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Rapidan Capital, LLCRegistered Investment Advisor510 Thornall StreetEdison, NJ 08837732.632.8854
S
ECOND
Q
UARTER
2009
 
I
NVESTOR
L
ETTER
 
 August 2009
No man's life, liberty, or property is safe while Congress is in session.
-frequently attributed to Mark Twain or, more occasionally, Will Rogers
Dear Investor and Friends,The second quarter began with stocks rising. Stocks, corporate bonds and commodities allrebounded from what we think will be “generational” March lows. We probably won’t see thoseprices again in our lifetime.But the run stalled in late May. The markets fell a bit from their highs in June. It’s one thing torebound from a generational low, it’s quite another to make up all the lost ground. The asymmetryof returns guarantees that when you go down-50%, you must go up+100%to get even. We are still in the process of restoring our wealth, but we are on the right path. Had we panicked out at thebottom, I have no doubt that many of us would be sitting here wondering
if 
it was the
right
time toget back in. The market is up around+50%from its bottom.The long-term growth oriented
Value Aligned
®
Folio account was up +14.2%gross (+13.9%net) in the separately managed accounts.
1
For the year as of June 30, 2009, the
Value Aligned
®
Folio accountsare up+5.2%gross (+4.7%net). We are doing well because we have tweaked our investment process; we are taking profits soonerand adjusting position sizes to volatility – that way more volatile stocks will not hurt intermediateperformance on the downside, but will still contribute to our goal of doubling our money(+100%)infive years on the upside.Leading indicators of future economic prospects drove the stock market off its March lows. Leadingindicators have continued to move higher over the past few months. Just as the rapid and suddendecline in leading indicators and economic prospects tanked stocks last year, this year'simprovement is driving them higher. So far in 2009, early expansion factors have dominatedreturns. Technology, materials and consumer discretionary stocks far outpaced the other sectors.We recovered most of the losses from some of our smaller consumer discretionary stocks from thefirst quarter of 2009, and many of the losses from 2008. As we discussed with you last quarter, webelieved that our losses in our small special situation stocks like AC Moore (ACMR,+161%,sinceMarch 9
th
low through June 30
th
), Borders (BGP,+667%), and Tempur-Pedic (TPX,+232%) were unwarranted by their fundamentals. Many of these stocks traded way below fair value because of low liquidity and investors’ fear of leverage. Since we judged that these companies would survive therecession, their shares were too cheap to sell. Sure enough as financial conditions returned to pre-Lehman bankruptcy levels the stocks rebounded. BGP is up+892%year-to-date; ACMR is up+158%; TPX is up+109%;Coach (COH) is up+42.5%;Fossil (FOSL) is up+58%(as of July 31st).
 
 2
The stress tests for the banks are now over, and private, as opposed to government capital, isavailable for some of the largest banks. As private capital went into banks, we saw a little pause inthe rally through quarter end. Of course, the market continues to power ahead through thebeginning of August. Until we have other reasons to doubt the rally we will remain invested – butwith some dry powder to take advantage of lower prices when they come. At the end of July we wereabout 85% invested in stocks of 
Value Aligned
®
companies and 15% in cash. We were overweightconsumer discretionary, technology and healthcare stocks.
S
TOCK
M
 ARKET
 –
 
F
ROM
F
EAR TO
P
 ANIC AND
B
 ACK
 
The “swing” chart (above) of the bear market starts at the high in October 2007. The “panic” stage of this decline started in September of last year when Lehman Brothers failed.Notice the latest rally from the March bear market bottom of +41.1%on the chart at above - that’sthe biggest rally so far in the bear market. But despite the rally, we are still down-39.0%from thetop in 2007.
1
 
 From Fear to Panic
The severe financial panic that came from the extreme uncertainty of outcomes from the LehmanBrothers bankruptcy and AIG rescue froze economic activity and caused one of the fastest andsteepest stock market declines in history. Financial conditions are back to normal recession levels – the conditions that existed prior to the September panic.The market downturn is now in its 19
th
month which makes it the longest bear market and recessionsince World War II. The drivers of the first part of the bear market were the downturn in residentialconstruction, housing price declines and declines in personal and business consumption. That wasreflected in the first nine months from October 2007 where the stock market declined by about-22%.
1
 
Through 8/13/2009 the S&P 500 index without dividends reinvested was up +49.7%.
 
