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3rd Qrt 2009 8 Page Final


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3rd Quarter 2009 D&C Viewpoint

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3rd Qrt 2009 8 Page Final

  1. 1. Helping You Navigate an Uncertain Investment World 3rd Quarter 2009 Volume 10 Issue 3 Inside this issue: Random Thoughts from the 3rd Tee Random Thoughts from the 1 3rd Tee A Hodgepodge of Stuff Straight from the Twilight Zone The Front Seat 2 The History of Money 3 W E LIKE TO THINK OF OURSELVES as an optimis- tic lot. After all, without elaborating on the specifics, we have to concede, we’ve got it pretty good. Throw in the purposely deceptive economic pro- nouncements put forth by this White House—and ech- oed faithfully and without question by their lackeys in Warren Buffett Speaks 5 Even though we face the same everyday challenges as the archaic media—and our task of filtering out the About ETFs 6 everyone else; what to have for breakfast, when to nap, noise and distortions to get to economic reality becomes and how to make money in a stock market more volatile exponentially more difficult with each passing day. Eating Healthy in a modern than a room full of eight-year olds hopped up on cup We’ve said it before and we’ll probably say it again environment 7 cakes and Mountain Dew, we somehow manage to get (many times actually), we’re not interested in deluding through the day. We do so primarily by plodding along, ourselves about financial or economic matters. Some Rules on Buying Gold 8 tirelessly putting The last nine one foot in front of months has been the other. particularly difficult As boring as it getting a read on may be, this me- economic reality for thodical approach to several reasons: the life and investing severity of the eco- has served us well nomic downturn, the over the last 30 enormous new gov- years as we ventured ernment spending— forth each day to do fueled by selling battle with the investing dragon. trillions in new government debt and printing trillions All poorly constructed metaphors aside, to be suc- of new dollars by the Federal Reserve—followed by a cessful such an approach to investing must be based first propaganda campaign of its effects—real or imagined. and foremost, in reality. Or, at least as close to reality as Throw in the relentless hyping of our celebrity our delusional mind will allow. As we like to restate President by an adoring antiquated-media followed by periodically in these pages, (lest you forget) our approach economically illiterate members of Congress helping sell to investing is steeped in historical grounding. We be- the social reengineering program, (whoops we meant, “A Great Source for healthy gin the investment process by assessing where the cur- economic recovery plan) to the great unwashed (that’d be eating disguised as a Cookbook!” rent economic and financial market cycle is relative to us), and its little wonder we feel like we’re stuck in a bad over 100-years of economic and financial history. “Twilight Zone” episode. Now available for Does this always make us right? Well, of course There’s not a day that goes by where we’re not left $17.00 not, but the way we figure it, it’s a tad better than stick- shaking our heads in utter astonishment at the economic To order Email Marnie at ing our finger in the air and making a wild—ss, guess. A pronouncements from the White House or members of historical foundation gives us a consistent frame of ref- Congress, thinking; “What in the world are they talking Or call (618) 604-1381 erence that helps us gauge prevailing asset prices and about?” That’s because whatever economic snake oil more importantly, their potential risk.(1) We know from they’re peddling that day simply doesn’t comport with Price includes tax our own experience, that if we didn’t periodically check anything we know to be true about economics or finan- Cash and Check Only a historical frame of reference, we’re susceptible to the cial markets. Free local delivery many erroneous and misleading short-term economic (Continued on page 3) ($7 for shipping or mailing) and market distractions affronting us daily. 1) The flip side of the investing equation often lost in the pursuit of riches.
  2. 2. Page 2 Deschaine & Company, L.L.C. VIEW FROM THE FRONT SEAT by Mark J. Deschaine Dividend Growth Revisited Tweaking our EQUITY INCOME Portfolio strategy to meet a changing investment environment. I DON’T HAVE TO TELL YOU its been a chal- company that bought back stock over the last lenging decade for equity investors—and the decade that wouldn’t love to have that money decade’s not over yet. The rally in stock prices back to help them weather the downturn. Changing Strategy to Meet the New Reality Obviously, with a siz- this year has taken some of the sting off of the able number of compa- market’s poor performance but, the reality is Dividends Take a Hit nies reducing or elimi- stocks have not provided investors with any The recession that began in December 2007 has nating their dividend, capital appreciation going as far back as1998. taken a heavy toll on revenues and earnings for finding companies that are likely to raise them The only positive contribution to stock almost all public companies and dividends have becomes increasingly more difficult. That’s returns over that period has been from divi- suffered as the result. The 28.6% drop in divi- likely to be true going forward when we look dends. Since the market peak in 2000, the S&P dend payments for the S&P 500 since December at recent results for corporate America. Casey 500 is down about 5% annually in capital return 2007 reflects the severity of the economic crisis. Research estimates that revenues for the S&P while earning about 2.2% a Our Strategy for Maximizing Dividend Income Before the credit bubble 500 for the 12 months ending June declined year from dividends. That burst in September 2008, from $9.1 trillion compared to $8.4 trillion for equates to a negative aver- Actual EIP Results 10-Year Forecast the financial sector was a the calendar year 2008, a decline in revenue of age annual total return of Dividend Yield: 6.1% Dividend Yield: 6.0% major force behind the more than $685 billion or 7.6%. about 3% since 2000. healthy growth in divi- Of the 500 companies, 363 of them, or At the same time, Dividend Growth: 22.0% Dividend Growth 10.0% dends. The credit crisis 73% experienced declining revenues over the dividends for the S&P 500 Reinvest All Dividends Reinvest All Dividends however, forced many of trailing 12 months. And 85 companies, or 