Helping You Navigate an Uncertain Investment World
Year End 2008 EQUITY INCOME Portfolio Strategy Update
Extraordinary Times Require Extraordinary Action to Protect Your Assets
T a long economic decline after slumping businesses and
HERE’S NO DOUBT, 2008 was a year for the Market 2008 Snapshot
unemployed consumers have exhausted their financial
history books. Easily on par with other notable
Core Bond Fund 7.8%
resources and have no choice but to default on their debt.
years like: 1929, 1933, 1941, 1945, 1963, 1968,
Physical Gold 6.0 The banking crisis of 1933, for example, happened four
1973-75, 1981, 1987, 1994, and 2001. We don’t have to
tell you why. Not withstanding the election of the first years into the Great Depression. Such historical realities
Gold ETF 5.0
African-American President, most of what occurred in do not bode well for 2009 and beyond.
5-7 Year Corp Bonds
2008 was not good. Some financial highlights for the More specifically, we figure we’re about a third of
1-3 Year Treasury ETF 3.0
year are tallied to the right. But again, if you’ve already the way through a recession that began in December
seen a recent account statement, you already know pain- 2007. We also expect that the economic decline will be
EIP Total Return* -18.0
fully well what happened in 2008. So we won’t spend a as bad as any in the post World War II period. Only
Dow Transport -21.0
lot of time sweating the details. Let’s just say that 2008 when insolvent banks are shut down, others are recapi-
EIP quot;Equity Only” Return* -24.0
was a year we’d like to forget and leave it at that. talized, and debt levels in general are reduced will the
But the overwhelmingly dismal returns for the conditions ease. Put it this way, we’ve just come off the
Dow Jones Industrials -33.0
financial markets don’t begin to tell the story of 2008. greatest credit bubble in the history of mankind. A bub-
Dow Utilities -34.0
The collapse of the credit markets has rattled the inter- ble that took more than 15 years to form. It’s going to
High Yield Bonds -34.0
national financial system to its very core and has yet to take at least that long to unwind. The “unwinding” will
regain its footing despite billions in federal loans, money, take the economy and the financial markets to levels last
S&P 500 -38.0
credit, federal and Treasury Department jaw-boning, reached in the early 1980s—single digit price-earnings
and even the political wizardry of the new guy in the ratios on depressed corporate earnings—at the bottom.
White House. And probably double digit unemployment.(1)
Emerging Markets ETF -55.0 Between now and then, we can expect further
That’s the message of this update: the economic road
downside risks in the stock market. With interest rates
ahead is likely to be a bumpy one. What has us concerned is Financial Sector ETF -55.0
at record lows, they only have one direction to go, and
the fact that the financial system is in a virtual meltdown Alternative Energy ETF -61.0
that’s up! Making any long-term bond or bond fund an
at the FRONT end of what is shaping up to be a long
* Equity Income Portfolio Total return for 2008
and protracted economic downturn. In the usual se- and the return from the equity holdings “only.”
quence of events, the financial system fails at the END of (Continued on page 2)
“Inflation Adjusted” The Dow Jones Industrials Market Peak Peak to Trough 18 Years?
Dollars: 1900 — 2008 The highest on record!
Market Peak Peak to Trough
30 15 Years
Peak to Trough
A B Our Market Forecast 2000—2035
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
30 Years 37 Years 34 Years 35 Years ?
1) If our economic forecast comes even close to realization, we think it’s a better than even money bet Obama is a one termer! Remember you heard it here first. One caveat: that’s
assuming the Republican’s put up someone who can talk about economic growth policies and walk and chew gum at the same time, no sure thing, that.
Year End 2008 Equity Income Portfolio Strategy Update
3-Month & 10-Year Treasury Monthly Yields 17.00
April 1954 to December 2008 16.00
INTEREST RATE OUTLOOK 15.00
Interest rates are at an all time low, in the case of short 14.00
term Treasury Bills, near zero! Call us crazy but we’re
betting the next move for rates is up! For our strategy for
bonds see Long-term Interest Short ETF on page 4.
for the market as a whole reach single digits. Dow Jones Industrial down 33.1% and the
(Continued from page 1)
equally risky place to be—and that’s before fac- Nothing we see changes that expectation. We’ve NASDAQ Composite index bringing up the rear
toring any defaults and a further erosion in the shown the chart at the bottom of page one of the at a 40.5% drop. We have to admit, we never
world credit markets. Dow Jones Industrial Average adjusted for infla- thought we’d rave about being down 18%, but
As we discuss in the feature, we do not be- tion a couple of times to give an estimate of a time that’s the world we live for now.
lieve the “economic recovery plan,” being cobbled line for reaching a P/E bottom. The section in All told 2008 will be a year to remember or
together by the new President and his collabora- red is our long-term expectation for the stock maybe to forget. Unfortunately, 2009 is shaping
tors in Congress is the fix for what ails the econ- market. We used this chart for our long-term up to bring us a similar outcome.
