“The \'cult of equities\' is the notion that stocks are special and should, bonds,globalization, be the centerpiece of a global asset allocation, no matter the price.” Blind support for stocks represents an “equity cult,” “a group of people who believe something that is based on faith, not based on fact and supporting evidence”. (Robert Arnott)

1.
Questioning the “Cult of Equities”
Quarter 1, 2010
To Our Clients & Friends,
In this, our first letter to you in 2010, we would like to share with you our thoughts and reflections on
the year and the decade just ended. Then, with that history as prelude, we will attempt to put those
observations into perspective for you as we discuss our outlook for 2010 with corresponding investment
ideas.
Ironically, I just returned from an investment conference which was held in Orlando at one of the Disney
hotels. The hotel was connected to the monorail, and as I took a quick ride through the various parts of
Disneyworld, I started to put into focus how to format this letter. While this truly has become a “small
world,” this letter may not be as short as my monorail ride if we want to discuss where we’ve been and
where we might be going.
Stocks vs. Bonds
As we prepared to share with you an overview of the investment world of the last year, it occurred to us
that looking only at 2009 would not be sufficient. To put 2009 into perspective, it will be helpful to have
an understanding of the last five years and of the last decade.
Perhaps this chart will begin to paint the picture.

2.
Bottom line – from December 31, 1999 through the end of 2009, the stock market as measured by the
S&P 500 lost money. It returned ‐ 9%. Using real numbers, if you started the year 2000 with
$100,000, you would have ended up with $91,000 at the end of 2009. With inflation averaging 2.5% per
year, and equities losing roughly 1% per year, the S&P 500 actually lost 3.5% in purchasing power
annually over the last decade. It was a tough decade for domestic equity investments. The last five
years were also difficult with the S&P 500 losing 3% over that period.
How could that happen? I only pose this question because the investment textbooks teach us that over
the last 20, 30, 40, and even 80 years the stock market’s long‐term average return has been about 10%.
The textbooks used to say that there was only one decade, ever, where the S&P 500 lost money – and it
had something to do with the decade of the Great Depression.
Stocks, primarily U.S. stocks, have traditionally been the primary building block of portfolios. But after
two significant stock market crashes in the last ten years, thoughtful investors are beginning to question
the conventional wisdom that stocks outperform bonds.
Robert Arnott, founder of Research Affiliates in Newport Beach, made an excellent observation that
we’d like to share with you. He said, “The cult of equities is the notion that stocks are special and should
be the centerpiece of a global asset allocation, no matter the price.” Blind support for stocks represents
an “equity cult,” contends Arnott, which he defines as “a group of people who believe something that is
based on faith, not based on fact and supporting evidence”.
In fact, as of last September 30, long‐term Treasury bonds had outperformed U.S. stocks over the past
28 years. Even if the next decade produces high stock market returns, the gains are likely to come with
more volatility than investors, mindful of the 2008 market crash, can tolerate. Baby boomers, who were
supposed to be accumulating assets for retirement, took 60% more risk in equities during that 28‐year
period and still slightly underperformed long‐term Treasury bonds. Investors have been hoodwinked
into thinking that equities should form the core of their portfolios, Arnott believes, leaving them with
little control over the prices they paid for their investments.
The demographics of the baby boomer generation are finally contributing to a fundamental change in
investment tactics. About 22 percent of Americans will reach retirement age by 2020, and as baby
boomers start drawing down their assets, they can’t risk wild fluctuations.

