QUARTERLY

Commentary
First QUArter 2011

economic overview

Sturdy Market Withstands Challenges

As 2011 opened, the stock market continued the rise that began on July 2nd last year, only to falter on February 22nd when unrest in the Middle East pushed oil over $100 a barrel. First Tunisia, then Egypt, Yemen, Bahrain, Libya, Saudi Arabia and most recently Syria, have experienced popular uprisings sparked by social media-coordinated days of rage. Then on March 9th, Japan was struck by a major earthquake and tsunami. Fear sent the Dow Industrials down 600 points in five days as investors struggled to understand the implications of these related natural disasters. This is a human tragedy of immense proportions, yet economically, like past disasters, the repercussions will be limited to disruptions in the supplies of certain manufactured goods. Ultimately, there will be economic stimulus, especially for Japan, as massive reconstruction gets underway in the next year. Once the market realized this, it rallied back over the next ten days, closing the quarter very near its post-2008 crash high. Political instability and natural disasters are not the only concerns investors should have. In addition, we see the following issues: State and local budgets and balance sheets have both significant deficits and ballooning debt. Political leaders continue to allow bloated and ineffective expenditures without producing viable, long-term solutions to our countrys biggest problems, including entitlement spending. The Federal Reserve persists in keeping short-term interest rates near 0% and creating money faster than it ever has before. Inflation is rising.
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Inside this Issue

economic overview

: : Sturdy Market Withstands Challenges

Asset mAnAGement

: : Putting Our Investment Themes into Practice

FeAtUred stocK

: : Myriad Genetics
Fixed income

State and local governments, unlike the Federal government, cannot run deficits. Declining tax revenues necessitate real-time cutbacks and the resulting reduction in expenditures restrains the economy. Many view this as a source of continued deflationary pressure and they believe this is offsetting the extremely high fiscal and monetary stimulus of the Federal government. With the current very low long-term interest rates, the bond market is saying that the Fed will cut the stimulus before inflation becomes a problem. On the other hand, the US dollars persistent weakness tells us that foreign investors do not believe this is likely. Who is right? We believe that inflation will rise too far and too fast for the Fed to manage perfectly. This will cause bond prices to fall, interest rates to rise and the consequent rise of the US dollar. In Congress, the budget-cutting focus is entirely on discretionary spending. Medicare, Social Security and Defense account for over half of total federal spending but no one is debating cutting these, at least yet. Healthcare reform will broaden coverage to care for those currently uninsured but has completely failed to
index PerFormAnce Dow Jones Industrials Standard & Poors 500 EAFE (international stocks) Russell 2000 (small stocks) Barclays Interm. Gov/Credit Barclays Municipal Q111 7.06 5.92 3.50 7.93 0.34 0.51 Ytd 7.06 5.92 3.50 7.93 0.34 0.51

: : Understanding the Municipal Bond Market

investment themes

: : Molecular Diagnostics Holds Huge Promise

Official inflation statistics show but those of us who eat, dri

top

economic overview

FiFteen Holdings
iShareS intl iShareS

Sturdy Market Withstands Challenges (contd)

address ever-increasing medical costs. Common sense dictates that Social Security cannot survive the baby boomers retirement without significant changes. The question we should all be asking our congressional representatives is: what are you waiting for?
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a standard 5-lb bag to 4 lbs and baby wipes come 72 to a box instead of 80. Retailers seem to think that consumers will not notice that volumes are dropping and prices are staying the same. Where size cannot be adjusted, producers are warning that prices will be going up. Last week, Hershey February 4, 2000 April 4, 2011 120 announced a 9.7% price increase for its products. Official inflation 110 statistics show a benign CPI of 2.1% year-over-year. Excluding food and 100 energy, the rate is 1.0%. Forgive our 90 sarcasm, but those of us who eat, drive and heat our homes are just 80 not buying it. 75.962
LAST PRICE HIGH ON 12/29/10 AVERAGE LOW ON 07/02/ 75.962 119.900 91.548 71.657

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The Federal Reserve continues on its path of expanding monetary stimulus. Quantitative Easing Two (QEII) is underway and will take the assets on the Feds balance sheet to a record high. Short-term interest rates are still at 0 for all practical purposes, leading to a falling dollar. (For more details on this particular INFLATION issue, see our May 2010 white paper Default or Devaluation.) CPI Index Inflation is either beginning to spin out of control or is a non-event, depending upon which data one chooses. A March 29th New York Times article was entitled Food inflation kept hidden in tinier bags. Canned vegetables, pasta and other staple food items now come in 13-oz containers rather than 16-oz sizes. Sugar has dropped from
2000

So what is driving the markets rise? To us, it looks like it is all about individual company performance. Costs have been cut, earnings are improving, factory orders are up and the economy is slowly, sluggishly, but finally turning around. The steady march of demographic changes will continue to drive macroeconomic growth world-wide.
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a benign CPI of 2.1%. Forgive our sarcasm, ive and heat our homes are just not buying it.