 3
The driver of the second phase was the September 2008 Lehman Brothers bankruptcy which causeda run on the nation’s banking system and on its money market funds that provided liquidity tobusinesses of all sizes. Credit seized up and economic activity halted. Confidence has returned astrust at least among our financial institutions is slowly returning. The public’s trust is anotherstory. That might take decades to repair.True financial panic as reflected in stock market volatility has only occurred three times in the lastcentury – 1929, 1987 and 2008. Here I am referring to a financial condition that produces intensefear where trust is driven from the system as participants - businesses, individuals and the banksthemselves - don’t understand who is solvent and who is busted.
 Panic Back to Fear 
Keith Hays of Hays Advisory shows the difference between panic and fear. He points out that
 fear
isa necessary condition for an extended bull market to begin. However,
 panic
erodes trust so muchthat normal bear market bottoms can’t form andwholesale liquidation of stocks and every otherasset starts a cascade price declines – severelyand suddenly exterminating the balance sheets of shaky companies and scared consumers.Normal fear is depicted between the two red linesin the chart above. These tops in volatility – ameasure of the degree of uncertainty in stockprices – correspond to
normal
bear marketbottoms. You can see from the chart at the leftthat sometime in the last three months panic hasreceded and normal fear is back.
 We love normal fear.
Many times normal fear is just a misunderstanding about the transitionfrom a terrible economy to a recovering economy. Fear is paralyzing for those without facts andmethods to make rational decisions. And fear is the essential ingredient for a new bull market tobegin. A huge market rally off an economic low point is always perceived as
 just
another bear marketbounce. The gains are dismissed because the stock market always sniffs out pending economicimprovement faster than improving fundamentals appear – and the fear from the previous panicprevents rational action by most investors.
CBOE SPX Volatility Index
Oct. 1995 - Aug. 2009
08/17/07, 29.9902/16/07, 10.0209/11/98, 43.7409/21/01, 42.6610/24/08, 79.13
0102030405060708090
     O    c     t   -     9     5     A    p    r   -     9     6     O    c     t   -     9     6     A    p    r   -     9     7     O    c     t   -     9     7     A    p    r   -     9     8     O    c     t   -     9     8     A    p    r   -     9     9     O    c     t   -     9     9     A    p    r   -     0     0     O    c     t   -     0     0     A    p    r   -     0     1     O    c     t   -     0     1     A    p    r   -     0     2     O    c     t   -     0     2     A    p    r   -     0     3     O    c     t   -     0     3     A    p    r   -     0     4     O    c     t   -     0     4     A    p    r   -     0     5     O    c     t   -     0     5     A    p    r   -     0     6     O    c     t   -     0     6     A    p    r   -     0     7     O    c     t   -     0     7     A    p    r   -     0     8     O    c     t   -     0     8     A    p    r   -     0     9
23.09
Source: Bloomberg
CBOE SPX Volatility Index
Oct. 1995 - Aug. 2009
08/17/07, 29.9902/16/07, 10.0209/11/98, 43.7409/21/01, 42.6610/24/08, 79.13
 
0102030405060708090
     O    c     t   -     9     5     A    p    r   -     9     6     O    c     t   -     9     6     A    p    r   -     9     7     O    c     t   -     9     7     A    p    r   -     9     8     O    c     t   -     9     8     A    p    r   -     9     9     O    c     t   -     9     9     A    p    r   -     0     0     O    c     t   -     0     0     A    p    r   -     0     1     O    c     t   -     0     1     A    p    r   -     0     2     O    c     t   -     0     2     A    p    r   -     0     3     O    c     t   -     0     3     A    p    r   -     0     4     O    c     t   -     0     4     A    p    r   -     0     5     O    c     t   -     0     5     A    p    r   -     0     6     O    c     t   -     0     6     A    p    r   -     0     7     O    c     t   -     0     7     A    p    r   -     0     8     O    c     t   -     0     8     A    p    r   -     0     9
23.09
CBOE SPX Volatility Index
Oct. 1995 - Aug. 2009
08/17/07, 29.9902/16/07, 10.0209/11/98, 43.7409/21/01, 42.6610/24/08, 79.13
 
0102030405060708090
     O    c     t   -     9     5     A    p    r   -     9     6     O    c     t   -     9     6     A    p    r   -     9     7     O    c     t   -     9     7     A    p    r   -     9     8     O    c     t   -     9     8     A    p    r   -     9     9     O    c     t   -     9     9     A    p    r   -     0     0     O    c     t   -     0     0     A    p    r   -     0     1     O    c     t   -     0     1     A    p    r   -     0     2     O    c     t   -     0     2     A    p    r   -     0     3     O    c     t   -     0     3     A    p    r   -     0     4     O    c     t   -     0     4     A    p    r   -     0     5     O    c     t   -     0     5     A    p    r   -     0     6     O    c     t   -     0     6     A    p    r   -     0     7     O    c     t   -     0     7     A    p    r   -     0     8     O    c     t   -     0     8     A    p    r   -     0     9
23.09
Source: Bloomberg
Figure 1. Source: HaysAdvisory.com
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