omy. In fact, we believe it could very will make market forecast in 2000. The chart has been im-
The Power of Dividends
things worse by propping up shaky financial portant in building a long-term investment strat-
institutions rather than letting them die so egy. Given the average 15-18 year peak to Cash Flow for Living and Reinvesting
healthy ones can prosper. The process is akin to trough ,the chart indicates a bottom somewhere Not since the Standard & Poor’s began keeping
thinning a forest of the dead trees so the healthy between 2015 and 2020. That’s the good news. track of dividends in 1956, have payouts been
ones can thrive. We point to Japan’s experience The bad news is stocks have a nasty tendency to worse than they were in 2008’s fourth quarter.
with a similar ineffectual program over the last 20 linger at the bottom for an extended period of The devastating effects of the credit mess on
years, as the ah, “model” we’re about to emulate. time. As much as ten years in some cases. banks and other financial companies pushed over-
Our opposition to Obama’s “stimulus” plan all dividend payouts down 30% for the year, while
EQUITY INCOME No Exception to the Rule
is not partisan. We’re not reactively anti-Obama, special dividends dropped 17% from last year.
it’s just that there’s no evidence to support a plan The year of 2008 was notable to us here at On an even more telling note, a total of 606
that is equivalent to the government handing out Deschaine & Company because it was the first out of 7,000 companies reduced or eliminated
credit cards and encouraging everyone to go to absolute down year in total return since we began their dividends in 2008, with half of the total in
the mall and spend their way to financial wealth. the fourth quarter. This compares to only 44 for
the EQUITY INCOME Portfolio strategy in De-
Yet, regrettably, the euphoria of Obama mania all of 2007. Conversely, S&P reports that the yield
cember 2000. We take some comfort in that well
insures its passage. on stocks paying a dividend has doubled over the
worn phase: “it could have been worse.” And yes, by
Obviously, such economic expectations last two years to 7.28%. But there are surely more
gum, it could have been a whole lot worse. For
implies risky times ahead for just about all finan- dividend cuts on the way.
one, we could have taken the Chinese's lead and
cial assets. So that leads us to the critical question; We were not immune to the dreaded divi-
bought Blackstone at their initial public offering,
what the hell do we do about it? dend cut in 2008. In fact, seven stocks in the EIP
($31 a share now $4.50 as share) and watch our
cut or eliminated their dividend last year trigger-
capital drop 86%. Fortunately, a modicum of ra-
THE STOCK MARKET OUTLOOK ing our SELL signal. The cutters were: BAC,
tional analysis prevailed and we managed to
ALD, ACAS, AINV, TICC, ARCC, and C. Note,
dodge that deadly bullet.
The Train to Single digit P/E’s right on Time
they’re all financial related businesses.
We held about 30% of the EQUITY INCOME
A Paradoxically, many of them raised their
S VETERAN VIEWPOINT READERS KNOW, Portfolio and a similar percentage of client port-
dividend in 2008. In ACAS’s case, right up to the
we’ve said the stock market’s been in a long- folios in money market funds to offer some princi-
time they announced they were eliminating it. As
term bear market since it peaked in 2000. The pal protection from what we saw coming in 2008.
the credit crisis hit financial stocks particularly
Standard & Poor’s 500 Index negative total an- Our high cash position did mitigate losses to a
hard because they have to continually access the
nual return of 2.9% over the eight years since 2000 negative 17.9% total return, while the stocks in the
validates our contention. We also believe the portfolio dropped 23.7%. Those numbers compare
current bear cycle will not end until P/E ratios to the S&P 500 index which was down 38.5%, the (Continued on page 4)
Deschaine & Company L.L.C.
nomic circumstances, we think
(Continued from page 2)
Equity Income Portfolio Annual % Returns
credit markets to operate a modest 5% bet the shaky
Cumulative Annualized financial sector will drop fur-
their business. Often, if a
2001 2002 2003 2004 2005 2006 2007 2008 Return Return
bank stock price got ham- ther is a reasonable one. We’ll
EQUITIES “ONLY” 21.8 8.1 28.2 24.4 4.6 21.9 .2 ‐ 23.7
mered, it presented a buy- limit our downside with stop/
TOTAL RETURN 15.8 6.9 19.3 19.4 3.8 19.0 1.1 ‐ 17.9
ing opportunity because losses on all shorts.
even in slow economic S&P 500 INDEX ‐12.0 ‐21.9 28.5 10.7 4.9 15.6 5.5 ‐ 38.5 - 20.9 - 2.9 • Short Dow 30 ETF. Bet-
times, banks have cash flow from interest and fees Portfolio Asset Allocation: In the most ting the Dow stocks will drop, see above.
