THE MKC GLOBAL REPORT

MANAGER’S COMMENTARY
August 2010

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and
dance. We’re still dancing." – Chuck Prince, July 2007

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Although we have chosen over 80 markets worldwide for potential trade, the MKC Global Fund will typically allocate to only a
handful of markets with the most short-term potential. A snapshot of our portfolio as of early September includes: government bonds,
corn, cotton, sugar, natural gas, live cattle, the Japanese yen, and various stock indices. With a well-managed portfolio like ours, it is
easy to see how investing in a commodity fund genuinely diversifies the typical investor’s portfolio. An investment in cattle and
cotton futures correlates very little with shares of General Electric and McDonalds, creating true opportunity.

Aside from government bonds, few recent opportunities have emerged in large global markets. The smaller markets like wheat, sugar,
cotton and cattle have been the playground of choice for traders. This seems to be a function of the gradual transition out of large risk
markets like stocks, energy and foreign exchange. Our thesis continues to be that on balance, global markets face a deflationary
environment and that equities are in the middle of a prolonged bear market in real terms. Although this downward trend seems to be
fast approaching, most stock markets may not be ready to resume their declines quite yet and several months of choppy market
conditions could continue.

How Will You Retire?

The United States hosted two of the greatest bull markets in history. An allocation to stocks returned an investment 13 times between
1980 and 2000 and 10 times between 1942 and 1965. The decades of opportunity in this country have been consistently profitable for
many investors. Unfortunately, the stronger the trend, the more it breeds complacency among its participants. Nowhere is this more
evident than with stock market investors in the United States. Retail investors witnessed decades when a buy-and-hold strategy proved
prudent; there were uncomfortable periods, but on balance it worked well. From our view, there is a high chance that the total real
return for U.S. stocks will be negative to zero through 2020 or 2030. This type of statement may sound extreme, but history and
financial data show it to be a probable outcome. The average secular bear market takes about 20 years to play out, and deflationary
depressions take longer still. No stock market has ever corrected for only 10 years after a historic bull market (like the one that ended
in 2000) and immediately returned to advance to new highs in real terms. Financial markets are incredibly efficient at punishing those
who think “this time is different.”

The point when we again begin to see long-term inflation adjusted gains from current stock prices may easily be after your lifetime.
How will you retire in that environment? If you are currently retired, how will you maintain your lifestyle and how will you pass on a
meaningful level of assets to your children and grandchildren? They will surely need that capital after enduring the same extended
period devoid of any investment opportunities.

The “solutions” to avoid are the answers to financial security used over the last 30 years. They worked beautifully in a historic bull
market, but are not applicable now. Allocating to index funds, dollar cost averaging into large caps or placing blind faith in the typical
financial advisor will only disappoint you. While maintaining a thorough choke-hold on risk, you must make the decisions that your
friends and colleagues won’t; enjoy the closest thing to a risk-free rate of return in the U.S. Treasuries (for at least a while longer),
avoid stocks until the opportunity for a short-term bull market stares you directly in the face, and allocate to actively managed funds.
The hedge fund world has many exceptional managers that will create if not find opportunity in the years ahead.

Market Environment

Richard Russell, author of the Dow Theory Letters, described the market’s May selloff and subsequent decline perfectly. When asked
what caused the day’s action, he responded “more sellers than buyers.” His comment was succinct and accurate. We’re in a bear
market, so the long-term trend is down. In short, our analysis indicates a resumption of a prolonged bear market in the near future. The
wildcard to this analysis is any government intervention. Will there be any stimulus/intervention? What will it look like? How will it

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impact markets, if at all? Most people realize the poor shape of our economy: there are few upside economic drivers. With that being
the case, some lesser known points will be discussed in detail below:

Compared to historic cyclical bull markets, this one falls among the most extended in magnitude and duration. Like all
others, this one will end at some point.

Mutual fund cash levels hit a historic low; this single-handedly is a powerful indicator.

In healthy bull markets, small cap or tech stocks tend to advance the most. Currently the Russell 2000 and the Nasdaq trail
the blue chip behemoth; the Dow Jones Industrial Average.

In our April commentary, we addressed the average magnitude and duration of cyclical bull markets within secular bear markets.
Revisiting that data from the Dow Jones Industrial Average and Japan’s Nikkei 225, the current rally now stands in roughly the 83rd
percentile in terms of duration of all cyclical bull markets within a secular bear and in the 81st percentile in terms of magnitude. Who
wants to start dollar cost averaging now?