17%, grew from $3.98 in 4th them to cut their dividend. experienced a revenue decline of 15% or more! quarter 2000 to $5.44 for the quarter ending The severity of the crisis means the financial If you assume, as we do, that the eco- June 30, 2009. That works out to a modest an- sector isn’t likely to contribute to dividend nomic recovery isn’t likely to generate signifi- nual growth rate of 3.7%. growth anytime soon. cant economic growth, then corporate Amer- But that’s only part of the story. As re- I note all this because since the inception of ica cannot be expected to show significant cently as the 4th quarter of 2007, the S&P’s the EIP in December 2000, dividend growth has revenue growth. No revenue growth means dividend was $7.62. So the S&P’s dividend been one of the key factors behind the portfolio’s little excess cash for dividend increases. growth from 2000 to its 2007 high was a excellent total return and exceptional annual That brings me to our strategy change, healthy 9.7% annualized. It’s instructive to note income growth. Which brings me to admit that which isn’t really a strategy change so much that the 9.7% annual growth in dividends oc- the EIP has suffered its share of dividend cuts as it’s a capitulation to reality. We certainly curred in an environment where a large number over the last two years, negatively impacting the intend to continue searching for quality com- of companies spent billions buying back their portfolio’s performance and income growth rate. panies with a history of growing dividends; stock. Had they not spent all that money buying Since the financial crisis began, the EQUITY we just don’t expect to find as many as we did their stock—at inflated prices to boot— INCOME Portfolio’s had 13 holdings cut or elimi- in the first nine years of the EIP. We also do dividends might’ve grown faster than 9.7% . nate their dividend. All but three of them were not expect dividend increases will be any- I point this out because I’ve never been a financial related. As a result, the EI portfolio’s where near the double digit annual rate of the fan of companies buying back their own stock investment income declined 22% from December period before the financial crisis. Instead, our for a number of reasons. The most significant is 2007 to June 2009, compared to the S&P 500’s modest expectation is the companies in the EI that most company managers are no better at 28.6% drop over the same period. Although, to portfolio don’t cut their dividend. timing the stock market than the average inves- be completely accurate, a significant part of the That’s the bad news on the strategy tor. Which is to say, not very good. Managers EIP’s decline was due to holding fewer stocks in front. Although, unofficially we do expect to have consistently bought their stock at or near the portfolio as a direct result of the dividend see some organic growth in dividends from the recent market highs and turned around and then cuts. That’s because we sell a stock if they cut portfolio. While future dividend growth may issued new shares to in effect “re” raise the capi- the dividend—for whatever reason. Selling the not match past growth rates we expect to be tal they just spent on their stock, at or near mar- 13 stocks (and some others), meant we held fewer able to increase annual income from com- ket bottoms. The amount of shareholder wealth stocks so fewer dividend payments. pounding and by being able to reinvest divi- destroyed in the process runs into the billions. We also sell if a stock gets one standard dends at higher yields as prices drop. The last five years have been a text book deviation below its 5-year average dividend Sadly, the economic environment implies example of why I think buy backs are a bad idea. yield, which indicates to us the stock is “over- lower revenues, lower net income, and higher The financial sector spent billions buying back valued.” As you can imagine, we haven’t had inflation, which leads me to believe dividend stock just prior to the onset of the biggest finan- much of a problem with “overvalued” stocks payments going forward might be lower as cial crisis in our lifetime. All that did was deplete lately—even after the 50 plus percentage run up well. If that’s the case, we’ll just have to grow their balance sheets of valuable liquidity at a in stock prices since March. income the old fashion way; by capturing time when liquidity has become the most pre- higher yields from lower stock prices. cious commodity on the planet. There’s not a
  3. 3. 3rd Quarter 2009 Page 3 (Continued from page 1) hold in the form of money, everyone will move precision that’s available to us. The emergence at thier own speed to make adjustments when of money substitutes, such as NOW accounts That leads us to ask, “does the Obama admini- their actual cash holdings seem to be off target. and money market funds, has added its own stration and its many well-worn, Clinton eco- And the process can seem to stall, especially muddiness to the picture of how growth in the nomic retreads really believe the crap their when fear is growing. When people are wor- money supply translates into a rise in the level peddling about a nascent economic recovery?” ried or otherwise feel a heightened sense of of consumer prices. It is only because the re- Or is their ill-conceived economic plan uncertainty, they will gladly hold on to abnor- cent episode of monetary expansion has been some sinister plot to render our economy bank- mally large amounts of cash—for a while. so extreme that we can look to the results just rupt thus forcing millions of our fellow citizens, But when fear abates, as it will when the listed for an indication of what’s to come. If we (read Democratic voters) dependent on govern- economy begins to recover from the recession, apply Friedman’s findings to the present situa- ment for their meager survival, thus perpetuat- that temporary demand for extra cash will also tion, here’s what we get. The peak growth rate ing Democratic control of the levers of power fade, and the process of paring down cash bal- in the money supply occurred last December, in Washington for generations to come? ances will emerge to do its inflationary work. so based on the general monetarist schedule: Or is it as we suspect, that the crowd now • Some of the effect on stocks and bonds pulling the levers of our economy are so egotis- Yes, But When? should already have been felt. (Stock tically self-certain that they simply can’t com- The speed at which the public tries to unload market rally since March.) prehend the inflationary consequences of a excess cash and the timing of the effects have • The peak effect on economic activity government spending, borrowing and printing actually been measured, in the work of the late should come between the middle of 2010 money on a scale that’ll put the Germany hyper- Milton Friedman and his monetarist col- and the middle of 2011. inflation of the early 1920s to shame? leagues. The method was indirect and round- • The peak effect on consumer price Regardless of the answer, at this point in about, and so the results, unsurprisingly, were should come between the middle of the economic cycle, even a complete 2011 and the end of 2012. rewrite of the script isn’t going to 2200 2100 change the inflationary ending to this 2000 1900 The Growth of Money Supply Since 1913, A More Particular Schedule Twilight Zone episode. 