3.
Harry Dent, the author of six books on the impact of an aging population on national economies,
predicted a stock market meltdown in the first decade of this century as the baby boom generation
approached retirement. It is fact that the U.S. economy benefited from the 1960s to the 1990s as the
boomers increased their spending, as well as their investments in stocks. Now as they retire, the trend
is moving in reverse. This 22% of all Americans, approximately 68 million people, are inclined to move
away from equities to safer investments.
Portfolio Building Blocks
At Silver Oak, we like to use a construction analogy as we explain our approach to building portfolios.
Every building needs a sound foundation – good strong building blocks. Fixed income investment
vehicles, with their stability and relative safety, create a much steadier base than utilizing stocks or
other investments with significantly higher volatility.
With the last ten years as backdrop, we believe the design elements required in building portfolios has
shifted. Since 2008, the world has been forced to acknowledge that severe downside volatility is
becoming all too common. Textbook asset allocation did not work since a portfolio that was diversified
among all the typical asset classes went spiraling downward together. The practice of utilizing asset
classes that move in opposite directions to reduce portfolio risk, while great in theory, provided limited
benefit in application when needed most. Partly because Wall Street had become so talented in
manufacturing investment products that were very complex and virtually impossible to decipher, and
because these products intertwined the risky elements in stocks to those of bonds, the ability to analyze
risk properly became as lost an art as building a Frank Lloyd Wright house.
If you knew ten years ago, at the beginning of 2000, that bonds would outperform stocks over the next
ten years, would you have allocated any of your portfolio to stocks? With perfect foresight, you might
have said no. But your thought process would, no doubt, have been impacted by the fact that stocks
had made 18% annually over the past decade and almost 21% during the year 1999.
Subsequently, the year 2000 became the starting point for our understanding of asset “bubbles”,
irrational exuberance, and our resulting conviction that markets are anything but efficient. By the time
the decade of the 2000s ended, we not only saw numerous textbooks written on the subject of the
origin and danger of
bubbles, but also understood how vulnerable our economic system is and how close we came to a
depression‐like calamity.
Another important element of portfolio construction should be mentioned also. During the last decade
we began quoting from Thomas L. Friedman’s now classic book, “The World Is Flat”. The basic theme
was globalization, with the title being a metaphor for viewing the world as a level playing field in terms
of commerce, where all competitors have an equal opportunity. As the first edition cover illustration
indicates, the title also alludes to the paradigm shift required for countries, companies, and individuals
to remain competitive in a global market. Historical and geographical divisions are becoming
increasingly irrelevant.
The last two years should have driven home this globalization theme. Not only was the U.S. faced with a
dire economic situation, but also the global economic infrastructure was threatened with total
destabilization. How is that for a flattened world! It drives home the point that economic globalization

4. requires investment advisors to think outside of the traditional geographic and stylistic approach that
worked for decades past. Building and managing portfolios using a rear view mirror approach will likely
disappoint investors going forward.
The traditional building blocks of the diversified global portfolio of 20‐30 years ago will likely be shown
to be ineffective going forward. While a U.S.‐centric portfolio may have been logical and based on
objective domestic growth statistics at that time, our current Gross Domestic Product – the value of all
goods and services produced – is now only 24% of the world’s GDP. The European Union now
represents 30%, and the region comprising Asia and the Pacific rim about 27.5% (and growing). For
comparison purposes, in 1970 the U.S. represented about 41% globally, and down from almost half of
world GDP in 1960.
Risk and reward have always been the bedrock analytics upon which portfolios were constructed. The
analysis of risk, however, has become much more complicated due to today’s “flatter” world and to the
complexity of investments that infuse stock‐like risk elements into fixed income vehicles. The increased
global influence of emerging nation economies and their fluctuating currencies add to the multiplicity
of risk factors. We believe that there is much compelling evidence supporting our focus on effectively
identifying and evaluating risk first and taking a global approach to locating the building blocks that
create the most stable foundation for the portfolios we build.
Risk & Reward and Asset Allocation
Which portfolio would you prefer to have based on these two choices?
1. A 100% portfolio of equities with an expected return of 10%; or
2. A 100% bond portfolio with an expected return of 10%
You might initially conclude that both portfolios will produce the same return, so the choice would be
moot. However, since the level of volatility of the equity portfolio would be double or triple that of the
bond portfolio, these two portfolios are not truly identical. On a risk‐adjusted basis, the bond portfolio
clearly would be the better choice. In fact, the bond portfolio would also have a higher compounded
return (more capital returned) over a number of years since its rate of fluctuation would be lower.
When we design portfolios, we are always mindful of the risk and return trade‐off. Our primary mission
in designing portfolios is the protection of capital. Therefore, as we select from various asset classes in
our pursuit of a rate of return that will accomplish your long‐term goals, our initial focus is on identifying
the total return opportunity of each investment based on its level of risk. In approaching portfolio
construction in this manner, we incorporate risk and return analyses as we build a lower volatility
portfolio.
Over the past 15 months, our asset allocation has included a broad array of fixed income vehicles. Our
belief at the end of 2008 was that on a risk/reward basis, most bonds would perform better than stocks.
In early 2009, bonds as well as stocks were being priced as if we would be entering another Great
Depression. As it turned out, once it became evident that we were only in a Great Recession and a more
major disaster was averted, all risky asset classes rebounded. Since in March of 2009 there remained
serious questions about our economy, we chose to focus on reaping the excellent returns in the fixed
income markets. We are proud of our emphasis on managing risk and creating effective diversification
strategies. We continue to be committed to our primary mandate that capital that can’t be replaced

