Throughout the year, the ominous backdrop of mounting government debt continued to worsen. As seen in the chart below, government debt in advanced economies (calculated based on the debt in the U.S., Europe, Japan, and other major economies) now surpasses levels realized after World War II as a percent of Gross Domestic Product. This may be the most significant determinant of economic growth and stock/bond market performance in advanced economies over the coming decade.

History of Advanced and Emerging Market Country Debts 1900 to Present

Sources: Reinhart (2010), Reinhart and Rogoff (2009 and 2011), sources cited therein and the authors.

Risks and Opportunities for both Stocks and Bonds

Investors tend to focus on short term outcomes such as the last or next quarter’s performance. But the size and direction of our government debt requires zooming out to at least a full market cycle to understand the implications and develop a strategy. The simple answer is that government debt at current levels produces significant risks to both stocks AND bonds. The size of market moves, both higher and lower, are likely to be significant.

Over the past year, EU countries have begun to implement austerity measures to reduce debt. Economics shows that, when governments cut back, economies slow. The inevitable outcome may be stock market losses if companies see revenue declines as economies falter.

As economies decline, government revenue that could be used to reduce debt declines too. If debt continues to increase, it ultimately may reach the point where governments are unable to repay, creating a strong incentive for them to print money and create inflation. High inflation, in turn, creates risks for bonds, CDs, and other fixed income assets. During the past three instances of hyper-inflation in the US, bonds have lost 28.3%(3) in inflation adjusted dollars on average.

Finally, if governments are forced to print money to effectively reduce their debt, this can and has in some instances created enormous stock market rallies as inflation pushes up company prices, revenue, and profits. Each of the past 2 inflation episodes in the US created stock market rallies approximating 200%(4). To summarize, historical data point to two outcomes, and one conclusion:

The Toews System and Current Volatility

Over the past year, markets have moved higher and lower on multiple occasions, generating exits and re-entries into stock and bond markets. Also, the amount that the market moved each day (one day volatility), on average, was higher than it has been historically. One day volatility has a direct impact on our system’s primary vulnerability. When we exit, if market moves are significant before we re-enter, the Toews system can underperform or experience losses.

Question: What is the historical outcome for the markets when one day volatility increases as it has over the past year?

Answer: High one day volatility has been a predictor of significant market trends, an environment that our system favors.

Since 1928, when the Dow Jones Industrial Average moved by an average of less than .5% per day over the prior month, the index was 13.5% higher or lower one year later. As one day volatility moved higher, the amount of the evolving trends increased too. When the Dow moved by over 2.5% per day over the past month, it ended 40% higher or lower one year later(5).

Over the past quarter, markets have moved by an average ranging from 1.5% to 2.5% each day. That data predicts a move of roughly 30% one year from now. Considering the global debt backdrop, that could be even higher.

We refer to this as a best/worst type of market for our system. As one day volatility increases, the system becomes more vulnerable to under performance. Typically, these trendless periods last for 12 months before a significant trend evolves. However, the outcome from that same volatility tends to produce big market moves. If the market moves significantly higher, we are in a position to potentially capture those gains. If the market makes a big move lower, we attempt to remain in money markets to avoid losses, and we aim to capture big gains during the market rebound (as we did during 2008/2009). Further, the size of the trends may dwarf any under performance or losses that occur during whipsaw markets.

Despite all of the headlines and volatility, our management team prefers the current environment to lackluster markets that rarely produce significant market moves. The key for investors is to avoid exiting the system before big trends play out (cautionary data point: peak redemptions from our system occurred in late 2007/early 2008).

Conclusion

The path to navigate these markets is straightforward but requires constant execution: 1) Stay committed to equity markets, the best performing asset class that helps protect investors against inflation; and 2) hedge your equity portfolios against losses. Both are pillars on which the Toews system is built.

Disclosure

Prior performance is no guarantee of future results. There can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews’ management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent to you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

(1) US stock returns based on the S&P 500 index
(2) Foreign stock returns based on the DJ Global index (ex US) Bond returns based on the Barcap US Agg Bond Index
(3) Source: Global Financial Data. Based on inflation adjusted returns of the Dow Jones Bond Total Return Index
(4) Source: Global Financial Data. Based on the S&P 500 index.
(5) Source: Global Financial Data. Data based on the Dow Jones Industrial Average – 10/28 to present

News flow moves between extremes from the sometimes positive news about the US economy to the “terrifying” (word choice of Mohamed El-Erian) news out of Europe. These divergent perspectives have peaked advisors’ concerns about both the outcome and volatility associated with this crisis.