1800 This time around, should we expect 1700 1600 the year the Federal Reserve was Founded. 1500 Ah, should we be worried? things to move more rapidly or Why We Expect Inflation 1400 1300 more slowly than average? Our bet The main reason we’re expecting 1200 1100 is on slow which would push the price inflation is the recent massive 1000 900 peak inflation rate out toward the 800 growth in the money supply and the 700 end of 2012. One reason for slow is 600 deficit-driven likelihood that more 500 that the government’s rescue pack- 400 such growth (in the supply of money) is 300 ages are delaying the process. Rescu- 200 coming. (Just take a look to the right.) 100 ing banks that are choking on bad 0 As of July, the M1 money sup- loans postpones the day of reckoning Jan‐18 Jan‐20 Jan‐22 Jan‐24 Jan‐26 Jan‐28 Jan‐30 Jan‐32 Jan‐34 Jan‐36 Jan‐38 Jan‐40 Jan‐42 Jan‐44 Jan‐46 Jan‐48 Jan‐50 Jan‐52 Jan‐54 Jan‐56 Jan‐58 Jan‐60 Jan‐62 Jan‐64 Jan‐66 Jan‐68 Jan‐70 Jan‐72 Jan‐74 Jan‐76 Jan‐78 Jan‐80 Jan‐82 Jan‐84 Jan‐86 Jan‐88 Jan‐90 Jan‐92 Jan‐94 Jan‐96 Jan‐98 Jan‐00 Jan‐02 Jan‐04 Jan‐06 Jan‐08 ply (currency held by the public plus for both the banks and the loan cus- checking deposits) had grown 17.5% in tomers. It retards the pace of foreclosure sales a year’s time. That’s not just unusually rapid, nothing as precise as nailing down the value of (whether of real estate or other collateral) and puts it’s extraordinarily rapid. Since 1913, M1 has a physical constant. the deleveraging that has been going on since grown more rapidly in only one other 12-month What the monetarists (or the first of them to be last fall into slow motion. A wilting of the re- period—and that was the one ending last June, equipped with computers) found was that when cent stock market rally would confirm this. when the M1 money supply jumped 18.4%. Even the growth rate of the money supply rises: in the inflation-plagued 1970s, M1 never grew The Inflation Process more than 10% in any 12 month period. • The initial effect is on the prices of bonds This excellent explanation by Steve Saville, of Dropping large chunks of newly created and stocks, an effect that comes within a few of how monetary injec- money into the economy leads to price infla- months. tions into the banking system affect not only tion, because the economy is flooded with cash. • The peak effect on the growth rate of eco- the general price level but the very structure of More dollars chasing few goods is the very nomic activity comes about 18 to 30 months the economy itself will help further explain our definition of inflation. As they try to unload the after the pick-up in the growth rate of the inflationary outlook. excess, they bid up the prices of the things they money supply. (2010, 2011 maybe?) buy, whether it be stocks, shoes, gasoline, silver • The peak effect on consumer price inflation 1) When the money supply is increased by, coins, or granola. The sellers of those things comes about 12 to 18 months after that, say, 10%, the result is not a 10% across-the- then find themselves cash rich and start doing which is to say it comes 30 to 48 months after board increase in prices. This is because the some buying of their own, and so the wave of the peak growth rate in the money supply. new money is spent in specific areas and on excess money and the bidding it inspires specific projects, rather than spread evenly propagate through the economy. As Friedman famously put it, the lags in the throughout the economy. The process isn’t instantaneous. It takes effects of changes in monetary policy are “long 2) Resources get drawn to the areas where the time. Just as each player in the economy has a and variable.” He might have said, “It’s a big, new money is spent, but no new resources sense of how much of their wealth they want to wide blur, but we’re sure it’ll come.” And even that picture exaggerates the (Continued on page 4)
  4. 4. Page 4 Deschaine & Company, L.L.C. (Continued from page 3) tion trends prompted by the monetary illusion). On New money also distorts production the other hand, if the flow of new money is schedules. At the very time when the market were conjured into existence along with the not constricted (if, instead, the central bank is pressuring long-term investment to pull new money. Consequently, existing re- chooses to perpetuate the monetary inflation), then back, the lower rates encourage expansion in sources get sucked away from some parts the end result will be hyperinflation. ways that prolong the crisis. It only delays of the economy towards the initial benefici- Analysis of the 1936-1939 period is instruc- and worsens the inevitable. The Great De- aries of the monetary injection. For exam- tive. Many people believe that the Fed erred pression and Japan’s experience since 1989 ple, let’s assume that the government de- by tapping on the monetary brake during have taught us that government is capable of cides to spend a pile of new money on the 1936-1937, and that if policymakers had sim- doing this to the point that the crisis can last construction of bridges. When it does so it ply kept the money flowing then the US econ- for 17 years. So this is no small matter. A gov- bids away resources, including construction omy would have avoided the 1937-1939 col- ernment determined to prevent recession is a engineers and bridge-building materials, lapse (the depression within a depression). How- government that might end up sustaining one to from other parts of the economy. Which ever, the collapse of 1937-1939 was the inevi- the point of the collapse of civilization itself. has the effect of increasing the operating table consequence of the fact that the preced- The belief that Washington can conjure costs of companies outside the bridge- ing economic rebound had