP. nuCor CorP. 3m ComPany gilead SCienCeS CheVron CorP. tJx ComPanieS inC.

asset management We had an active first quarter. Early in January, we took a loss on Genzyme. Following the fall 2008 report of viral contamination, the company subsequently disclosed two additional incidents of contamination in their main manufacturing plant. We concluded that this indicated management problems and we would look elsewhere. The 7% dip in the market from mid-January to early February provided us with a buying opportunity. We added Nucor (NUE), Akamai (AKAM) and Lindsay (LNN). Nucor is the best-run steel manufacturer in the U.S. It uses scrap steel as the primary ingredient in its process, recycling 9 million cars every year. For a complete description of Akamai, see the featured stock box on page three. Lindsay is responsible for the beautiful green circles we see when we fly over the dry western U.S. Their pivot irrigation equipment allows farmers to produce the same crop yield using 1/3 less water than traditional drip or flood irrigation.

In mid-March, we took our lumps and sold both Gamestop and Dynamic Materials. Gamestops extensive retail store network will prove a liability as more video games are delivered online (using AKAMs services), just as Blockbuster has lost out to Netflix. Dynamic Materials continues to struggle with sales to its endmarkets, particularly the oil refiners, so we elected to sell it and buy Praxair (PX), which processes and delivers atmospheric gasses to diverse markets. The net result is that our equity cash dropped from an average of 9% at year end to just over 2%, making us fully invested. While there are certainly reasons to be concerned about the stock market, we believe it is the place to be right now. There is virtually no return on cash and, in general, bonds are even more expensive than stocks. As Warren Buffett says, the stock market serves as a relocation center from the reactive investor to the patient investor. We prefer to be patient and believe that our patience will be rewarded.

out an incredible year of recovery for the ntinue to be mixed at best.

featUred StocK

Akamai (AKAM)
Akamai has created the worlds largest and most widely used on-demand distributed computing platform, comprising more than 61,000 servers in 1,000 networks in 70 countries. The company provides managed services for powering video, dynamic transactions, and enterprise applications online. Akamais business takes advantage of two trends in technology: cloud computing and video over the Internet. Most of Akamais clients are businesses for whom access to their websites or use of the Internet is critical. Clients include retailers who sell over the Internet, companies who host applications offsite or enterprises that use the Internet as a mode of product delivery. The company was founded in the late 1990s by professors and a graduate student at Massachusetts Institute of Technology. They developed proprietary algorithms to route and replicate data to more efficiently transport Internet traffic. Over the last decade Akamai has continued to grow its business by helping others more effectively use the Internet. However, the feature-rich content of video and cloud computing now requires increasingly intelligent Internet pipes which will drive a new phase of demand for Akamais services.

AKAMAI TECHNOLOGIES INC.

October 1, 2009 March 31, 2010

$32.00 $31.42 $30.00

DAY SESSION
LAST PRICE HIGH ON 03/17/10 AVERAGE LOW ON 10/01/09

31.42 32.08 25.39 18.65

$26.00 $25.34
PURCHASE PRICE FEBRUARY 6, 2010

$24.00

$22.00

$20.00

$18.00 OCT 15 OCT 30 NOV 16 NOV 30 DEC 15 DEC 31 JAN 15 JAN 29 FEB 16 FEB 26 MAR 15 MAR 31

2009

2010

2010 Bloomberg Finance L. P.

integrity

Where do you find integrity?

It emanates from tradition, endures market cycles, and sustains long-term partnerships. Trust lies at the heart of what we do, how we serve and who we employ.

[in tegr te] n. honesty, sincerity, completeness

internet technologY trendS

Video and Cloud Computing

Video over the Internet is not new. Victorias Secret brought down the Internet one night in February, 1999, after advertising for their then Internet-only fashion show during the NFL Super Bowl. In the early days of the Internet boom, several hundred thousand miles of fiber optic cables were laid across the U.S. The cost was staggering (billions of dollars) and when actual use fell well below estimates, several telecommunications companies went bankrupt. Now, however, feature-rich applications such as Internet video and cloud computing are beginning to absorb the glut of excess bandwidth built ten years ago. With the heightened demand and high definition quality, Internet broadcasts are requiring an increasing amount of capacity. Events such as the NCAA tournament, the U.S. Open and President Obamas inauguration have all been available real-time over the Internet. Distribution of video over the Internet will at least augment, if not replace, video delivery through traditional portals like cable or satellite. Today, 700 million video users watch an average of 10 minutes of video every day. These are predominantly short clips found on YouTube or news clips from CNN. com or other sources. However, the demand for live sports, full-length shows and films is growing as availability and quality improve. Netflix launched a partnership with Microsofts Xbox LIVE that enabled users to access a portion of the Netflix library via the Internet connection on the video game console. Over 1 million users signed up for this service in the first six months. Netflix has since expanded its platform beyond the Xbox and now offers more than 12,000 of its titles for streaming, which is just a fraction of the 100,000 total in its library. Other providers have also added significant content. For example: Hulu offers commercial-supported streaming video of TV shows and movies from NBC, Fox, and ABC, as well as other networks and studios. Major League Baseball provides live coverage of out- of-market baseball games for an annual subscription fee of $99.95. CBS Sports has live coverage of all 63 of this years NCAA tournament games. Five of our current holdings stand to reap substantial benefits from this trend: Adobe, whose Flash technology embeds video in web pages and plays the video on an end device, Akamai (see Featured Stock box), Cisco Systems, which sells the equipment necessary to transport data from end to end and provides videoconferencing capabilities, Disney, which own the rights to a huge amount of content, and Verizon, which owns Internet pipes and provides Internet access.