that can cover the dividend. As an investor, the radical change in the EQUITY INCOME Port- Think GM.
smart thing to do was to use the opportunity to folio’s asset allocation in its history, begin- • Short Emerging Markets ETF. With the
buy more shares. Not so in 2008. The credit envi- ning February 1, 2009 portfolios asset struc- world economy in a protracted slump, the
ronment in 2008 was so severe and changed so ture will be as follows: still overvalued emerging markets are
quickly that many banks had years of uninter- likely to fall further.
rupted dividends broken before being acquired or Equities: 50.0%
• Long-Term Interest Short EFT. This
bailed out. ETF and the Gold Stock ETF below are
Short Financials ETF: 5.0%
bets on inflation returning once the world
Short Dow 30 ETF: 5.0%
EQUITY INCOME Portfolio gets a gander at the trillions in bonds our
Short Emerging Markets ETF: 5.0%
government will be issuing soon. That fact
Strategy Review for 2009 Long-Term Interest Short EFT: 5.0%
alone is likely to push interest rates, which
Gold Stock ETF: 5.0%
It’s Not the Return on Your Money,
in the case of the short-term treasury bill
Total Portfolio: 100.0%
it’s the Return of Your Money!
are currently close to ZERO, much higher
W the usual Let’s discuss our thinking for each asset class: from fears of rising inflation
E’RE GOING TO SKIP
• Gold Stock ETF. This is a basket of Gold
detailed review of the EQUITY
INCOME Portfolio and in its • Equities. We’ll continue to manage the mining stocks. Since few gold stocks pay
50% of the portfolio in equities just as we’ve much of a dividend, we can’t find any that
place offer a more generic investment strat-
done with the EIP over the last eight years. meet our investment criteria. Besides, this
egy including specific recommendations. We
We will just focus on stocks we believe offers us more diversification than we could
think such an approach will be more useful to
have the financial strength to maintain do on our own.
their current dividend. Any dividend
Some of the assumptions we used in com-
growth we’ll just consider a bonus. Any There you have it. The most radical strategy
piling our recommendations are:
purchases will be made with the full expec- change in EQUITY INCOME Portfolio history. A
tation that the stock will be 20 or 30% (or strategy designed to protect our assets in what we
• The economy is in a protracted downturn
more) cheaper in the future. Which, now believe is the most difficult investment environ-
that could last as long as five years.
that we think of it, is the way all equity ment in a generation. We’ll do our best to keep
• The credit down cycle that began in late investing should be done. you apprised of our strategy in future issues.
2007 will continue to unwind, causing
• Cash. We will maintain 25% of the portfo- We always welcome your questions regard-
deflationary pressures on prices and asset
lio in money market funds. While short- ing our strategy or any other aspect of our invest-
values short term.
term rates don’t offer much return, the cash ment management services. As well, we’re happy
• The economic stimulus will have little cushion, just as it did in 2008, will help to meet with you to discuss our strategy and offer
effect on economic growth, but will fuel an protect portfolio’s downside risk. Second, our thoughts on it’s suitability, in whole or in part,
inflationary cycle over the long term. the cash will provide buying power as for your personal circumstances.
• Interest rates will remain low until the stocks get cheaper, as we are certain they We would also be happy to review your
credit cycle shows sign of a bottom, at will—eventually. And last, as interest rates existing portfolio or asset list. The portfolio re-
which time inflationary pressures will push rise for inflationary pressures, the cash view is always free and with no obligation.
them higher. allows us to benefit from rising rates. If you’d like us to do a review of your invest-
• Stock prices are still 50% above their long- • Short Financials ETF. The last ten years ment portfolio. all you need to do is provide us
term bear market bottom. with the ticker symbol and the number of shares
has brought investors what’s known as
• The financial sector remains the most or units, either as one list or listed by portfolio,
“Exchange Traded Funds.” Theses are
you prefer and we’ll enter the information in our
vulnerable sector of the stock market. baskets of stocks set up to achieve a specific
handy-dandy computer and provide you with a
• The economic slump will put many nor- investment objective. In the case of the
detailed review all your own. Free for nothing!
Short Financial ETF, its a basket of large
mally safe dividends at risk.
Simply email the information to
financial stocks designed to go up when the
email@example.com. We keep all informa-
financial sector of the S&P 500 index goes
Those are just a handful of the many assump-
tion provided to us in strict confidence.
down. Its what’s known as “shorting the
tions we considered when formulating the
We see the next couple of years as challeng-
market.” In ordinary times we would re-
investment strategy for 2009 and beyond.
ing ones. We want to do what we can to help you
frain from making such bets, however like
survive it with your wealth intact.
we said, “extraordinary times require extraor-
dinary measures.” Under the current eco-