At Toews, the concerns expressed by several of our advisors (especially those new to Toews) relate to our how our system will perform given all of the unrest. “We’ve never seen volatility like this,” commented one advisor. And the follow-up, “how can the Toews system function when the markets behave indecisively, and with such big one day moves?” A question that hasn’t been asked, but that is poignant, is “what is the historical outcome when one day volatility increases.”

As scientists of the markets, I thought this would be a good time to share not only our experiences in navigating volatile markets, but a portion of our studies that look all the way back to 1928, providing a thorough historical examination of volatility as it relates to our system.

Let’s start with the first assertion: “We’ve never seen volatility like this!”

Why this is important:
One day volatility has a direct impact on our system’s primary vulnerability. When we exit, if market moves are significant before we re-enter, the Toews system can under perform or have outright losses.

Using Dow Jones Industrial Price data that looks back to October of 1928, the market has moved by an average of .75% per day (monthly average), with a range of .2% to 5.4%. The current monthly average is 1.45%.

As the above graph shows, while daily volatility is elevated, it’s not at unprecedented levels. During our period of management, we’ve seen similar levels of volatility on 11 separate occasions. Each time, news flow and huge market gyrations bring calls to our office like those that we’re receiving now. Our system is modeled to address this volatility. Despite the elevated volatility that we’ve experienced, our system has produced a compelling performance advantage relative to the markets, and has dramatically reduced downside participation during significant downturns.

Now on to the more relevant question: What is the historical outcome for the markets when one day volatility increases?

The answer: High one day volatility is a predictor of significant market trends, an environment that our system favors.
When the market has one day moves averaging between 1.5% and just over 2%, as it has over in the past few months, the index has ended roughly 30% higher or lower one year later.

How this relates to Toews

We refer to this as a best/worst type of market for our system. As one day volatility increases, the system becomes more vulnerable to under performance. However, the outcome from that same volatility tends to produce big market moves. If the market moves significantly higher, we are in a position to potentially capture those gains. If the market makes a big move lower, our relative performance improves, and we aim to capture big gains during the market rebound (as we did during 2008/2009). Further, the size of the trends tends to dwarf any under performance or losses that occur during whipsaw markets.

Despite all of the headlines and volatility, our management team prefers the current environment to lackluster markets that rarely produce significant market moves. The key for advisors is to avoid exiting the system before big trends play out (cautionary data point: peak redemptions from our system occurred in late 2007/early 2008).

Market Environment

The coordinated efforts by central banks to alleviate the EU crisis produced significant gains on Wednesday this week. Yet, even as global equity markets surged, the cost to fund Italian debt remained static. We offer two critically important observations: 1) if larger EU economies (Italy, Spain) become unable to fund their debt, the problem may escalate outside of the capacity of even Germany and France to contain, and; 2) if the situation expands to encompass all of the EU as stated above, we face the prospect of a debt/banking crisis that will surpass the sub-prime crisis in its likely impact on financial assets and the global economy.

This is overtly not a market that will be friendly to modern portfolio theory based portfolios. As we saw in 2008/2009, when the turbulence of crises escalates, correlations across asset classes tighten, and all assets move lower together.

Even fixed income may not be the panacea of safety that it has been over the past 3 decades. As we discussed in our webinar series earlier this year, and as documented in the book This time is different by Rogoff and Reinhardt, sovereign debt crises tend to ultimately produce hyper-inflation. Fixed income tends to be the most vulnerable asset class during these periods.

The path to navigate these markets is straightforward, but requires constant execution: 1) Stay committed to equity markets, the best performing asset class that helps protect investors against inflation; and 2) hedge your equity portfolios against losses. Both are pillars on which the Toews system is built.

Mutual Funds involve risk including possible loss of principal. There are special risks associated with international investing, including currency fluctuation, economic conditions, and different governmental and accounting standards. Emerging markets or equities may involve greater risks than foreign investing due to their smaller size and lesser liquidity. This material is prepared for institutional use only. It may not be reproduced, shown, quoted, or otherwise communicated to members of the public or used in written form as sales literature. Beta measures the risk of an investment relative to a market (the “market” can be defined as an index).