no real foundation. up billions of dollars in new assets without building sector that also employ construc- The rebound was based on monetary inflation anyone having to do anything to make those tion engineers and use similar materials. and increased government spending, rather assets appear is perverse, but pervasive none- These companies will likely find them- than on increased private investment in pro- theless. It is held by both political parties, the selves in financial difficulty due to the gov- jects that made economic sense. It was there- president, the media, and the Congress (except ernment’s decision to direct resources to- fore a foregone conclusion that any slowdown in for Ron Paul). It is a reflexive belief, one that wards bridge building, and some will go monetary and/or fiscal stimulus would soon be reflects a failure to think abstractly between out of business. For another example, let’s followed by a collapse. The only question was stages and recognize the unseen and unforesee- assume that plowing new money into one when. If the stimulus had been maintained for an able negative effects of government intervention. segment of the economy causes the compa- additional year or two, then the ensuing collapse nies within that segment to consume more would have been even more devastating; and if Some Comments from People who Actually oil, leading to an increase in the oil price. policymakers had attempted to make the stimu- Know what they’re talking about. This imposes an additional financial burden lus never ending, then the US dollar would have Austrian School economists argue from the on all other oil consumers, curtailing some been destroyed. logic of scarcity: “There are no free lunches. expansion plans which causes some busi- Shortly after today's policymakers slow the There is no free capital.” When an investor nesses that would otherwise have been viable pace at which the economy is being buys a government bond, he’s deciding against to go under. “stimulated” by new money and increased investing in a private business. He’s also decid- 3) The idea that the government can target government spending, the economic rebound ing not to lend to a private consumer. The the spending of newly created money to- will unravel with startling speed. Alterna- government then allocates this money to fur- wards so-called “idle” resources is a fantasy, tively, if policymakers attempt to maintain the ther the government’s political agenda. That but even if it were true it wouldn’t prevent stimulus indefinitely, then they will create agenda is clear: to expand the power of the monetary injections from changing the hyperinflation. government over the private sector. structure of the economy in an adverse and Over time, the allocation of capital to the unsustainable way. This is because the act of Why is Mr. Saville correct? Because govern- public sector reduces the productivity of the spending the money that has been created out ment creates no wealth of its own. Everything it private sector. The private sector must pay of nothing transfers existing purchasing has, it has to get from us, one way or another. It higher interest rates, or offer more profitable power from the overall economy to the first can tax. It can borrow. And, finally, it can inflate opportunities than the government. People recipients of the new money. by means of credit-market manipulation. This who want safety buy government debt. People third option is the most disguised and poten- who want to accept risk and uncertainty do In summary, when the central bank or the tially the most harmful and it’s what being done not. Over time, those who want safety outbid private banks inject new money into the econ- on an unprecedented scale. those who want more risk. Why? Because the omy the net result is that some businesses are When people hear the words “monetary amount of capital available to the risk-takers helped, some businesses are hurt, resources policy,” they figure that this is something they declines compared to the risk-avoiders. Private are transferred, wastage occurs due to the less will leave to experts. And central bankers capital is “crowded out” of the market place. At efficient use of resources and the govern- have an astonishing talent for obfuscation to that point, corporate retained earnings become ment's take, and a new economic structure the point that no one knows with certainty the main source of new capital. However, retained evolves based on monetary illusion. precisely what they are doing. earnings decline as government grows and regu- The distortions and the wastage caused by The unvarnished truth is that when the lation increases. monetary inflation will be revealed after the Fed artificially lowers rates, it’s creating new The reality of crowding out is evident to flow of new money is constricted. When that money that waters down the value of the those who pursue the logic of economics, happens, many of the activities that sprang up existing money stock, lowering the purchas- meaning the logic of scarcity. Scarcity is over- on the back of the money supply expansion ing power for the dollar in the process. Thus, come by economic growth. Economic growth will collapse and the economy will be forced inflation is, “the increase in the money supply depends on these factors: 1) increased thrift per to reallocate resources based on sustainable that causes general price levels to rise.” consumption trends (as opposed to the consump- (Continued on page 5)
  5. 5. 3rd Quarter 2009 Page 5 (Continued from page 4) Even with these heroic assumptions, the which is just another name for growth economics. Treasury will be obliged to find another $900 The world has yet to see a successful version capita; 2) increased capital per capita; 3) increased billion to finance the remainder of the $1.8 trillion of “trickle-up economic,” an egalitarian society in retained earnings; 4) a lower rate of interest that of debt it’s issuing this year. Washington’s print- which the state ensures that the fruits of eco- comes from greater future orientation among inves- ing presses will need to work overtime. nomic growth are universally and equally shared. tors; and 5) a profit-and-loss system that eliminates Slowing them down will require extraordi- The trouble with this idea—it is, of course, the the inefficient producers and or investors. nary political will. With government expendi- socialist idea—is that it does not produce those The expansion of government erodes all five tures now running 185 percent of receipts, truly fruits in the first place. Economic growth is pro- factors. 