December 31, Where do we go from here? Copyright , All rights reserved. investwithcornerstone.com

Transcription

1 2009 Year End Chartbook December 31, 2009 Where do we go from here?

2 The year that was After 2008 when the S & P 500 declined almost 40%, stocks got off to a scary start in 2009.

3 with banking at the epicenter of the crisis. We are using Bank of America as a representative for much of the industry. The first quarter of the year was a bear run on the financial system, and the risk was that the market would become a self-fulfilling prophecy of collapse.

4 The Response The Federal Reserve, the Treasury Department and even Congress each supplied some type of remedy that kept the system from tipping. While the effort was not always internally consistent and much of the work remains, the end-goal of saving the economy (from itself, in some ways) was accomplished. Some of the programs used are listed as follows: TARP, plans I and II the troubled asset relief program sought to provide capital directly to banking institutions whose assets were impaired (a fancy way of saying they paid way too much for the assets a couple of years ago ). Si Stimulus packages the Congressional response to the banker bailout plans various programs to benefit others impacted by the weakening economy. Some of these have actually been quite necessary as municipal budgets have been reduced due to lower revenue. (Are we all Keynesian s now?) PPIP the Public / Private Investment Program which sought to set a market for some of the distressed securities. Mark to market accounting a good idea in theory, forcing banks to write asset values to their market value each quarter, proved to be a poor idea in practice as there were no buyers for the securities in question. Put simply, assets that were worth probably 65 cents on the dollar were trading near 15 cents. This was feeding the bear market in financials. Naked short sales the final piece of the puzzle was the self-reinforcing mechanism of short sales by those who have not first borrowed the shares to short. We are not opponents of short-selling, but doing so without first borrowing the shares can put significant downward pressure on shares.

5 The Result The result of this effort is the return of an appetite for risk to the marketplace. Most important to notice in this chart is YTD return both high return categories and low return categories.

6 What we believe Even though we used this chart last month, it perfectly illustrates the global growth in business we feel will be the primary economic engine for the coming period - growth will come from an increase in business activity both in the United States and around the globe.

7 The economic recovery will not be based on consumption Retail Sales as a % of Personal Income 40.00% 39.00% 38.00% 37.00% 36.00% 35.00% 34.00% 33.00% 32.00% 31.00% Consumers have reduced spending considerably in recent months. While this extreme change is unsustainable longer term, it illustrates an important shift in behavior.

8 because the American consumer has returned to saving (part I). Personal Savings Rate Part of this may also be due to the lack of dis-savings as opportunities to spend from your assets (read home equity lines of credit) have diminished.

9 because the American consumer has returned to saving (part II) Debt Service Ratios Debt Service Ratio Financial Obligation Ratio Homeowners FOR Renters FOR Source: US Federal 0.00 Note the decline in debt service ratios across categories each of these measures is well off its historic peak.

10 Unemployment will remain high through the summer, 800,000 Initial Jobless Claims 700, , , , , , ,000-5 Week Average 52 Week Average Source: US Department of Labor but both initial and continuing claims indicate that the job situation is not getting worse.

11 Some concerns (not necessarily shared by us at this time, but worth mentioning nonetheless). Money supply Inflation Rising interest rates Weakening dollar Each of these is inter-related, and we believe that with proper timing and execution, each issue can be avoided. But, if there are problems with either the timing or the execution, the probability of a problem increases.

12 Money supply % Adjusted Monetary Base Growth rate yr/yr % 80.00% 60.00% 40.00% 20.00% 00% 0.00% % 00% The adjusted monetary base is high-powered money, meaning money that is simply created by the Fed. There was an unbelievable increase in the base of money over the past 18 months, but the growth rate has fallen off substantially. This needs to continue.

13 Inflation as measured by a market source Market Anticipated Inflation Maturity adjusted Inflation (L Scale) 10 yr Change in Expectations (R Scale) 60.00% 50.00% 00% 40.00% 30.00% 20.00% 10.00% 0.00% Inflation expectations measured by TIPS back to historic norms, with significantly higher expectations than one year ago. But, nothing that is a dangerous warning sign yet. A major component of US inflation is the capacity in the labor markets which will not be supplying pressure for some time..

14 Interest rates part I Interest rates remain at low levels on both a relative and a historic basis. These charts present both the 3 month Treasury bill and the 10 year Treasury note.

15 Interest rates part II Treasury Yield Curve Historic Yield Curves 4.00% 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% -3.00% -4.00% But the yield curve is wide, offering banks the opportunity to lend for the spread that will return them to profitability. Short-term rates can be increased up to 1.5% without putting upward pressure on longerterm rates using historical spreads between rates as a guide.

16 What we expect and what we re watching

17 The Outlook -The recession is over, but the economic recovery will be gradual for a number of reasons. -Consumer behavior has been modified and the areas of growth are not going to be linked to consumption. -Job recovery will remain weak. -There will be continued demand d for equities, but the rapid returns from the crisis are already realized. -Estimated annualized returns of ~ 8% for the next 5 10 years as the heroic measures are undone. -There will be pockets of opportunity and pockets of value destruction. -Selective global opportunities will be better than domestic.

18 Interest rates of highly liquid and highly sensitive economic instruments Both of these Treasury securities should offer guidance about global risk-aversion, the direction of the US dollar, and interest rates in the US. We will be watching them closely in the coming months. We will have to take our medicine at some point will it be our choice or someone else s?

19 Leading indicators Economic Momentum 80.00% 60.00% 13 Week 52 Week 3 Year 40.00% 20.00% 0.00% % % % This is still an impressive chart that has us hopeful for a continued recovery.

20 Parting shot It was hubris that fostered an environment of aggressive risk-taking, and now almost everyone can make big and risky bets. We have not done enough to contain or moderate this hubris going forward. Protecting capitalism from itself is a full-time responsibility, and it needs to be treated as such. By the way, is this book published in Icelandic?