Investors should carefully consider the investment objectives, risks, charges and expenses of the Toews Hedged Mutual Funds. This and other important information about the Fund is contained in the prospectus, which can be obtained by calling 877-863- 9726. The prospectus should be read carefully before investing. The Toews Hedged Mutual Funds are distributed by Northern Lights Distributors, LLC member FINRA.

From its peak this year through September, the S&P 500 declined 17%. In the first days of October, the decline continued, pushing the S&P 500 briefly into bear market territory (defined as a decline of 20% or more). To put this into context, the advance off of the lows in 2009 brought the market 101.6% higher. The market would have to fall an additional 38% before we pierced the lows in 2009.

Investors scrambled to exit stock funds. In excess of $75 billion was withdrawn from stock funds during the past four months according to the Investment Company Institute. By comparison, following Lehman’s bankruptcy, outflows totaled $72.8 billion from October 2008 through February 2009. This could be taken as a contrary indicator, suggesting that we’re at the bottom. However, it may also be an indication of investors’ willingness to abandon stocks during market declines. If the market continues on a volatile path lower, we anticipate a possible “investor revolt” from investors who have grown weary of stock declines over the past 12 years.

What Lies Ahead

Early last week, the Economic Cycle Research Institute (ECRI) notified clients that the U.S. economy “is indeed tipping into a new recession–and there’s nothing that policy makers can do to head it off.” The ECRI has correctly predicted the last three recessions, without any false alarms in between. If, as it appears, we’re reliably headed back into recession, let’s take a look at the implications for the economy and for our investors’ portfolios.

We would point out that recessions are a natural part of economic cycles. Since the beginning of the Great Depression, the country has entered into a recession every 4 and 3/4 years . Assuming that we do enter into another recession, the effect on the economy will be determined by its duration and severity.

The circumstances surrounding the most recent recession stand out relative to other post-war recessions. The sustained increase in unemployment and decrease in housing prices during the past three years far exceeds those of all other post-war recessions. We also have the ominous and growing sovereign debt crisis in the US, Europe, and Japan. These additional factors increase the possibility of additional shocks to the system which could turn a mild recession into a full blown economic fracas. In our opinion, entering into recession increases the chances that stocks will continue to decline. A severe recession practically guarantees it.

The Toews Strategy during Periods of Crisis

Our purely reactive strategy attempts to exit markets during the beginning phase of a decline and thus avoid big drops. We typically don’t avoid all declines and often experience some losses as we exit during the “initial phase of losses” as we have this quarter.

However, when the market experiences big declines, it creates opportunities to buy near market lows and participate in rebounds. As a result, we are capable of producing positive returns even when the market is losing money or moving sideways.

The reason that we have been able to produce positive returns during the secular bear market that began in 2000 is that long-term declines often include not just large drops, but sizable stock market rallies. During the Great Depression, the stock market was in various stages of decline from 1929 through 1942. Despite the decidedly negative bias of the market, there were 7 bull markets with returns producing average gains of 54%, lasting on average 7.5 months .

In summary, we view the risks ahead as an opportunity for profit.

Disclosure

Prior performance is no guarantee of future results. There can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent to you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

Mutual Funds involve risk including possible loss of principal. There are special risks associated with international investing, including currency fluctuation, economic conditions, and different governmental and accounting standards. Emerging markets or equities may involve greater risks than foreign investing due to their smaller size and lesser liquidity. This material is prepared for institutional use only. It may not be reproduced, shown, quoted, or otherwise communicated to members of the public or used in written form as sales literature. Beta measures the risk of an investment relative to a market (the “market” can be defined as an index).

Investors should carefully consider the investment objectives, risks, charges and expenses of the Toews Hedged Mutual Funds. This and other important information about the Fund is contained in the prospectus, which can be obtained by calling 877-863- 9726. The prospectus should be read carefully before investing. The Toews Hedged Mutual Funds are distributed by Northern Lights Distributors, LLC member FINRA.

As we write this letter, the market is continuing the advance that began in the last week of June into the 3rd quarter. As a result, our system began to move back into the markets in the first week of July. Should this market rise prove to be very short lived and markets turn lower over the short term, our system is poised to exit once again to cash.