1) Thrift falls when people trust the gov- major changes in both taxes and outlays will be moted by entrepreneurs and innovators, whose ernment for their future income. 2) Capital in- required. A revived economy can’t come close to ambitions, when realized, create inequality. No vestment in private ventures falls as the govern- bridging that sort of gap.” one with any knowledge of human nature can ment absorbs invested funds. 3) Retained earn- Welcome to the real world, Warren. Some of expect such people not to want to be relatively ings fall as a result of reduced capital and in- us have been preaching for years that deficits, if rich, and if they are too long frustrated they will creased regulation. 4) Interest rates rise because unchecked, will ultimately lead the government cease to be productive. Nor can the state substi- of reduced concern about the government- to put the printing presses in overdrive, in an tute for them, because the state simply cannot guaranteed future. Present-orientation increases. attempt to inflate our way out of debt. This will engage in the “creative destruction” that is an 5) The profit-and-loss system fails because the eroded the value of the dollar. Buffet ended with the essential aspect of innovation. The state cannot government bails out the biggest, least efficient following tidbit: “Unchecked carbon emissions will and should not be a risk-taking institution, since firms, above all large banks. likely cause icebergs to melt. Unchecked greenback it is politically impossible for any state to cope The bottom line of it all: more government emissions will certainly cause the purchasing power with the inevitable bankruptcies associated with begets more government all to the determent of of our currency to melt. The dollar’s destiny lies economic risk taking. private wealth creation and a rising standard of with Congress.” living for the rest of us. And, President Obama too. Right Warren? Do Share Buybacks Benefit Shareholders?(3) Buffett Speaks the Truth—Finally Buffett recently piped up on the subject of gov- Thomas G. Donelan Editor, Barron’s October 5, 2009 T here’s a school of thought that companies engage in share buybacks to support the share price to the general benefit of shareholders. ernment financing and offered the following analysis. Since he is a high profile Obama sup- porter, we thought, in the interest of fairness, we M ore regulation can make Americans safer, stronger, happier, better informed, and less free. Or so it seems. Insufficient regulation Share buy backs indirectly return excess cash generated by the business to shareholders by bidding up the share price when buying their include his comments. has been the diagnosis offered this year to iden- stock. We’re not convinced. A study by Standard Buffett noted: “An increase in federal debt tify what ails banks, brokers, health care, drugs, and Poor’s might help to explain our position. can be financed in three ways:” medical devices, securities, business competition, Here are some highlights from the study. transportation, and the Internet. We can’t deal For the three years ending December 2007, 1. Borrowing from foreigners, with them all in one week, so we take special the companies in the S&P500 index spent: 2. Borrowing from our own citizens or, note of the regulators on our turf. Although the 3. Through printing money. Securities and Exchange Commission was • $1.318 trillion in share buybacks; founded in the 1930s, its efforts to protect con- Let’s look at the prospects for each individually, sumers have not yet succeeded. But it knows • $1.276 trillion in capital expenditures; and in combination. why: All it needs is a little more power. • $376 Billion on research and development; and The current account deficit—dollars that we We’ve heard that a government with enough • $605 Billion for common dividends. force-feed to the rest of the world and that must power to do a lot of good is a government that then be invested—will be $400 billion or so this equally has enough power to do a lot of harm. To put these numbers in perspective, at the time year. Assume, in a relatively benign scenario, After examining a recent report from the SEC’s the entire market capitalization of the S&P 500 that all of this is directed by the recipients— inspector general on their mishandling of the was approximately $14 trillion. We were under China leads the list—to purchases of United Madoff mess, we must add a codicil: A govern- the impression that corporate America spent States debt. Never mind that this all-Treasuries ment pretending it can do a lot of good automati- more on R&D than share buybacks. allocation is no sure thing: some countries may cally will do a lot of harm.” Share buybacks was the highest expenditure decide that purchasing American stocks, real while dividends came in last. Over the last ten estate or entire companies makes more sense Income Inequality Without Class Conflict years, dividends were approximately half what than soaking up dollar-denominated bonds. By Irving Kristol(2) was shelled out in share buybacks. But are share Rumblings to that effect have recently increased. The Wall Street Journal, Dec 18, 1997 buybacks really returning value to the sharehold- Then take the second element of the scenario - borrowing from our own citizens. Assume that Americans save $500 billion, far above what I t is often said that capitalism—that is, a mar- ket economy—is morally obnoxious because its “trickle-down” economics inevitably creates ers? If they do, why aren’t companies on a buy- ing binge in this market environment? The cur- rent environment provides the best buying op- they’ve saved recently but perhaps consistent inequality of income and wealth. Now it is cer- portunity for their stock in years. Shareholders with the changing national mood. tainly true that “trickle-down” economics” has that need downward price support “now.” Instead Finally, assume that these citizens opt to put effect. It is also true, however, that if you want eco- companies are preserving cash. Why didn’t they all their savings into United States Treasuries nomic growth and greater affluence for all, there is (partly through intermediaries like banks). simply no alternative to “trickle-down economics,” (Continued on page 6) 2) Kristol was the “Godfather of neo conservatism, which he defined as “a liberal mugged by reality.”Kristal passed away recently at 89. 3) This article was from by Dividend