5. must be protected. The risk of missing out on greater potential gains is a lesser risk which we are willing
to take.
Our current thinking for 2010 has not changed much from our 2009 outlook. Our expectation is that
equity returns will be below their long‐term averages. We’ve referred in previous letters to PIMCO’s
belief that we are in a period aptly dubbed the “New Normal”. In this New Normal, it is doubtful that
investors will be adequately compensated for the risks assumed in the equity markets. We prefer to
invest, and take on risk, only when we believe the rewards will be sustainable.
Recessions result from many different factors, some are more cyclical and short‐term in nature, and
others happen because the structural underpinnings of the economy have fundamentally been altered.
We believe this Great Recession is the result of the latter. Therefore, we find it very hard to believe that
we should be viewing this recession and recovery through the same lens as prior recessions. With an
array of economic challenges before us, we believe that the depth, magnitude, and lingering fallout
from this recession are anything but normal. Therefore, we don’t buy into the notion that we should
expect “normal” economic growth.
While we believe we can build a case to include some allocation to equities, we expect to continue to
underweight them in our asset allocation. One of the “indicators” we utilize in coming to that conclusion
is The Shiller P/E Ratio, which sheds some light on valuations. Robert Shiller is a Yale economist who
wrote the
book “Irrational Exuberance”, and has developed a widely accepted method to measure the
Price/Earnings (P/E) ratio of the S&P 500.
Shiller P/E Ratio
In the above graph, the red line is the long‐term average P/E ratio which computes to about 16 times
earnings. The measure today is above the average, and at close to 20x earnings, indicates that stocks
are still relatively expensive. Because in this New Normal a P/E of even 16 may be too high, stocks may

6. be even more overvalued than they might appear.
Conclusion
We are under no delusion about the economic challenges that we face both domestically and
internationally. This past week we have seen how even a smaller country in the European Union,
Greece, can have a major impact on the global investment climate. A year ago, hardly anyone would
have suspected that Greece might throw such a monkey wrench into the progress toward world
economic stability. But this is exactly symptomatic of this “New Normal”: the pace and increasing
frequency of unexpected, negatively impactful events will have a destabilizing effect and should cause
us to reassess our analysis of opportunity and risk.
As you know, bond yields are historically low. We do not believe the U.S. can risk raising rates soon
because the effect on recovery could be disastrous. Deflation continues to be more of a threat than
inflation. Yet the government needs to begin at some point to reduce the deficit and address the money
supply. The risk before them of acting too soon or precipitously, besides stifling the recovery, is that
rates might rise and inflation might rear its head. This is a dilemma for the government and a challenge
for us as we build portfolios in 2010.
Our goal and commitment is to continue our research and macro‐economic observations to find solid
and appropriate building blocks to form the foundation of our portfolios. Although there are now fewer
very attractive domestic individual bonds available, we continue to find a number of bonds that offer
good returns. We expect that as the domestic and international economies progress through 2010, we
will find new opportunities to supplement our fixed income strategies.
In general, the higher risk allocation to most clients’ portfolios is between 20% and 40%. The specific
investments chosen to fill this allocation will continue to evolve as we see opportunities and identify
what passes for trends in these volatile times. As such, our research and resulting investment selections
continue to reflect our out of the box, and go‐anywhere independent thinking.
As always, we are available to answer your questions or to discuss your specific portfolio strategy at
your request. We greatly appreciate your loyalty and support as we continue to work hard to earn your
trust and provide excellent client service.
Sincerely,
Joel H. Framson
President