The Risks from External Factors Remain High

Although the turnaround for stocks in the past few weeks has been robust, the risks to the market from factors external to the stock market remain high. The decline that began in the fall of 2007 that wiped out half of stock market valuations over the following 18 months started as a result of hyper-inflated home prices. Yet coming into the fall of 2007, corporate profits and growth were showing few signs of weakening. When home prices fell, it set off a chain reaction. Under-collateralized mortgages threatened to bankrupt banks. Banks and other financial institutions which had exposure to derivatives that insured against losses in debt instruments saw huge liabilities emerge on their balance sheets. The banking crisis quickly fed into the real economy and depressed corporate revenue markedly.

Much of the coverage during the decline last quarter focused on the possible default on debt by Greece. So, at a time when corporate profits are growing and the U.S. economy continues to recover, why does Greece matter? It matters for precisely the same reason that defaults on mortgages mattered during the previous crisis. Should Greece default on its debt obligations, it would potentially set off a chain reaction of instability throughout the financial sector. Banks (primarily in France and Germany) would be weakened. The destabilization could push other already weak Euro zone countries and organizations into default, which would accelerate debt exposure globally throughout the banking system.

All of this is occurring at a time when many developed economies are struggling to recover from the recent downturn and when many stock investors are unwilling to tolerate significant losses. In our view, the primary threat from the sovereign debt situation is that it will create a crisis of confidence similar to what we saw during the mortgage driven crisis. Should this play out, it could present considerable risks to the stock market.

Choosing Safety over Speed

In our year-end commentary we made the analogy between investments and airline manufacturers. One airline manufacturer, we posited, produces planes designed to fly at 500 miles per hour but are built to endure all levels of turbulence. Another produces planes designed to fly at 600 miles per hour but are only built to fly safely at low levels of turbulence. At high levels of turbulence these planes are vulnerable to…break up.

At Toews, we designed our system to attempt to avoid “breaking-up.” Based on a rigorous study, our system attempts to exit markets in the early stage of declines, before major losses are realized. We believe that this provides our investors a competitive advantage. It allows investors to commit to the stock market, even at a time of elevated risk. However, it also means that there will be many times when we’ll advance slower than the stock market. When risk events happen, at least as far as your investment portfolio is concerned, remain calm. We’ve got it covered.

Disclosure
Prior performance is no guarantee of future results and there can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

As of the end of March, just 2 years after the market bottom, the S&P has now increased 90.5%. Consequently, investors have become increasingly comfortable adding to stock funds during the first quarter of this year. After pulling assets from stock funds during the majority of 2010, investors added a net $10.7 billion to stock funds in the first quarter through March 23*.

* Data from the Investment Company Institute through March 23

After significant advances in the stock market, investors become desensitized to the need for risk management and are vulnerable to what behavioral economists call the law of small numbers. The law of small numbers refers to an inclination for investors to draw conclusions based on small amounts of data and then erroneously extrapolate those conclusions to assume that they generally or always occur the same way. After big advances, investors conclude that “the stock market generally, or always, moves higher.” However, if we’ve already eclipsed the average gain, it may mean that the gains ahead are limited. So instead of beginning to increase risk in portfolios, we are recommending that investors be particularly vigilant and to make sure that their portfolios have adequate loss avoidance strategies in place.

Markets Move Lower, Recover Quickly

In March we saw a number of global crises that had the potential to put an end to the market rise (see above). Japan suffered, and continues to reel from, a devastating earthquake and tsunami. Rebellions peaked in the Middle East and North Africa, and the European Debt Crisis found its place back on the front page (when other crises were less poignant). As a result, markets took a hit in March. Our system reacted to the price declines and completed exiting US and Developed International Stocks on March the 17th and 18th.

By the time we exited, markets were already beginning to recover. After slightly more than a week we began re-entering markets. By April 1, we had completed re-purchasing stocks and are once again fully invested. Most short term moves like this fall into the “false alarm” category. Had the multiple crises turned into a significant decline, we were poised to robustly avoid losses across our portfolios.

The Need to Lower the Risk of Stock Investing is Constant and Imperative

At 2:45 on March 11, it was a sunny, normal day on the Northeast coast of Japan. One minute later, a 9.0 magnitude earthquake shook the region. In a matter of minutes, a 37 meter tsunami tore into the coast, together producing over 27,000 casualties and destroying over 125,000 buildings. It’s shocking how quickly things can go from normal to complete disarray.

Like nature, the economy is vulnerable to exogenous shocks, which can be sudden, relentless, and unpredictable. Analysts often talk about the stock market as being “fairly valued.” “Fair value” means that the prices of stocks are appropriate based on the prices of other asset classes, interest rates, and projections of growth, and conveys a sense that stock market risk is low. Yet, the way we price stocks subjects them to potentially huge price swings even from their “fair values.”