  6. 6. Page 6 Deschaine & Company, L.L.C. (Continued from page 5) $31.3 billion on dividends. It’s important to note How Did It Happen? that during the period reviewed, GE’s dividends How did it come about that Americans, long preserve cash when they had piles of the stuff? were higher than their buybacks. The share respected for independent thinking and a strong Standard and Poor’s noted the following: count went from 10.5 billion in 2005 to 10 bil- sense of individualism, hand over the reins of the “Traditionally, companies have used buybacks lion in 2007, or a drop of approximately 500 mil- nation’s destiny to an entrenched bureaucracy— to offset the issuance of employee options, M&A lion shares. So does $25.7 billion buy 500 millions busybodies who take no career risks, who care activity, to temporarily support their stock and shares? The math says, $25.7 billion/500 million for little other than tenure, and think nothing of to reduce their share count. Over the past decade shares, is approximately $51 per share. But during taking their daily bread from the mouths of the the option portion has accounted for the major this period GE stock price never reached $51. productive sector while simultaneously interfer- use of repurchased shares and actual share re- The study tells us PEP, INTC and GE ing with their ability to produce? ductions the least. Companies usually highlight bought back their shares primarily to offset the We’ll tell you how: one insidious step at a time. and lump these expenditures, along with divi- options exercised by management thus transfer- As always, thanks for reading. MJD dends, and present them as a return to investors ring profits more to management then share- of shareholder value.” holders. It appears that management at the three A majority of the buybacks were used to offset companies were more intent on balancing the the shares related to the exercise of stock op- options pricing than create shareholder value. About Exchange Traded Funds (ETFs) tions by managements and employees. Typi- By Matt Powers cally, the majority of the options are held by Cash for Clunkers Vice President & Portfolio Manager management, while employees’ have a minuscule Just one more bad idea from government percentage. Buying back stock helps keep prices With the administration and Democrats in Con- at higher levels, so that management gets more gress hailing the “Cash for Clunkers” program such E XCHANGE TRADED FUNDS, more com- monly known as ETF's have increasingly become a key investment vehicle for individu- value for their shares. This is an indirect way to a huge success, we thought we’d take a look at the als as well as institutions. From 2000 to 2008, pay themselves. In addition, results of the program for our- total ETF investments grew from under $100 the reduction in shares out- “One key point to pay attention selves. Here’s what we found: billion to close to $600 billion in the U.S. alone. standing helps increase EPS to going forward is the expira- With a growing pool of ETF options and (assuming controlled buying tion of the Bush-era tax cuts, • Number One. The rank of the the strategies available to employ them in a through-out the year). In the schedule to end in 2011. Even if Ford Explorer as the most- portfolio, it can be difficult for an individual to study, S&P looked at a num- Obama didn’t add a single new traded-in clunker. Also the rank determine which ETF suits them best. In this ber of stocks, we’ll look at tax or increase those we al- of the Toyota Corolla as the most article we will give you a brief introduction to three: PEP, INTC, and GE. ready pay, the expiration of purchased new car in cash-for- ETFs. In future issues of Viewpoint we’ll go Pepsi (PEP): From 2003 those tax cuts will amount to clunkers deals. into more detail including our strategy for to 2007, PEP spent $10.3 one of the largest tax increases • 2.878 billion, total cash dis- $ using them in portfolios. billion in share buybacks and in U.S. history.” pensed by the program. $8.1 billion paying quarterly — “The September 2009, Casey Report” What Exactly are ETF's? • 15.8 mpg, the average mpg dividends. During each of the An ETF is very simply a hybrid of an index rating on the clunkers traded in last four years, dividends were consistently fund and a stock. The fund itself is usually compared to 24.9 mpg average of the new cars created to closely track an index or an individ- lower than buybacks. Now the conventional sold. wisdom says the number of shares outstanding ual market sector (i.e. S&P 500, Russell 2000, or should have been reduced by now. The share • 80 , the percentage of U.S. auto makes traded in % financials) but it trades like a stock in that you count went from 1.705 billion in 2003 to 1.605 and the percentage of foreign auto makes pur- can buy and sell the ETF all day long as with a billion in 2007 or about 100 million fewer shares. chased under the “CFC” program. common stock. One advantage for investors is Did $10.3 billion buy only 100 millions shares? • 28 days’ supply of Chrysler’s inventory at the end they instantly gain exposure to a sector or asset The math says, $10.3 billion/100 million shares, of the program compared to the usual 60 days. class--index-like diversification--with one trade. is approximately $100 per share. But during this • 55 days, the total length of time the program was This is similar to an open-end mutual fund. period PEP market share price never went near in effect. $100 per share. • 690,114 total 700 Why invest in Intel (INTC): From 2003 to 2007, INTC number of ETFs? 600 The Growth of ETFs spent $22.4 billion buying shares and $8.4 billion “Cash for 2000 to 2008 (in billions) First, ETF man- on dividends. During the four years we looked at Clunkers” 500 Source: (IShares) agement ex- dividends were consistently lower than buy- transactions. 400 penses are usu- backs. The share count went from 6.5 billion in • And the most ally lower than 2003 to 5.8 billion in 2007, or about 669 million notable stat of 300 those of tradi- shares. So does $22.4 billion buy 669 millions all, drum roll 200 tional mutual shares? The math says, $22.385 billion/669 million funds, sometimes please: 40 , the % shares, is approximately $33 per share. But again, 100 much lower. For average drop in during this period, INTC was well under $33 (it example, the auto sales for 0 peaked at 33 for brief period in December 2004). 2000 2001 2002 2003 2004 2005 2006 2007 2008 average “Large- U.S. Auto General Electric (GE): From 2005 to 2007, makers in the 30 days after the program ended. (Continued on page 7) GE spent $25.7 billion in share buybacks and