www.nelsonroberts.com | 650.322.4000

Firm Updates
::

Congratulations to Brian and Jennifer Roberts on the birth of their third child, Olivia Reese Roberts, born on March 9th.

wealth management

Roth IRA Conversion Tax Traps

Many high-income earners were eagerly anticipating tax-rule eligibility changes in 2010 that would allow them to convert traditional IRAs to Roth IRAs. However, when it comes to the tax code, the rules are never straightforward. Here are some tricky pitfalls to be aware of: 1. Individuals over 701/2 years old MUST take a required minimum distribution (RMD) before converting the balance of their traditional IRA to a Roth, or face a 50% penalty on the RMD. Further, any RMD that was mistakenly converted will be subject to a 6% excise charge for each year the money remains in the Roth account. 2. When there is a partial conversion of IRA assets, a pro-rata amount of after-tax money is calculated for each dollar converted. Suppose an individual has $1,000,000 in IRA money of which $100,000 is aftertax and $900,000 is pre-tax. The tax-free percentage is 10% ($100,000/$1,000,000) and the remaining 90% is taxable. If the $100,000 is converted to a Roth, $90,000 will be taxed as ordinary income. 3. Rolling money into an IRA rollover from a qualified retirement plan the same year an individual converts to a Roth will make the rollover part of the pro-rata calculation. Because money held in qualified retirement plans is excluded from the Roth IRA conversion calculation, delaying a rollover to the following year can reduce tax liability. 4. Ordinarily, a RMD can be taken from any combination of IRA accounts. However, the rule is different for company plans such as 401(k)s. RMDs must be taken from EACH plan before the remaining funds can be converted to a Roth. 5. Funds from an inherited IRA are not eligible for a Roth conversion. If money from an inherited IRA ends up in a Roth IRA, the money will be subject to the 6% excise tax for excess contributions for each year it remains there. This is all very complicated and potentially costly if done incorrectly. Please contact us if you need more information or assistance with Roth conversion.

www.nelsonroberts.com | 650.322.4000

Investment Team
Brooks Nelson, CFA Brian Roberts, CFA, MBA Steve Philpott, CFP , MBA Dennistoun Brown, MD Ann Oglesby, MD, MBA

fixed income

A Potpourri of Fixed Income Notes

1. Extremely low short-term Treasury rates continue to frustrate investors who are looking for yield. The spread between high-grade corporate bonds and Treasuries has declined to 1.51%, the narrowest spread since November, 2007. We do not think that investors are being adequately rewarded for the additional risk at this level. Municipal bonds are also attracting interest, yet revenues for state and local governments have declined an average of 4.1% in the fourth quarter of 2009 compared to a year earlier. Again, we question whether investors are getting appropriate returns for the added risk in this climate. The Treasury yield curve has reached historically steep levels as long-term rates have crept upward while short-term rates (controlled by the Fed) remain steady. A steep yield curve is a positive indicator for economic growth and an inverted yield curve (long rates are lower than short rates) usually indicates future economic contraction. However, it appears the current steepness of the curve is being driven by concern that excess government borrowing will eventually lead to higher inflation. Demand for Treasuries has been weak at recent auctions. The yield on the 10-year Treasury climbed as high as 3.88% from a low of 3.5% in February before ending the quarter at 3.83%. 2. Beginning in April of 2010, Moodys and Fitch, companies who rate bonds, will modify the way municipal debt is rated. The scale will be comparable to how corporate bonds are measured. The changes are expected to improve municipal debt ratings and lower borrowing costs for issuers. Historically, both Moodys and Fitch assessed municipal bonds on a separate scale from corporate issuers, leading to complaints from states that municipalities were being held to more stringent standards despite historically low default rates. California, which holds one of the lowest ratings of the fifty states, is expected to see the rating on its General Obligation debt rise three notches, to A1 from BAA. 3. Are the U.S., France and Germany at risk of losing their AAA credit ratings? Debt is growing in all three countries, increasing the risk of a future downgrade. Downgrades would lead to significantly higher interest rates, increasing borrowing costs for governments. All three nations would be well-advised to get their financial houses in order sooner rather than later.

Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Please contact us for a complete list of portfolio holdings. For additional information on the services of Nelson Roberts Investment Advisors, or to receive our Newsletters via e-mail or be removed from our mailing list, please contact us at 650-322-4000.

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2010 Nelson Roberts Investment Advisors