Only about 1/3 of the value of stocks is comprised of tangible assets that can be sold. The remaining 2/3 of stocks’ value is primarily determined from projections of companies’ earnings growth. Translation: a majority of the value in your stock market portfolio is derived from predictions of earnings growth. Shocks to the economy that affect earnings growth trajectories can have a dramatic effect on the value of stocks. For example, if long term U.S. GDP growth projections were reduced from 3% to 0% due to a shock to the system, this might justify as much as a 50% reduction in stock prices.

At Toews, we designed our system based on a rigorous study of stock market declines. Our system is designed to attempt to exit markets in the early stage of declines, before major losses are realized. We believe that this provides our investors a competitive advantage. It allows investors to commit to the stock market. However, it addresses the fact that a calm, normal market can change for the worse very quickly. When risk events happen, at least as far as your investment portfolio is concerned, remain calm. Very likely, we’ve got it covered.

Disclosure
Prior performance is no guarantee of future results and there can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

The mid-year decline that began in April and bottomed with a decline of 16% in early July proved to be a deterrent to equity investors. For the year through December 21st, a net $81 billion flowed out of equity mutual funds*, making this the third consecutive year of net outflows from stock mutual funds. Despite a cumulative gain of 86% in the S&P off of the bottom in 2009, retail investors are not yet convinced that it’s safe to own stocks. As a contrary indicator, this may be a positive sign for stocks moving into 2011. At the very least, outflows from retail funds show that we’re not approaching a euphoric top in the market.

Strong Trends Create Opportunities for Profit

With the gains in 2010, this has now become a sizable move off of the market bottom that we saw in 2009. Our system prefers strong trends over indecisive markets. As markets rise and become over-extended, we aim to capture the over-shoot and lock in those gains for our investors.

Since we’ve been managing portfolios, we’ve experienced two prior stock advances (see below).In each prior instance, the case could be made that the market was over-extended from the perspective of both corporate earnings and historical averages. Currently, however, the market is priced at 13.1 times estimated 2011 earnings, which puts it several percentage points below historical averages. Solely from that perspective, the market may continue to advance into 2011.

However, the latent effects of “the great recession” along with several underlying macroeconomic factors, could easily derail the rally. From our perspective, a primary risk factor is that the government (and the Fed) may be out of ammunition. Any number of events could trip up this economic advance, including the fear of sovereign debt defaults abroad or a continuation of the decline in housing prices. Typically the government is able to deploy fiscal or monetary stimulus to help assuage economic down turns. Yet, monetary stimulus is already fully deployed with interest rates near 0% and the Fed making unprecedented purchases of treasuries.

Our federal debt level as a percent of GDP is higher than at any point since the Great Depression, and is believed by many to be near the tipping point. Should the US Government attempt to deploy additional fiscal measures, such as additional state or local government aid or aggressive tax cuts, we risk our own sovereign debt crisis. To frame the situation in the simplest possible language, the enemy is any event (housing prices, bank failures, etc.) that will cause a downturn in GDP growth. If GDP growth remains strong, unemployment improves, and housing prices stabilize; we may see this rally continue for several more years. However, if GDP growth falters for any of the reasons stated above, it’s likely to set in motion a feed back loop that could prove disastrous for financial markets. Our government will have little capability to intervene. The crucial question is: will the enemy advance?

The Benchmark Paradox

A milestone of success in any industry is the ability to objectively measure the value of contributions made by its companies. In the field of investing, we assess the value added by managers in two ways: How a manager does relative to broad benchmarks such as the S&P 500; and how a manager does relative to his peer managers. Our assessment of these performance measures is that, while they are essential at ranking performers, they grossly underserve investors. The reason? The benchmarks that we measure the performance of managers against correlate poorly with what investors are trying to achieve.

To illustrate, imagine two airplane manufacturers. One produces planes designed to fly at 500 miles per hour, but are built to endure all levels of turbulence. Another produces planes designed to fly at 600 miles per hour, but are only built to fly safely at low levels of turbulence. At high levels of turbulence these planes are vulnerable to…break up. Now, what’s your perspective about a service that rates airlines exclusively on the basis of their speed of travel between cities, and doesn’t say anything about the fact that faster planes may break up if air conditions are poor? Welcome to the world of investment performance measurement.

