Short Version Making Money In A Lt Bear Market

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  • 1. Making Money Stocks in a Long-Term Bear Market A Historical Example, The 1966 to 1982 Bear Market Deschaine & Company, L.L.C. © All Rights Reserved Page 1
  • 2. SINCE DECEMBER 2000 we’ve managed client equity portfolios using the following primary assumption: 1) We’re in a Long-Term Bear Market 1) The history of the stock market is one of long alternating bull and bear market cycles. In long-term bear markets, investment returns come primarily from income not capital appreciation. 2) Long-term bear markets do not end until price/earnings ratios reach single digit levels. The stock market’s current p/e ratio is about 13.5 on the S&P 500 index. 3) The stock market is “overvalued” making positive capital returns difficult to achieve. Protecting principal as price/earnings multiples erode during a long-term bear market is critical to portfolio results. The Question is:“How do you make money in a bear market?” Page 2
  • 3. The Current Long-term Bear Market (in Red) 3 2000 Stock 45  “Inflation Adjusted” The Dow Jones Industrials Market Peak As you can see, Dollars: 1900 — 2008 the highest on record! 40  35  2 1966 Stock Market 30  Peak 25  1 1929 Stock 20  Market Peak December 31, 2008 15  10  5  D? A B Our Market Forecast 2000—2035 C ‐ 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 35 Years ? 30 Years 37 Years 34 Years What did the last Long-term Bear Market look like? . . Page 3
  • 4. The last long-term Bear Market 1966 to 1982 (Standard & Poor’s 500 Index) The 1966 to 1982 bear market had a 1.07% annual return on capital, 200 2.00 STANDARD & POOR’S 500 1966 to 1982 Bear Market Results 190 1.90 Index Annual and a 3.49% annual return from dividends. Annual compound total return   1966 1982 Change Return 180 1.80 1.07%  S&P 500 Index at Year End  92.43  109.61  17.18  4.16%. The S&P 500 annual dividend grew from .81 cents to 3.49%  67.70  Dividends Received   170 1.70 4.16%  Total Return   84.88  160 1.60 $1.76 or 4.97% annually. Not very compelling % Quarterly Dividend Rate  4.97   0.81  1.76  0.95  150 1.50 returns, wouldn’t you agree? 140 1.40 130 1.30 S&P 500 Index 120 1.20 110 1.10 100 1.00 90 0.90 S&P 500 Quarterly Dividend 80 0.80 70 0.70 60 0.60 50 0.50 40 0.40 Dec‐69 Dec‐74 Dec‐79 Aug‐66 Oct‐70 Aug‐71 Oct‐75 Aug‐76 Oct‐80 Aug‐81 Apr‐68 Apr‐73 Apr‐78 Jan‐67 Nov‐67 Sep‐68 Feb‐69 Jan‐72 Nov‐72 Sep‐73 Feb‐74 Jan‐77 Nov‐77 Sep‐78 Feb‐79 Jan‐82 May‐70 May‐75 May‐80 Jun‐67 Jun‐72 Jun‐77 Jun‐82 Mar‐66 Jul‐69 Mar‐71 Jul‐74 Mar‐76 Jul‐79 Mar‐81 What would have a $1,000,000 earned over this Bear Market? . . . Page 4
  • 5. Making Money in the 1962-82 Bear Market required patience and regular dividend reinvestment. $5,000,000  $1,000,000  Yet, over the 16-year bear market a portfolio would have more than doubled from diligently reinvesting $4,500,000  $900,000  a growing dividend. In addition, portfolio income would have grown at a healthy 10.48% annual rate from $4,000,000  $800,000  $29,428 a year in 1966 to over $144,986 by year end 1982.Remember these returns are earned $3,500,000  $700,000  from passively investing in the S&P 500, which includes over 130 stocks that don’t pay a divi- dend! What would happen if we eliminated the 130 stocks that don’t pay a dividend? $3,000,000  $600,000  $2,500,000  $500,000  Green: Cumulative capital return Blue: Cumulative investment, $1 million initial investment and all