Asset mAnAGement

Putting Our Investment Themes into Practice

The equity markets continue to claw their way back toward the high water marks set in October 2007. The appreciation in the market has been supported by a solid recovery in company earnings and healthier corporate balance sheets. The Dow Jones Industrial Average ended the quarter up 7.06%, to 12,319 and 13.0% below its high of 14,164. The S&P has been on a similar trajectory, also up 5.92% to 1,326, or 15.3% below its October 2007 high of 1,565. For Nelson Roberts, the energy sector has fueled a quarter of solid market gains. The combination of economic recovery and Middle East unrest has sent oil over $100 a barrel. Our position in Marathon Oil rose 44.7% vs. an overall energy sector increase of 13.8%. Lindsay Corp has also benefitted from rising commodity prices. As a supplier of irrigation equipment to the agriculture industry, the demand for Lindsays products rises with the price of crops. Lindsay is up 35.1% for the first quarter of 2011. Our worst-performing stocks for the quarter were in technology, with Cisco (down 11.1%) and Akamai (down 21.5%) both underperforming. Akamai retrenched in Q1 of 2011 after the stock doubled in value in 2010. Ciscos stock has stagnated despite announcing the companys first-ever dividend to shareholders. We believe both companies will continue to benefit from the dramatic increase in the amount of video traffic over the Internet. As our confidence in the recovery has increased, we have focused on investing our cash while reshaping our exposure in the healthcare sector and increasing our weighting in materials. In February, we began to initiate our investments in molecular diagnostics (see Page 6 article on Investment Themes) by buying Gen-Probe, which focuses on nucleic acid testing for infectious agents. That initial purchase was followed closely by related investments in Myriad Genetics (see our Featured Stock article) and Illumina, Inc. (the leading DNA sequencing company). To fund these purchases, we sold a profitable position in Volcano Corp. Though we think the prospects for the companys products continue to be attractive, the companys acquisition strategy is being met with increased litigation, which is often a distraction for management. Furthermore, a substantial amount of company revenues are generated in Japan, which will likely result in short-term challenges for Volcano as Japan slowly recovers from its horrifying natural disaster. We also added a position in REMX, a Rare Earth Material Exchange Traded Fund (ETF). We introduced the rare earth material investment theme in our Q4 2010 quarterly commentary and elected to pursue that investment using an ETF. The demand for rare earths is on the rise and companies that may participate span both size and the geographic spectrum. The ETF enables us to gain diversified exposure through a 1% position in our equity portfolios.

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

Featured stock

Myriad Genetics
Myriad Genetics (MYGN) is a molecular diagnostics company focused on developing and marketing novel predictive medicine, personalized medicine and prognostic medicine products. In English, this means that the company has or is working on products to predict the likelihood of a person getting a disease, products that help determine how a person will respond to a drug and products that predict how an individual with a particular disease will likely do in the future. The company aims to understand the link between genes and human disease in order to identify important disease-mediating genes, the proteins they produce and the biological pathways in which they are involved. MYGN employs 870 people and is headquartered in Salt Lake City. Revenues for fiscal year 2010 were $363 million. The majority of revenues come from the companys breast cancer analysis (BRACAnalysis) tests. It offers seven other commercial products, including tests for hereditary colorectal and uterine cancer, hereditary melanoma, tests to assess patient response to a particular chemotherapeutic agent, a prognostic medicine product for prostate cancer and an immunochemistry test that looks for loss of a particular gene that suggests a cancer will be more aggressive. Most tests are covered by insurance and range in price from $500 to $3,500. In addition to researching new tests, MYGN is also focused on getting the word out about its current products. The companys goal is to introduce one new test a year and to expand from the United States into Western Europe over the next two years. Its products are covered by numerous patents.
MYRIAD GENETICS OCT 15, 2010 MAR 31, 2010
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www.nelsonroberts.com | 650.322.4000

Firm Updates
::

We are pleased to welcome the clients of Sylvan H. Kline Jr., Inc., who have consented to Nelson Roberts acquisition of the firm. We are also delighted to announce the addition of a new employee, Meg York, who came on board two weeks ago.

