EPIC INVESTMENT MANAGEMENT

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1 EPIC INVESTMENT MANAGEMENT Epic Charts Epic Investment Management data source: Bloomberg, unless noted otherwise Copyright 2010 Epic Investment Management All rights reserved.

2 SP Since 1927, the S&P 500 index on a price-only basis has grown over 100-fold. From its bottom in 1932, it has grown 400-fold. Adjusted for dividends, total returns are much higher. Long-term investors have been richly rewarded for owning stocks, which have outperformed virtually all investable asset classes. The price for this substantial performance is high volatility and bear markets.

3 wealth accumulation value of $1 invested since 1945 $1,000 $100 S&P 500 $1407 Treasury notes $40 Gold $31 Treasury bills $17 inflation $13 $10 $1 Long-term returns on equities far exceed those of alternative asset classes, with this advantage magnified by the compounding of returns over decades. source: Bloomberg Federal Reserve Aswath Damodaran, New York University

4 Since 1940, S&P 500 rolling 10-year total returns have always been positive, until 2008 and After a lost decade of equity returns, a rebound in stock prices was predictable.

5 40% S&P 500 monthly returns % 20% 10% 0% -10% -20% -30% -40% The scatter graph of monthly returns* has a deceptively favorable ratio of 59% positive to 41% negative, with an average return of 0.57%. At first blush, it appears that stock returns are volatile, random and centered around zero. Only the volatile appearance is true. 70% S&P 500 price change frequency % 50% 40% 30% 20% 10% 0% daily monthly yearly up down Stock returns are positive 52% of all trading days. Yet returns are positive 59% of all months, and 66% of all years. What appear to be random day to day market moves actually create favorable long-term outcomes. Investors who are habitually negative, so called "perma-bears", are in fact on the wrong side of historic results. * returns are price change only

6 Equity returns vary greatly from decade to decade, much more so than would be explained simply by real economic growth. The strongest decades of growth were the 1940s and 1960s. The highest market returns came in the 1950s, 1980s, and 1990s. 80% real GDP growth by decade % 60% 50% 40% 30% 20% 10% 0% 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s In the prior decade, both S&P 500 returns and real GDP growth were the worst since the depression. The outlook for a slow-growth 'new normal' is in fact a reflection of conditions already in place.

7 Over extended investment horizons, equity returns typically far outpace bond returns, recent history being an exception.

8 Valuation swings on the stock market can be exceedingly wide, and at today's prices stocks are far from cheap.

9 Using a 10-year rolling average EPS series smooths out the effect of short-term profit peaks and troughs, creating a more normalized view of market valuations.

10 Decades ago -- back to the 1950s -- stock dividend yields exceeded Treasury yields, partly due to high payout ratios, partly due to a more primitive view of the financial world. Those days were supposedly long gone -- until recently.

11 0% bear markets SP 500 price change % -20% -30% -40% -50% -60% The two bear markets of the past decade were severe downturns, much worse than average.

12 Since 1954, S&P 500 EPS has grown at a compound annual rate of 6%.

13 0% US corporate profit declines % -20% -30% -40% -50% Why do investors care about recessions? Because they cut into corporate profits.. in the most recent downturn, to a much greater extent than usual.

14 50% Percentage of time spent in recession % 41% 30% 20% 10% 0% 17% 18% % source: National Bureau of Economic Research Before the recent "great recession", downturns in the US had become less frequent -- and also less intense. Policymakers thought they had the magic formula to sustain "the great moderation". In reality, pressure on the entire economic system was building under a mountain of debt.

15 US Treasury yields are exceptionally low, offering little premium above expected inflation and no real investment appeal. The US has moved from a tech stock bubble, to a housing bubble, to a credit bubble.

16 Before the great depresssion and World War II, federal spending was a negligible part of the overall economy, then rose until settling in the 18-22% range for the past half century. Will the current policy of high federal spending subside, or plateau at a new level? More likely the latter, representing a greater role of government in the US economy. source: OMB, CBO

17 The federal budget went from surplus to record deficits during the past decade. Short-term budget improvements mask long-term spending issues likely to drive future deficits significantly higher. source: US Treasury, CBO

18 The theory of large budget deficits creating high interest rates is an easy concept to grasp -- and a difficult concept to prove. Soaring deficits have yet to result in higher interest rates.

19 The US debt bubble was not built overnight. We now have $60 trillion of debt in our financial system, representing 330% of annual economic output. The bubble was bound to burst at some point, but the timing was by no means obvious. source: Federal Reserve, Bloomberg

20 In the past eight years we have taken on more new Treasury debt than in our nation's first 230 years combined. Treasury debt as a percent of GDP is now 84%, up from 41% in source: Federal Reserve, Bloomberg

21 One of the great myths is that housing is usually among the best of investments. It has its moments, but in over a century, housing's returns have barely exceeded inflation. source: Robert Shiller, Yale University

22 At the moment, inflation is the least of our worries.

23 The unemployment rate has fallen to more normal levels, partly due to people dropping out of the workforce.

24 Over the past half century, the US Dollar has lost one-fifth of its value against a trade-weighted basket of major currencies, notwithstandng two significant multi-year rallies. Measured against stronger currencies, and against gold, the dollar's decline is much worse.