reinvested dividends $2,000,000  $400,000  Yellow line: Quarterly dividend income $1,500,000  $300,000  $1,000,000  $200,000  $500,000  $100,000  $‐ $‐ Nov‐66 Nov‐67 Nov‐68 Nov‐69 Nov‐70 Nov‐71 Nov‐72 Nov‐73 Nov‐74 Nov‐75 Nov‐76 Nov‐77 Nov‐78 Nov‐79 Nov‐80 Nov‐81 Jul‐66 Jul‐67 Jul‐68 Jul‐69 Jul‐70 Jul‐71 Jul‐72 Jul‐73 Jul‐74 Jul‐75 Jul‐76 Jul‐77 Jul‐78 Jul‐79 Jul‐80 Jul‐81 Mar‐66 Mar‐67 Mar‐68 Mar‐69 Mar‐70 Mar‐71 Mar‐72 Mar‐73 Mar‐74 Mar‐75 Mar‐76 Mar‐77 Mar‐78 Mar‐79 Mar‐80 Mar‐81 Mar‐82 Anything we could do to enhance our returns? . . . Page 5
  • 6. Yes! Step One: Eliminate S&P 500 Stocks that don’t pay a dividend. $10,000,000  $1,500,000  If we simply eliminate the stocks in the S&P 500 that don’t pay a dividend, the portfolio’s dividend $1,400,000  $9,000,000  yield goes from 3.05% in 1966 to 4.55%. The annual dividend growth rate goes from 6.12% to a $1,300,000  $8,000,000  $1,200,000  healthy 11.19%. As a result, the portfolio’s quarterly income grows at a healthy 23.32% from $1,100,000  $7,000,000  $43,908 annually to over $1,256,634 per year. $1,000,000  Which works out to an annual compounded total return from 1966 to 1982 of 12.13%! $6,000,000  $900,000  $800,000  $5,000,000  $700,000  $4,000,000  $600,000  $500,000  $3,000,000  $400,000  $2,000,000  $300,000  $200,000  $1,000,000  $100,000  $‐ $‐ Jul‐66 Jul‐67 Jul‐68 Jul‐69 Jul‐70 Jul‐71 Jul‐72 Jul‐73 Jul‐74 Jul‐75 Jul‐76 Jul‐77 Jul‐78 Jul‐79 Jul‐80 Jul‐81 Nov‐66 Nov‐67 Nov‐68 Nov‐69 Nov‐70 Nov‐71 Nov‐72 Nov‐73 Nov‐74 Nov‐75 Nov‐76 Nov‐77 Nov‐78 Nov‐79 Nov‐80 Nov‐81 Mar‐66 Mar‐67 Mar‐68 Mar‐69 Mar‐70 Mar‐71 Mar‐72 Mar‐73 Mar‐74 Mar‐75 Mar‐76 Mar‐77 Mar‐78 Mar‐79 Mar‐80 Mar‐81 Mar‐82 Is there anything else we could do to enhance our returns? . . . Page 6
  • 7. Enhancing Return: STEP TWO: Manage Stock Selection and the timing of dividend reinvestment $15,000,000  We can identifying high yield stocks with a history of dividend growth (and good future $3,400,000  $14,000,000  $3,200,000  prospects of increasing dividends) and selectively reinvest dividends periodically in the $13,000,000  $3,000,000  $12,000,000  $2,800,000  stocks in the portfolio with the highest current yield. We believe this step will add an $2,600,000  $11,000,000  additional 1% in annual yield. We also we can increase the annual dividend growth rate an $2,400,000  $10,000,000  $2,200,000  additional 1% per year.. Now our annual dividend yield is 5.55% and our annual dividend $9,000,000  $2,000,000  $8,000,000  growth rate 12.26%. Annual income grows 28.95% and the portfolio’s total annual re- $1,800,000  $7,000,000  $1,600,000  turn: 16.10%. Since 2000, our EIP: Dividend Yield: 6.20%. $6,000,000  $1,400,000  Annual dividend growth rate:14.45%, and annual total return 9.50%. $1,200,000  $5,000,000  $1,000,000  $4,000,000  S&P 500 annual total return: -2.90% over the same period! $800,000  $3,000,000  $600,000  $2,000,000  $400,000  $1,000,000  $200,000  $‐ $‐ Nov‐66 Nov‐67 Nov‐68 Nov‐69 Nov‐70 Nov‐71 Nov‐72 Nov‐73 Nov‐74 Nov‐75 Nov‐76 Nov‐77 Nov‐78 Nov‐79 Nov‐80 Nov‐81 Jul‐66 Jul‐67 Jul‐68 Jul‐69 Jul‐70 Jul‐71 Jul‐72 Jul‐73 Jul‐74 Jul‐75 Jul‐76 Jul‐77 Jul‐78 Jul‐79 Jul‐80 Jul‐81 Mar‐66 Mar‐67 Mar‐68 Mar‐69 Mar‐70 Mar‐71 Mar‐72 Mar‐73 Mar‐74 Mar‐75 Mar‐76 Mar‐77 Mar‐78 Mar‐79 Mar‐80 Mar‐81 Mar‐82 A Stock Selection and Dividend reinvestment example: Page 7
