US Economic Recovery: positive outlook; US Credit Rating: negative outlook.

The economic recovery in the US displayed remarkable resilienceduring the first quarter. Growth was sustained even with a disaster inJapan, continuing European debt crisis concerns, the threat of a USgovernment shut down and record high oil prices. The athleteanalogy we used in the third quarter of 2010 is still relevant. Now offsteroids (overleveraged debt markets) and with a successful rehabprogram completed (economic stimulus), we entered our athleteinto the high hurdles (unanticipated events). Although we didn’t winthe gold, we did at least make the podium (sustainable growth).

Ongoing interest and concerns about perceived inflationarypressures lends itself to greater discussion on the topic. This isclearly not a new topic, as inflation fears have been prevalent sincethe latter part of 2009. In the first quarter 2010 commentary wediscussed the origins of inflation (commentary available at:www.oppenheimerim.com). This quarter we will review how inflationis monitored and reported. Additionally, we will discuss a measurethat we monitor - inflationary pressures coming from labor costs. Wewill briefly discuss Standard & Poor’s change in outlook on theUnited States (from stable to negative), the value of the dollar andour expectations from the Fed after ending QE2.

The Consumer Price Index (“CPI”)The CPI, as reported by the Bureau of Labor Statistics (“BLS”),

tracks the change in price for a few hundred consumer goods andservices weighted to reflect their impact on a typical household’sspending. Like most government indices, there are several versions,but the one most widely reported in the newspaper is the “All UrbanConsumers” (CPI-U) version covering 87% of the total populationliving in Metropolitan Statistical Areas (MSAs) with 2,500inhabitants or more. CPI-U is the reference index for TreasuryInflation-Protected Securities. The CPI-U was created after WWII tocorrect the shortcomings of the narrower CPI for Urban WageEarners and Clerical Workers (CPI-W) and only covers 32% of thepopulation. This version is still used for social security cost of livingincreases (COLAs). The measure that excludes volatile food andenergy components is called the “Core CPI”. The Fed and mosteconomists suggest that higher food and energy prices may impactconsumer sentiment, but they only become problematic if theyremain elevated long enough to leak into Core CPI components.Below is a graph that depicts the energy and somewhat less volatilefood components of the CPI over the past ten years as compared tothe Core CPI.

The Fed and others (OIM included) tend to use the Core CPI asthe true measure of imbedded inflation and one source to estimatefuture inflation expectations.

Food and Energy comprise 15% and 9% of the CPI, respectively.The “core” components of the CPI and their weightings include:

Housing/Owner equivalent Rents (Housing) 38%Transportation (excluding fuel) 12%Medical 7%Recreation 6%Apparel 4%Education 3%Communication 3%Other 3%

Owner Equivalent Rents/Housing (OER) is the single most importantcomponent to the Core CPI. The OER concept was adopted by the BLSin the 1980s in an effort to accurately reflect the costs associated withthe provision of shelter. Before its development, housing upwardlybiased reported inflation because it included a mortgage interest ratecomponent that rose as the Fed increased rates to further combatinflation. OER incorporates rental expense and home ownershipexpenses via an estimate of the implied rent paid by homeowners.These changes reduced the impact that higher interest rates and homeprices had on the short-term cost of shelter. Below is a graph thatcharts OER and the Freddie Mac House Price Index (FMHPI) anddepicts the “smoothing” effect that OER has on overall inflation.

The latest Core CPI report suggests that inflation remains undercontrol, but remember these data are historical. We have stated inprior commentaries that labor cost is the critical ingredient that canlead to inflation. With the unemployment rate at 8.8% (U-3) and theunderemployment rate at 19% (U-6), we are far from fullemployment and a point where employees can demand higherwages. However, capacity utilization is improving and could be anearly indicator that inflationary pressure is on the horizon. Below isa chart that graphs capacity utilization over the past ten years aswell as the Core CPI. The graph suggests that inflation lags 12-18months behind capacity utilization and could reach the 2-2.5%range in 2012. However, this potential source of inflation could beoffset by a continued depressed housing market and other factors,mitigating the impact. We will continue to monitor inflation andinflation expectations closely.

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Source: Bureau of Labor Statistics

Source: Bureau of Labor Statistics, Freddie Mac

Source: Bureau of Labor Statistics, Federal Reserve

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DISCLOSURE

Oppenheimer Investment Management LLC is an investment adviser registered with the Securities and Exchange Commission and is an indirect subsidiary of OppenheimerHoldings Inc. The opinions expressed herein are those of the portfolio manager and not necessarily those of Oppenheimer Investment Management LLC or its affiliates and aresubject to change without notice. The information and statistical data contained herein has been obtained from sources we believe to be reliable. Any securities discussed shouldnot be construed as a recommendation to buy or sell and there is no guarantee that they will be held in a client's account or that they will be profitable. Past performance is nota guarantee of future results. An index is unmanaged and is not available for direct investment and does not reflect management fees or operating expenses.

The threat of a US downgrade – just that – a threat,should lead to positive action in Washington.

As widely reported in the press, S&P put a negative outlook on USdebt instruments effectively giving the government two years to get itsfiscal act together. Like all things finance, the details are important, andunfortunately we cannot repeat them within the context of thiscommentary. However, S&P is providing a great deal of detail for itsunprecedented move on its website: www.standardandpoors.com.Although it is hard to believe, we suspect that S&P is doing us a favorby taking this action. Now the politicians can make S&P the “bad guy”and can take cover from some of the challenging and tough decisionsthat have to be made to bring the annual fiscal deficit more in line withother AAA rated sovereign countries from the current 11% of GDP to amore rational (although still unacceptable) 5%.