Fixed income

Understanding the Municipal Bond Market

The municipal bond (muni) market took a big hit during the first quarter of 2011 as fear of defaults caused many investors to panic and dump holdings of state and local government debt. Meredith Whitney, a research analyst who gained notoriety in the fall of 2008 by warning of Citigroups downfall, predicted in a December 2010 appearance on 60 Minutes that 50 to 100 local and state governments would default on billions of dollars of debt in 2011. Since that interview, record levels of money have exited munis, causing prices to fall and liquidity to dry up. Bid-wanted activity is a measure of the volume of bonds designated for potential sale by investors. It has grown and is now above its 12-momth average. Yet trading volumes have remained relatively low, meaning that there are very few buyers out there, especially for lower quality bonds. As a result, muni yields have risen to levels not seen since the late 1990s. Last fall, prior to Meredith Whitneys interview, Nelson Roberts sold several municipal bonds. We were concerned that liquidity was declining and headline risks were increasing as the 2011 budget discussions heated up. We view the probability of default on the bonds our clients currently own as quite low, since we have adhered to our discipline of buying only high quality issues that are backed by essential service revenues or general obligations. Caution is certainly warranted given the current poor financial health of state and local governments, but the selling frenzy has been overdone. Many state and local governments have problems that will not be solved in the immediate future, but the vast majority will continue to make timely payments on their debt obligations.

How Do Municipal Bonds Trade? The municipal bond market has very little transparency compared to other capital markets. Unlike the stock market, muni bonds do not trade on an exchange, but rather through bond dealers at brokerage firms. The brokers make money by marking bonds up and selling them to investors. The spread between what a broker buys a bond for and what it is sold for is typically not disclosed. The only way to know you are receiving a fair deal is to shop around. We recently put a California Water Revenue bond out for bid to eight different brokers (see table below). The difference between the high and low bids, all of which were due at the same time of day, was over 3.5%. Naive sellers could have given up close to one years worth of interest if they had used only one broker to sell the bond. In order to insure tight spreads and low trading costs, investors must be knowledgeable about the inner workings of the muni bond market and have access to a national network of brokers.

Bids from eight different brokers for the same muni bond:
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1 $100.5 #2 $102.7 #3 $102.0 #4 $99.0 #5 $102.0 #6 $102.2 #7 $101.3 #8 $102.6

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

investment themes

Molecular Diagnostics Holds Huge Promise

Molecular diagnostics is the use of DNA, RNA and proteins to test for specific states of health or disease. Genotypes (someones genetic make-up), mutations (changes in the normal DNA sequence) or biochemical markers can either indicate the presence of a disease or suggest a predisposition to certain medical conditions. Many industry observers suggest that the field can be divided into four main areas: genetic testing, molecular oncology, infectious disease testing and pharmacogenomics (the fancy name for personalized medicine). Genetic testing is done to either look for specific inherited disorders or to look for particular genetic mutations that make it more likely that an individual with that mutation will develop a certain disease. An example of a specific inherited disorder is cystic fibrosis. Over 10 million Americans carry the recessive gene. A child who inherits two copies of the gene, one from each parent, will have the disease. Companies now offer carrier screening to see if someone carries a copy of the gene. Myriad Genetics, our featured stock, offers tests that predict a high likelihood of developing certain hereditary forms of breast cancer, ovarian cancer, colon cancer and malignant melanoma. Molecular oncology applications include screening high-risk populations for cancer, monitoring for cancer recurrence during treatment, and predicting prognosis or responses to certain types of cancer therapy. In infectious disease testing, highly sensitive, rapid assays are used to look for specific infectious agents, especially viruses, by detecting tiny amounts of DNA in blood or tissue samples. There are now tests available for HIV, Hepatitis B and C, and human papilloma virus. Other tests are directed at identifying bacteria. In general, the sooner an infectious disease is diagnosed, the sooner treatment can begin and the more likely it is that a positive outcome will occur. Finally, there is personalized medicine, the holy grail of drug therapy. The concept is simple: predict which patient will respond to which medicine. Much of current therapy is based on trial and error; doctors try different drugs or combinations of drugs until they see which ones work for particular people. Pharmacogenomics will eliminate this inefficient and sometimes dangerous approach to drug therapy by identifying ahead of time who might have negative side effects or benefit the most from a certain medication. This industry is expanding rapidly. Analysts estimate it will grow to $42 billion by 2019. The number of companies has quintupled from 100 to 500 in the last fifteen years.

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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2011 Nelson Roberts Investment Advisors