  • 8. Here’s how We Reinvest Dividend Income: ALTRIA CORP Dividend &Yield History March 1980 through December 2008 12% $1.30 NOTE: As of December 31, 2008, All date includes Kraft and Phillip Morris International $1.20 11% MO was a buy (or an addition to with new cash) as its dividend yield (5.0%) was above it’s 5-year aver- $1.10 age 4.5%. (As was KRT and PM) A current yield above the green line is a screaming BUY! 10% $1.00 9% $0.90 8% MO Dividend Yield: $0.80 Above 5.3% Is a Strong Buy Signal 7% $0.70 6% $0.60 BUY 5% $0.50 HOLD 4% SELL $0.40 3% $0.30 Quarterly $ Dividend (right axis) 2% $0.20 Dividend Yield is quarterly dividend rate annualized, divided by month end 1% $0.10 share price. The peak? March 2000 when tobacco litigation concerns depressed MO’s stock price. 0% $- Mar‐96 Mar‐97 Mar‐98 Mar‐99 Mar‐00 Mar‐01 Mar‐02 Mar‐03 Mar‐04 Mar‐05 Mar‐06 Mar‐07 Mar‐08 Mar‐80 Mar‐81 Mar‐82 Mar‐83 Mar‐84 Mar‐85 Mar‐86 Mar‐87 Mar‐88 Mar‐89 Mar‐90 Mar‐91 Mar‐92 Mar‐93 Mar‐94 Mar‐95 Want to really juice portfolio returns? . . . Page 8
  • 9. Throw More Money at the Portfolio: STEP FOUR: Invest Regularly and Often $15,000,000  When it comes to investing, nothing beats the simple magic of compounding! Throwing money into the $3,400,000  $14,000,000  $3,200,000  portfolio to augment the cash flow from a growing dividend exponentially increases an investor’s return. $13,000,000  $3,000,000  Adding $10,000 a quarter to our $1 million initial deposit grows the portfolio’s annual dividend $12,000,000  $2,800,000  $2,600,000  $11,000,000  income from $53,662 in 1966 to over $3,389,918 MILLION in 1982. That’s an annual income $2,400,000  $10,000,000  growth rate of 29.58%!! As a result, annual total return jumps to 16.66%. This example $2,200,000  $9,000,000  $2,000,000  demonstrates the power of steady and growing cash flows regularly reinvested $8,000,000  $1,800,000  $7,000,000  $1,600,000  at bear market prices. $6,000,000  $1,400,000  The bear market advantage: Capturing higher dividend yields as prices decline! $1,200,000  $5,000,000  $1,000,000  $4,000,000  $800,000  $3,000,000  $600,000  $2,000,000  $400,000  $1,000,000  $200,000  $‐ $‐ Jul‐66 Jul‐67 Jul‐68 Jul‐69 Jul‐70 Jul‐71 Jul‐72 Jul‐73 Jul‐74 Jul‐75 Jul‐76 Jul‐77 Jul‐78 Jul‐79 Jul‐80 Jul‐81 Nov‐66 Nov‐67 Nov‐68 Nov‐69 Nov‐70 Nov‐71 Nov‐72 Nov‐73 Nov‐74 Nov‐75 Nov‐76 Nov‐77 Nov‐78 Nov‐79 Nov‐80 Nov‐81 Mar‐66 Mar‐67 Mar‐68 Mar‐69 Mar‐70 Mar‐71 Mar‐72 Mar‐73 Mar‐74 Mar‐75 Mar‐76 Mar‐77 Mar‐78 Mar‐79 Mar‐80 Mar‐81 Mar‐82 A critical part of the return equation? Patience! Page 9
  • 10. The last long-term Bear Market 1966 to 1982 (Standard & Poor’s 500 Index) The Results of a $1,000,000 investing in the S&P 500 on December 31, 1965 and all dividends reinvested STANDARD & POOR’S 500 1966 to 1982 Bear Market Results Select Dividend Stocks   Select Dividend Stocks,   S&P Dividend  and Time Dividend  Time Dividend Reinvestment      S&P 500   Stocks Only  Reinvestment  Plus $25,000 per Quarter  Beginning Dividend Yield (YE: 1965) 3.51% 4.55% 5.50% 5.50% Average Dividend Yield 4.10% 5.60% 6.60% 6.60%   Annual Dividend Growth Rate 6.12% 11.19% 12.26% 12.26%   Annual Capital Return 1.07% 1.07% 1.07% 1.07%   Beginning Annual Income $ 29,428 $ 43,908 $ 53,662 $ 53,662   Ending Annual Income $ 144,986 $ 1,256,634 $ 3,134,960 $ 5,684,536   Ending Portfolio Market Value $ 2,290,593 $ 6,246,914 $ 10,890,069 $ 19,746,656   Annual Compounded Rate of Return 5.32% 12.13% 16.10% 16.66%   Total Invested Capital $2,050,365 $ 6,198,952 $ 11,327,048 $ 18,968,672   Total Dividends Received $ 1,087,090 $ 5,198,952 $ 10,327,048 $ 17,968,672   Total Capital Return $ 240,228 - $ 49,962 - $ 436,979 $ 777,985   Current Yield on Invested Capital 7.07% 20.11% 27.68% 29.97%   S&P 500 Dividend Yield 1982 6.42%   What would have a $1,000,000 earned over this Bear Market? . . . Page 10