The self regulatory organizations that oversee the investment industry demand that investment advisors compare their performance against market benchmarks. These market benchmarks measure how well the market does as a whole, but they do nothing to tell us about the risk of loss. For advisors whose objective IS to out-perform benchmarks, there may be some value in making the comparison. However, for firms like ours, these benchmarks can represent a constant temptation for investors to leave risk managed products and jump into products that are unsuitable based on their risk profile.

As a result of this disconnect, this quarter we’ll begin including “chance of loss” metrics with our published performance reports. Initially we’ll include two measures. First, we’ll show how many times our portfolios and their benchmarks have lost more than 50% (the equivalent of a plane breaking up in mid-air) since their inception. Second, we’ll show the chance of loss of 20% or greater within any one year for portfolios and their benchmarks. Our flagship Aggressive Growth Portfolio, as an example, has never experienced a loss of 50% or greater during its 15 year history. Its benchmark, however, has lost 50% on two separate occasions: during the 2000-2002 period and from the peak in 2007 to the market bottom in 2009. Similarly, our Aggressive Growth Portfolio has never had a loss of 20% within any one year period. Its benchmark, however, has lost 20% or more during 6 out of 15 years, giving it a 40% chance historically of experiencing a 20% loss in any one year.

We’re constantly attempting to find new ways to build products around our investors’ needs. By including these new risk measures, we hope to help investors better assess our ability to achieve that goal.

Disclosure
Prior performance is no guarantee of future results and there can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

Looking at the Year Ahead

In our last commentary we looked at two divergent outcomes from the second quarter decline: 1) that the decline would be a short-lived pause in a rising market; or 2) that the decline was the beginning of a larger term market drop.

Evidence suggests that the first scenario is being realized, as stock prices continue to move higher coming into the 4th Quarter. A continued rally would have positive effects on our investors’ portfolios. It could also spill over into consumer confidence and the real economy; reducing the possibility of a second recession.

If this were a normal stock market decline absent peripheral factors, there would be a strong case for a continuation of the stock market recovery. This, however, is not a normal stock market decline. Unemployment and declining housing prices are at levels not seen since the Great Depression and far exceed those of any other post-war recession. As a percentage of GDP, our current federal debt level is higher than it was 3 years into the Great Depression. If the US economy is unable to enter a sustained period of GDP growth, this will ultimately undermine any stock market recovery.

It is possible, then, that both scenarios will be realized. We may have a significant stock market rally that is followed by further declines. While extended bear markets have a downward bias, they are often comprised of market rallies among significant declines.

In our last commentary letter, we highlighted the stock market rallies during the Great Depression. We’ve added to that chart the stock market drops during the Great Depression (see below).† If we remain in a cyclical bear market it will be important to understand that short term moves higher may not be an “all clear” sign that the markets are in for an extended recovery.

As we’ve stated before in this commentary, declining markets can potentially produce profits for our investors. First, by remaining in money market funds during the duration of the decline, we help avoid losses. Second, declining markets can increase our investors’ chances for gains.

As the stock market moves lower, our target point for buying back into stocks moves lower too. That means that as the market moves down we have the opportunity to buy back into stocks at bargain prices, potentially setting the stage for fresh gains.

Disclosure
Prior performance is no guarantee of future results and there can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

Despite signs of economic expansion, as we entered the second quarter of this year, the market turned down in the latter part of April. From the high on April 23 through the end of the quarter, the S&P 500 has lost just over 15%. The Toews system exited stocks early in May. At the end of the quarter, 100% of our US and Developed International Stock positions were held in money market instruments. We remained fully invested in high yield and high quality bonds.

How to View the Recent Downturn

There are two competing views on this downturn. One view is that this is simply a routine stock market correction. Significant stock rebounds virtually always have corrections along the way. These are defined as stock market losses of more than 10% but less than 20%, and are short lived pauses in an otherwise healthy and rising stock market.

A second perspective suggests that this is not a normal recovery. Instead of this being a correction, this view argues that significant public and private global debt issues create a high probability of entering into a second US recession, often referred to as a double dip recession. The most negative among strategists with this view suggest that this stock market decline is only the beginning of a decline that could re-test or pierce the lows seen in March of 2009. The implications of these two divergent outcomes are so profound for individual investors that we’ll look at the risks of either scenario occurring. We’ll also consider how our system might react should either occur.