The declining value of the US dollarAs tracked by the dollar index, which dates back to 1971, the value of

the dollar as compared against a basket of currencies is currently within5% of its all time low in April 2008. The dollar is down 9.1% from a yearago. A weaker dollar is positive for US exporters, as their productsbecome more competitively priced. This has been particularly favorablefor technology, pharmaceutical and other manufacturing companieswhere an increasing portion of their sales comes from abroad. Since thebeginning of the recovery in the third quarter of 2009, exports haveaccounted for 1.4% of the US’s 3.0% annualized growth rate. Thedownside of a weak dollar is higher oil, gas, and other commoditiespriced in dollars, which in turn reduces consumer discretionaryspending, and raises concerns about inflation as previously discussed.When compared with other developed economies, US gas prices are farless expensive even at current levels. Out of 155 countries surveyed byAIRINC, the US ranked 45th for least expensive gas. A weakening USdollar will likely bring the US trade imbalance closer to equilibrium andserve as a catalyst for further US economic growth.

The end of QE2It may not be as hard to predict what the end of QE2 will mean to fixed

income investors. Since the commencement of QE2, the ten-year USTreasury has increased from a rate of approximately 2.5% to approximately3.4%. We do not believe that the Fed will take additional monetary actionto further stimulate economic growth. Nor do we anticipate an increase inthe Feds Funds rate in the near term. Although we are in what appears tobe a sustainable recovery, we have underperformed on the job creationfront and 1Q11 GDP is expected to be revised from 3.1% down to 2% onApril 28th. Without wage pressure, there is no core inflation to combat.The Fed’s current accommodative stance will remain and the market itselfwill dictate the need for a Fed move.

Capital Markets, Performance and Strategy The fixed income markets once again delivered attractive positive

returns much to the surprise of the talking heads that have beenpontificating about a bond bubble for the past eighteen months or so.Being on the sideline in cash or very short paper would have beenpainful during this time. The investment grade bond market, asmeasured by the Barclays Capital Aggregate Index, returned 42 basispoints for the quarter. The high yield market, as measured by theBofA/Merrill Lynch High Yield Master II Index (MLHYI II), returned

3.90% for the first quarter - off to another strong start as defaults andnew distressed debt positions were virtually non-existent.

We are happy to report that once again the OIM Core and Core Pluscomposites outperformed the Barclays Capital Aggregate Index. TheIntermediate composite outperformed the Barclays Capital IntermediateGovernment/Credit Index and the High Yield composite outperformedthe Merrill Lynch/BofA High Yield II Index. The leading contributor toour outperformance in all composites remains our continuingoverweight to corporate securities. Over the longer term, we continue tobelieve corporate bonds offer the best opportunity for outperformance,and we remain overweight that sector. Additionally, we will continue tounderweight US Treasuries versus the benchmark as we believe there islimited upside as the U.S. economy improves. Our high yield exposurein the Core Plus accounts is at the maximum 20%. We plan to hold ourhigh yield positions at these levels as long as the economicenvironment remains favorable.

Our extensive research and understanding of our corporate creditpositions contribute to our performance. While never losing sight of theglobal economic environment, our long only style of investing deliveredpositive results with limited volatility. If you have any questions onstrategy, performance or business development, please do not hesitateto contact us.

Michael Richman, CFA Leo J. Dierckman(317) 843-3602 (317) 843-3603michael.richman@opco.com leo.dierckman@opco.com

John Saf, CFA, CPA(317) 843-3610john.saf@opco.com

Michael Richman, CFA is a Senior Director, Portfolio Manager for OppenheimerInvestment Management LLC. He has primary portfolio management duties for theCore, Core Plus and Intermediate composites in addition to his researchresponsibilities for the Aerospace, Agencies and Auto/Auto Parts sectors. Prior tojoining OIM, Mr. Richman was Vice President, Portfolio Manager and Head ofCorporate Trading at 40|86 Advisors, Inc. He holds a B.S. in Finance from IndianaUniversity and is a CFA charterholder.

Leo J. Dierckman is a Senior Director, Portfolio Manager for OppenheimerInvestment Management LLC. Leo is primarily responsible for management dutiesfor the High Yield, Bank Loan and Core Plus composites in addition to his researchresponsibilities for the Healthcare, Homebuilding, and Municipal Bond sectors.Leo also serves on the Board of Oppenheimer Distressed Opportunities, L.P. as arepresentative of Oppenheimer & Co. Inc. Prior to joining OIM, he was VicePresident, Portfolio Manager for 40|86 Advisors, Inc. While at 40|86 Advisors, Leoserved as the lead portfolio manager for the 40|86 Strategic Income Fund(NYSE:CFD), a publicly traded closed-end mutual fund and the Manager’sConvertible Securities Mutual Fund (NASDAQ:MCXYX). He holds a B.S. in Financefrom Indiana University.

John C. Saf, CFA, CPA is a Senior Director, Insurance Portfolio Manager forOppenheimer Investment Management LLC. He is primarily responsible forInsurance portfolio management. Prior to joining OIM, Mr. Saf was a VicePresident and Portfolio Manager at 40|86 Advisors, Inc. He served as a co-portfoliomanager for the Conseco insurance portfolios and primary manager for the non-affiliated insurance clients as well as performing and overseeing Asset LiabilityManagement (ALM). He holds a B.S.B.A. from Drake University with majors inActuarial Science and Accounting. He is a Fellow in the Life Management Institute,holds a Certified Public Accountant certificate and is a CFA charterholder.

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Oppenheimer Investment Management LLC Sales and Client Service

630 W. Carmel Drive, Suite 250Carmel, IN 46032CONTACT: Cyndi Collins, 317.843.3607

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