  7. 7. 3rd Quarter 2009 Page 7 MAN MADE & HARMFUL REPLACE WITH GOD MADE First Rule of Healthy Eating, Do No Harm Eliminate artificial sweeteners: consider Raw sugar, Agave, Honey or Brown Rice Bad food is more harmful than good food is helpful them the poison they are. Syrup. From Women for Well Families new cook book, “The Art of Eating Well.” Eliminate all microwave cooking. It literally Buy a teapot, and use your cook top. I n today’s processed food world, it is almost impossible to eat turns healthy food into poison. healthy 100% of the time. The center isles of our supermar- Limit lattes, cappuccinos and macchiato. Black organic coffee or use organic half and kets are filled with processed, FDA approved “foods” that are half and one of the above sweeteners. devoid of nutrients and filled with toxins that can actually be Strictly limit white sugar and flour. Whole wheat and white whole wheat flours. chemically addictive. Think Cheeto’s Cheese Puffs. In fact, Above sweeteners. most of the things people eat today are so devoid of any benefi- cial ingredients that arguably they’re not even food. Eliminate soda, diet soda, Crystal Light, Pure, filtered and pH balanced water bottled sweetened teas, colored flavored (between a 7.0-7.8 ph). Fiji and Evian bottled Sadly, even the produce-section of the average grocery waters, sports drinks, and Dasani, Nestle water is best. Or use a Brita pitcher. Do not store is a mine field of unhealthy eating. That’s because over and Aquafina waters. These will not provide alkalize with artificial additives. Too the last 50 years the advent of pesticides, genetically-modified the desperately needed hydration to cells. muchalkaline is just as unhealthy as too foods, and depleted soil means even healthy raw fruits and little. Make your own green tea. vegetables have significantly less nutrients then they did in our Strictly limit preservatives, dyes and fillers Grandma’s canned food. Fresh and if not grandparent’s day. For example, did you know that baby car- in packaged and canned foods. The longer fresh than frozen. Real oatmeal vs. instant. rots are dipped in a solution of water and chlorine to preserve the list of ingredients and the harder to Avoid shopping in the middle aisles. Try pronounce—the less healthy. organic whenever possible. them! Consequently, making better food choices like fruits and vegetables alone will not be enough to restore and maintain Strictly limit animal protein: red meat, Organic, range - fed, hormone and antibiotic your family’s health. It will be equally important (if not more so) chicken, fish, eggs, all dairy. Animal protein free animal protein and dairy 3-4 days a creates an acid environment (read Alkaline week. Eat only 40-50 grams per day. Or- to identify and eliminate, where possible, the harmful foods and Reserves). ganic beans and raw nuts on a salad, in soup habits. A salad at lunch will not compensate for poor food and in brown rice. Hummus on whole grain choices the rest of your day. As with anything in life, the bad Like fake sugar, avoid completely margarine wraps and crackers. Small amounts of real will drive out the good. And so it is with food as bad food will and egg beaters! They do much more harm organic butter or organic eggs can be than good! healthy. do many times the harm than the good food will help to restore you and your family’s overall health. Avoid Soy unless you are menopausal. Soy If you want to use soy as an animal protein Making this even more critical is the realization that the milk should be avoided, especially by chil- substitute, use it in its whole form— dren. Today, our over stressed livers cannot edamame (soy beans). They’re in the pro- current generation of children are almost certainly born under- handle the excess estrogen promoted by duce section. They look like pea pods. nourished from the poor eating habits of their parents. It was soy. unavoidable. Since birth, this same generation has experienced little in the way of health building nutrition, but rather we’ve PESTICIDES AND PRODUCE been subjected to health depleting meals, beverages, medica- BEST TO BUY ORGANIC NO NEED TO BUY ORGANIC tions, toxins and emotional stresses. Apples, bell peppers, carrots, celery, cher- Asparagus, avocadoes, bananas, broccoli, With all this working against us in achieving health for ries, lettuce, nectarines, peaches, potatoes, cabbage, eggplant, kiwi, mangoes, onions our family, wouldn’t now be a good time to begin reversing the spinach and strawberries. and pineapples effects of unhealthy eating by switching to more nutritional and less harmful foods and habits? Love Your Liver: Drink fresh squeezed lemon juice from half of a small lemon or ¼ of a large lemon in a cup of hot (temperature of hot tea or coffee) water before bed. The liver Here is a table of suggestions on how to begin making the does its repair and maintenance between 1and 3 a.m. The hot lemon water will help the transition from harmful to helpful eating. Remember, the most liver detoxify and stimulate enzyme release. You may add a bit of Agave if too sour. Rub important thing is to begin. used lemon rinds on “liver spots” on your skin—it helps break them down and fade. Other foods that love your liver: cabbage, cucumbers, carrots, celery, garlic, onions, See front page for information on buying a copy:“The Art of Eating Well.” lemongrass, sesame and cilantro. (Continued from page 6) Traditional mutual funds have the flexibility to shift from one stock Cap” equity mutual fund’s expense ratio is 1.43% while the Vanguard to another, or even out of stocks to hold cash. Index based ETF's always Large Cap ETF's expense ratio is only .13%, well over a 1% difference. track their respective index, no moves to cash. This is one of the advan- This can result in a significant savings over the life of the investment, tages of ETFs in a portfolio designed to meet a specific asset allocation, particularly in the low return environment we’re in today. because we can be certain the fund will remain true to its sector or asset ETF's have a real-time quoted unit price during regular stock mar- class and will not undermine our asset allocation by changing theirs. ket trading hours as they are bought and sold on an exchange just like a stock. Compare that to the traditional open-end mutual funds shares Designing a Portfolio with ETFs which are calculated and priced daily after the market closes. This makes Next quarter, in the year-end edition of VIEWPOINT, we will explore our it difficult when making a purchase or liquidation as the true share price of process of selecting and our method and strategy for utilizing ETFs in a a mutual fund is not known until market close. The current share value is portfolio. In the mean time, please feel free to contact us and we would be known immediately with an ETF. happy to sit down with you to discuss how ETFs might fit into your overall portfolio strategy. MTP