Risk to Investors of a Correction – Missing a Stock Market Rebound

Before discussing the risk of a double dip recession, it is worth mentioning the risk to investors presented by the first scenario: the risk of a correction. Fear reigns during corrections, especially those following declines as significant as the drop in 2008. Investors, freshly back from the brink of big losses, are unwilling to tolerate a repeat. As a result, investors tend to exit stocks quickly and decisively when the market turns lower. Data confirms that in May of 2010, only one month following the beginning of this decline, almost $15 billion left US Stock Funds, the largest outflow since the market bottom in March of 2009 . Once investors exit stocks, some time can elapse before they re-enter. After record redemptions during ‘08/’09, investors added a meager 7.8 billion dollars in the 6 months following the 2009 market bottom. In other words, investors who left the stock market may have missed the subsequent rebound. Based on historical data, we simply can’t rule out the strong possibility that this is only a correction and that stocks will rebound from these levels. In fact, if the economy continues to grow this year and companies follow through with expected earnings, a strong case can be made that the stock market will see considerable advances from here.

The Risk of a Double Dip Recession

A growing chorus of respected strategists is sending warning signals about the possibility of a second recession. One exceptional study on the history of banking crises is outlined in the book This Time is Different by Carmen Reinhart and Kenneth Rogoff. Their vast study of global banking crises revealed that home prices declined for an average of 6 years and unemployment rose for almost 5 years after crises similar to the global banking crisis in 2008. Should this time prove not to be different, these statistics project anything but an economic recovery over the coming years. Such data takes the focus off of the immediate outcome of this stock market decline and zooms out to what may be a very challenging period of up to 5 years or more. The implications for the stock market would be dire and would make projections of a return to the stock market lows of March 2009 not only feasible, but likely.

The Toews Strategy during Crisis Environments

Our purely reactive strategy attempts to exit markets during the beginning phase of a decline and thus avoid big drops. When the market experiences big declines, it creates opportunities to buy near market lows and participate in rebounds. As a result, we are capable of producing positive returns even when the market is losing money or moving sideways. Our flagship Growth and Aggressive Growth portfolios produced returns net of all fees of roughly 50% since 2000, a period when the S&P 500 was flat.

The reason that we have been able to produce positive returns during this secular bear market is that long term declines often include not just large drops, but sizable stock market rallies. During the Great Depression, the stock market was in various stages of decline from 1929 through 1942. Despite the decidedly negative bias of the market, there were 7 bull markets with returns of roughly 20% or greater. These rallies produced average gains of 54% and lasted 7.5 months on average .

Cumulatively, these rallies produced total returns of 376%. We view these gains as money making opportunities no different from those that occur during long term bull markets.

Regardless of the outcome of this current decline, we strongly recommend that investors incorporate risk management tools into their portfolios. If the market continues to decline, remember that we built our system to specifically address declining markets.

Disclosure
Prior performance is no guarantee of future results and there can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

The chart below shows the returns for the IRMS Aggressive Growth portfolio to illustrate the effect of our management over the past two years. This portfolio is 100% equity. Other portfolios that are less aggressive may have had returns which are lower due to a higher bond allocation and other factors (please refer to your attached statement).

Results above show performance for the Toews IRMS Aggressive Growth Portfolio to illustrate the effect of Toews management on US and Intl. Stocks. Performance of individual accounts will vary based on your investment risk profile and your specific investment funds. For your individual account performance, please refer to your statement included with this commentary.

Can the Stock Market Continue its Rise in 2010?

Pundits have disparate projections for the stock market in 2010. A survey of 12 investment strategists in Barron’s predicted on average that the stock market would increase by 12% in 2010. However, prominent investor and PIMCO CEO Mohamed El-Erian warns that stocks are on a “sugar high,” and that weakened US consumers may lead to a decline in economic growth and the US stock market.

Our system is “market agnostic,” which means that we don’t make calls about market direction. If themarket continues to move higher, our system is designed to remain invested in stocks. However, our target exit level for US and International stocks has adjusted up to within several percentage points of current market prices. That means that the risk of loss in our portfolios is relatively smaller than it was earlier in 2009 in the nascent stages of this market rise.

Having a target sell level that attempts to limit losses provides us a competitive advantage over other
investment strategies. If the stock market continues to advance, we’ll continue to participate even if that rise isn’t justified by market fundamentals. Sugar high or not, we’ll gladly take what market gains we can get.