Particularly interesting is that of the five past market periods that exceeded our current rally, all originated in economic environments
with macro drivers propelling stock prices higher. Three began from the lows during the Great Depression; the lows in 1932 and 1938
were truly the low base and low valuation from which new bull markets begin. The fourth and fifth markets were ignited by low rates
and a housing boom from 2003 into the 2007 peak. It is a small sample size of data, but of the 24 cyclical bulls examined, only five
exceeded the current rally. The present environment has no macro fundamental drivers that resemble those during the previous five
examples.

In addition, recent data shows mutual fund cash levels stand at approximately 3.6%, the lowest reading on record. This piece of data
alone is a powerful contrary indicator when readings move to extreme levels (below 5% or over 10% cash). Mutual funds across the
board are fully invested; they are one of the largest participants in the stock market and have virtually no more buying power. Data for
pension funds is sparse, but chances are they maintain similar cash levels. Don’t mistake this as a bullish indication, by definition the
masses must be wrong at major market turns, this absolutely includes managers of mutual funds and pension funds. (Since markets
are comprised of individual participants, everyone cannot be out of a market before it tops or fully invested before it begins to
rise).With their minuscule cash levels, these managers have only two moves. The first is to make zero transactions and provide the
broad market with no upside thrust. This means, barring other outside influences, the stock market stalls at best. The second option is
to begin selling their $30+ trillion under management (roughly $10+ trillion for mutual funds and $20+ trillion for pension funds),
with the obvious outcome of downward selling pressure on stock prices.

Comparison between the S&P 500 (top) and mutual fund cash levels (bottom), courtesy of SentimenTrader.com

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Lastly, among the S&P 500, Dow Jones Industrial Average, Russell 2000 and Nasdaq, the Dow Jones is currently the strongest U.S.
index and has been since 05/10/2010. What is the significance of this? In most prolonged and sizeable bull markets, small cap and
higher risk stocks tend to lead the advance. Environments in which the Nasdaq or small cap oriented Russell 2000 lead tend to be the
most rewarding. The fact that the one index comprised of the largest and “safest” stocks is outperforming further highlights the rollout
away from risk assets and provides further evidence that the environment is changing.

The market seems to be in a precarious position. If stocks and other asset markets are forming a top, that places anyone invested
across a basket of stocks or mutual funds in the single most dangerous and damaging position possible in any investment
market; at the top of a secular bear market rally. What comes next is truly is a mechanism of wealth destruction.

What Can We Expect?

No one knows what a future stock market decline will look like. History suggests that crashes like the one in 2008 don’t often occur
back-to-back. This isn’t a rule, simply an observation. Any decline in the coming months or years may be the attritional type where
price levels are sanded down like a soft wood — a scenario where market participants slowly realize that the old party is over and a
new one may be much further down the road.

David Rosenberg of Gluskin Sheff offers an excellent point of view on some economic drivers as well as the impact of the U.S.
consumer:

“The cumulative household debt-income ratio peaked in Q1 2008 at 136%. Currently, this ratio is at 126%. But the pre-bubble norm
was 70% (no wonder 25% of Americans have a sub 600 FICO score). To get down to this normalized ratio again, debt would have to
be reduced by around 6 trillion. So far, nearly $600 billion of bad household debt has been destroyed. In other words, we have much
further to go in this deleveraging phase . . . What about debt in relation to household assets? That debt-to-asset ratio is currently at
20% (the peak, set back in Q1 2009, was 22.7%) but again, the pre-bubble norm was 12.5%. The implications: . . . a further $7 trillion
of debt extinguishment.”

The problem Mr. Rosenberg describes above does not disappear without being reflected in asset prices. The buildup of the described
credit and borrowing was a major driver of higher asset prices over the last 30 years. Why on earth would that credit creation benefit
asset prices on the way up, but the destruction of the same credit and borrowing power not punish prices on the way down? Although
the repercussions may sound depressing, they simply create an opportunity-laden framework for the next bull market.

My views on market conditions fall in the minority; to succumb to the consensus view is accepting financial defeat. Given the choice
between all the investment bank research and market fundamentals, or a market with a heavy consensus view and non-confirming
price action; I’ll choose the latter every time.

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MKC Global Investments is currently accepting new investments for Q4 2010. Please note we have raised our initial investment
minimums. Please contact Andrew McCormick at 206.920.4788 with any questions.

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