  8. 8. Deschaine & Company, L.L.C. A REGISTERED INVESTMENT ADVISOR 128 South Fairway Drive Belleville, Illinois 62223 Looking to Buying Gold, We Suggest: “Proceed with Caution” 1) Physical Ownership: Physically buying gold bullion is relatively By Jason Loyd, Vice President & Portfolio Manager simple, but some homework is required. There are a growing number of companies that sell gold coins and even small bars to the public. The T HERE’S NO WAY AROUND IT, gold is a popular topic of discussion catch for you as a potential investor in physical gold is that you have to be among investors these days. Yes, gold certainly is a “hot commodity,” able to make sure you are getting the highest quality gold content in your no pun intended. One would have to be living in a cave (or at least not asset at the right price. Certainly one trustworthy place to go to buy gold watched television in the last decade) to not be aware of all the hype now sur- is the US Mint. rounding gold. If I had a dime for every commercial I’ve seen in the past 2) Gold Certificates: These provide you with a certificate of owner- year trying to convince me to buy gold, I’d be, well, rich. ship of gold without hassle and cost of physically storing and safekeeping. At the same time, with all the uncertainty in the economy, it’s under- 3) Gold Bullion Exchange Traded Funds: These recent develop- standable why folks are jumping into gold. The rapidly weakening US ments are an innovative and cost effective way to invest in gold without dollar is one of the reasons investors have been flocking to the yellow stuff. having to find a mattress or digging a hole. Gold ETFs capture the price The dollar is weak because of a growing concern about the potential for of gold minus a nominal administration cost. To buy a gold-tracking ETF inflation, as a result the price of an ounce of gold has skyrocketed to an all can be done through your brokerage account. Since ETF’s are traded on time high. Gold has averaged a healthy return of 12.96% per year over the the stock exchange as discussed on page 6; they provide liquidity and past 10 years, while at the same time the S&P 500 has lost about 3% of its transparency. value. The US Dollar continues to weaken against other currencies, and it 4) Gold Stocks: Buying gold mining companies is certainly a viable doesn’t take a PhD to figure out why. Take a look at the chart of the his- option; although it should be noted that it does tend to have higher risk to tory of the US money supply on page 3. When our government creates, return ratio than just buying gold because there is the added risk of mar- prints, and shovels this much money into the economy this quickly; it di- ket fluctuations that often have little to do with the fluctuations in the lutes the value of the dollar. Since there is not a corresponding increase in price of an ounce of gold itself. Additionally, there’s the usual amount of the stock pile of gold its price rises. Customarily, the dollar and gold have security research, knowledge, and monitoring that goes along with any an inverse correlation. That means that when the dollar goes down, gold equity investment. usually rises. Historically, as inflation rises, gold has risen with it. Just as with any investment, it’s important to take a long hard look at Let me first say that gold is not the answer to all of the worlds’ finan- the potential downsize before investing in gold. We think one of the pri- cial problems. There have been many times we recommended reducing a mary downside to gold right now is this; it’s just too darn popular. Our gold position rather than increase it, for one simple reason—risk. While experience tells us we should get nervous when an investment or asset many indicators point to the price of gold going higher, it is still prudent to class gets too fashionable. Over the past five years, about 65% of the de- remain diversified, regardless of the conviction you may have on a particu- mand for gold has been for making jewelry. India is the largest buyer of lar investment. Second, we have to remember that while gold can be an gold, as they buy up 25% of the world’s gold supplies. With a slow world important store of value in these times of potential inflation it is not par- economy, what happens to the price of gold if the Indians decide that silver ticularly useful as every day currency. It may not be convenient to carry or platinum is more in vogue? around, but enough gold can buy almost any good, service, or currency we The key is to remember that no single investment is a sure thing. want, in nearly any economic scenario. Thus, our advice to anyone buying gold today would be to proceed, but Gold can however, act as a hedge against inflation, (or hyper-inflation with caution. Meaning? Maybe get your toe wet buying a little and see possibly?), stock market meltdowns, and economic or global turmoil. where the price goes. If it drops from here you would always have the op- Let’s briefly look at the different ways to buy and own gold: tion to buy more. Just remember, too, that old adage: “What giggles isn’t always Jell-O and what glitters isn’t always gold.” JML PUBLISHER: MARK J. DESCHAINE EDITOR: JOHN H. DESCHAINE CONTRIBUTING EDITOR: TOM O’HARA COPY EDITOR: MARNIE E. DESCHAINE STAFF CONTRIBUTORS: MATT POWERS, JASON LOYD TECHNICAL ADVISOR: Joseph M. Deschaine. VIEWPOINT is a comple- mentary publication of Deschaine & Company, L.L.C. a registered investment advisor in Belleville, Illinois. This information has been prepared from sources deemed reliable, but its accuracy is not guaranteed. It should not be assumed that any securities discussed will be profitable or will equal past performance, or is it an offer to buy or sell any security mentioned. Deschaine & Company and/or one or more of its clients, employees, family or friends may have a position in the securities discussed herein. © 2009 All rights reserved. Reproduction of this publication is strictly forbidden without written consent from Deschaine & Company. This issue was published on October 20, 2009. If you would like to receive a complementary copy each quarterly, simply send us your address and the preferred method of delivery: snail-mail or email, to: 128 South Fairway Drive, Belleville, IL 62223 Or email us at and we would be happy to add you to one of our mailing lists.