With regard only to the performance of our investors ’ portfolios (and apart from the considerable global implications of significant market losses), we “don’t care” if the markets move higher or lower. As we’ve just seen over the past two years, significant losses produced an opportunity for gains during the recent stock market rebound. If investors’ worst fears are realized and the stock market begins to sink once again, we hope to be in a position to produce additional gains in the subsequent market rebound.

Winning by Not Losing

We have two objectives with our management strategy*:

1. Provide above inflation returns for our investors
2. Attempt to limit losses

Avoiding big losses profoundly affects investor’s portfolios and their lives. Avoiding a majority of the
losses last year has allowed many of our investors to continue with their savings and retirement plans intact. Incorporating a loss avoidance strategy also provides investors with the confidence that they need to stick to their investment strategy despite the many challenges confronting our economy. We hope that you find some peace of mind knowing that our investment strategy is actively attempting to avoid losses in order to further your goals.

Disclosure
Prior performance is no guarantee of future results and there can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.

• · Emerging markets (EM) possess a high rate of growth of GDP relative to developed countries
• · Emerging markets are expected to be an increasing percentage of global GDP Emerging markets return on equity is attractive
• · Due to future age & wealth demographics, developed markets may be unable to provide equity rates of return US investors have come to expect

Yet despite the many reasons for investing in emerging markets, our research has shown that emerging markets exhibit higher volatility than their developed country counterparts and have increased losses during crisis markets. This trend has continued during the past two years. During 2008, emerging markets lost 53.3% compared with a loss of 43.4% in the MSCI EAFE index*. As of December 31, 2009, emerging markets had gained 74.5% during 2009 relative to a gain of 27.75% in developed countries.

As a consequence of increased emerging markets volatility, as well as a high correlation with developed country markets, the addition of emerging markets to portfolios predictably increases volatility. The characteristics of high volatility, coupled with the possibility of high returns, make EM ideal for risk amelioration strategies. The objective of our emerging markets strategy is to provide investors access to emerging markets while reducing the risk of significant loss. By doing so, we allow investors access to this potentially lucrative market while attempting not to increase overall portfolio risk.

Our Strategy and Fund Performance

Our dynamic hedging system enters and exits markets based entirely on asset class price movements. When prices are rising, the system is fully invested in equities and we attempt to replicate the MSCI Emerging Markets Index. At every point during a rising market our system maintains an exit point at some percent below the market at which we will exit. As prices rise, the exit level “rolls up” at a rate that correlates roughly to the rate of increase of index prices.

From the Fund launch on May 15, 2009 through early November 2009, the parameters for a sale out of the index were never met. Our Fund remained fully invested for this period. In early November of 2009 we reduced our exposure to the index slightly only to restore it to 100% a few market days later. We remained long until late January when we reduced our exposure to MSCI Emerging Markets index to 0%. In early March of 2010, we restored our participation in the index to 100% and remained long for the rest of the period covered in this letter (April 30th).

Several factors have affected Fund performance relative to the MSCI Emerging Markets Index. The Fund underperformed the index during the first day after the launch as it was scaling up to be fully invested in the index. Also, the Fund attempts to participate in index performance by employing an index replication strategy. Index participation may vary from the index due to a difference in the performance of these instruments relative to the underlying index. Obviously, our performance will differ significantly when we reduce our exposure based on our risk management strategy.

Our Outlook

Since market bottom of October of 2008 through the end of April 2010, the MSCI Emerging Markets index** increased nearly 125%. In our experience, big market gains increase the possibility that the market will fall and vice versa. However, there are also instances when markets have continued to advance for long periods after significant increases. Our system affords us the ability to stay committed to emerging markets as long as they are rising and to exit once they turn lower and meet our parameters for a sale.

Disclosure
Prior performance is no guarantee of future results and there can be no assurance, and individuals should not assume, that future performance of any of the portfolios referenced will be comparable to past performance.

There can be no assurance that Toews will achieve its performance objectives.

This document refers to the performance of the majority of Toews portfolios to illustrate the effect of Toews management on US and intl. stocks and high yield bonds. Performance of individual accounts varied based on the client’s investment risk profile and their specific investment funds. For your individual account performance, please refer to the enclosed quarterly statement or the quarterly statement recently sent you. In addition, not all model portfolios were referenced in this letter. It is not, nor is it intended to be, a comprehensive accounting of Toews asset management. There are other portfolios that Toews manages that performed differently than what is referenced in this letter.