  • 11. But the Dividend Growth Strategy doesn’t work if we’re not patient! The 1966 to 1982 bear market is a tale of two markets: 1966 to 1974 and 1974 to 1982 STANDARD & POOR’S 500 1966 to 1974 Results STANDARD & POOR’S 500 1974 to 19782 Results 200 2.00 Index Annual Index Annual     190 1.90 1966 1974 Change Return 1974 1982 Change Return % % S&P 500 Index at Year End  92.43  63.54  ‐28.89  ‐ 4.58   S&P 500 Index at Year End  63.54  109.61  46.07   7.05   180 1.80 3.20%  6.01%  26.48  37.79  Dividends Received   Dividends Received   170 1.70 ‐ .33%  11.09%  Total Return   Total Return   ‐ 2.41  83.86  % % Quarterly Dividend Rate  Quarterly Dividend Rate  1.18   10.19   0.81  0.89  0.08  0.92  1.76  0.84  160 1.60 Many investors got of the market at the bottom in 1974 and missed excellent long-term re- 150 1.50 140 1.40 turns as prices recover and dividends almost double! Just like today, the 1973-74 130 1.30 bear market was scary, but long-term investors were eventually rewarded. 120 1.20 110 1.10 100 1.00 90 0.90 80 0.80 70 0.70 X Note the market bottomed in September 1974, a modest economic recovery began in 60 0.60 late 1976. It wasn’t so much that the economic recovery was strong that drove the stock market, it’s that it started from such a low level. Sound like today, maybe? 50 0.50 40 0.40 Dec‐69 Dec‐74 Dec‐79 Aug‐66 Oct‐70 Aug‐71 Oct‐75 Aug‐76 Oct‐80 Aug‐81 Apr‐68 Apr‐73 Apr‐78 Jan‐67 Nov‐67 Sep‐68 Feb‐69 Jan‐72 Nov‐72 Sep‐73 Feb‐74 Jan‐77 Nov‐77 Sep‐78 Feb‐79 Jan‐82 May‐70 May‐75 May‐80 Jun‐67 Jun‐72 Jun‐77 Jun‐82 Mar‐66 Jul‐69 Mar‐71 Jul‐74 Mar‐76 Jul‐79 Mar‐81 Where do we stand in the current bear market? . . . Page 11
  • 12. The Current Bear Market (2000 to 2008) Are we in for a repeat of the second half of the 1966 to 1982 bear market? We think it’s certainly possible. 2.00 200 Are investors selling today getting out at exactly the WRONG time. The Red line is the S&P 500 index, the 1.90 190 orange is the dividend. While the current credit crisis is far from over, we think with careful selection, dividend 1.80 180 1.70 170 yields on stocks offer attractive long-term appeal. The risk is the weakening economy causes otherwise sound 1.60 160 companies to cut their dividend. If you have ten years 1.50 150 to wait, the stock market quite possibly 1.40 140 1.30 130 offers the buying opportunity 1.20 120 of a lifetime!! 1.10 110 1.00 100 0.90 90 0.80 80 0.70 70 0.60 60 The S&P 500 on January 31, 2009 0.50 50 0.40 40 Jun‐66 Jun‐67 Jun‐68 Jun‐69 Jun‐70 Jun‐71 Jun‐72 Jun‐73 Jun‐74 Jun‐75 Jun‐76 Jun‐77 Jun‐78 Jun‐79 Jun‐80 Jun‐81 Jun‐82 Dec‐65 Dec‐66 Dec‐67 Dec‐68 Dec‐69 Dec‐70 Dec‐71 Dec‐72 Dec‐73 Dec‐74 Dec‐75 Dec‐76 Dec‐77 Dec‐78 Dec‐79 Dec‐80 Dec‐81 To Summarize . . . Page 12
  • 13. A Plan for Achieving Superior Results in a Long-term Bear Market STEP ONE: Buy high yield dividend stocks STEP TWO: Diligently reinvest dividends at the highest current yields available in the portfolio at the time. STEP THREE: Invest early, regularly and invest often—capturing higher yields as prices continue to weaken throughout the bear market cycle. LAST: Be patient!We’re only half way through the current bear market! For long-term investors, keep investing all the way to the bottom! Page 13