Cornerstone Chartbook September 2010

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10/5/2010 The September 2010 Chartbook: “The Challenges of Being an Optimistic Contrarian” September 30, 2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Mine was the only hand in the room. : 

Mine was the only hand in the room. The title for this month’s Chartbook comes from a recent meeting of fifty some-odd leaders in Mobile present to hear our Congressman provide his assessment of what was going on in Washington. During the presentation, he asked if anyone thought we were in a robust recovery. No hands went up. He then asked if we were even out of recession yet… one hand went up. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term - valuation : 

Why we like stocks for the long-term - valuation The collective earnings of the companies in the S & P 500 continues to improve. At an aggregate Price / Earnings ratio of 15x, stocks are not expensive. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term - valuation : 

Why we like stocks for the long-term - valuation In fact, corporate profit growth has been strong, especially for companies with international exposure. This is partially why firm balance sheets have improved and why company cash levels are so high. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term - valuation : 

Why we like stocks for the long-term - valuation The alternatives to stocks are unappealing as evidenced by this comparison of the “yields” of stocks (based on earnings) to that provided by bonds. In this case, we use investment grade corporate bonds for our evaluation to more fairly compare risks. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term - valuation : 

Why we like stocks for the long-term - valuation Another look at stock valuations over the long-term. Over time, the total market capitalization of the S & P 500 should approximate GDP (i.e., Price to Sales for the economy is 1x). We have adjusted the metrics for interest rates, and while the market has moved considerably off the bottom, equities remain under-valued to historic measures. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – consumer behavior : 

Why we like stocks for the long-term – consumer behavior At the same time stocks are reasonably valued if not under-valued, American consumers have become really aggressive with cleaning up their personal balance sheets as evidenced by declining debt. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – consumer behavior : 

Why we like stocks for the long-term – consumer behavior This fact is also illustrated by the declining measures for financial obligations ratios – how much of our disposable income is required for debt repayments. Lower interest rates certainly play a role in this as well (but not in the previous slide). 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – consumer behavior : 

Why we like stocks for the long-term – consumer behavior Savings rates have increased to our 30 year average of 5.7% as the ability to “dis-save” has been eliminated. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – consumer behavior : 

Why we like stocks for the long-term – consumer behavior But, the consumer is not dead. This chart demonstrates that retail sales as a percent of personal income is actually improving. We just shouldn’t count on a consumer-led recovery – that’s part of what got us into this mess to begin with. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – other factors : 

Why we like stocks for the long-term – other factors Another example of retail sales improving. Consumers have been cutting back for two years; there are some things they just have to purchase and replace. This is not necessarily frivolous consumption, but it can assist in the stabilization of the economy. Chart courtesy of Economy.com 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – other factors : 

Why we like stocks for the long-term – other factors This is an example of growth in the economy – the purchase of capital goods. And, it illustrates the importance to us of global recovery that is business led. While it is slower recovery, it’s far better than depending upon consumers spending money they don’t have. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – other factors : 

Why we like stocks for the long-term – other factors Manufacturing activity has slowed, but is still demonstrating growth. Chart courtesy of Economy.com 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Why we like stocks for the long-term – other factors : 

Why we like stocks for the long-term – other factors While the yield curve is no longer at its widest point, it still offers opportunity. Wide yield curves often forecast future growth as banks are more likely to lend when their cost of funds is minimal. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Possible concerns… : 

Possible concerns… 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com We read recently that if we end up in a bear market, it will have been the best advertised in the history of the world. Everyone we talk to seems to have a potential “boogeyman” out there that causes them anxiety. (Hence, the challenge of being an optimistic contrarian.) The ones we hear about the most are: Housing Unemployment Inflation

Housing : 

Housing 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com The growth in housing prices has slowed, but this is partially due to government intervention in this market. Housing is far more complicated than one (or two) simple charts, and home price strength or weakness will largely be a function of location in the coming years. Chart courtesy of Economy.com

Housing : 

Housing 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com Why we like stocks for the long-term This chart demonstrates housing affordability based on average household income. Between much lower interest rates and much lower prices, houses are far more affordable than just a few years ago. One lesson here – don’t fight the Fed, because the Fed’s going to win.

Employment : 

Employment Initial jobless claims has shown some seasonal weakness, and the employment situation is not improving much. But, in the coming months the unemployment rate will likely go up, which will be positive. How? By more people joining the labor force and looking for work. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Employment : 

Employment This is good news, though. Announced layoffs are at their lowest point in a number of years. As a matter of fact, this level is consistent with a period of economic optimism. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Employment : 

Employment While it might be counter-intuitive that lower productivity is a good thing, we view this as a harbinger of increased employment. Entities both large and small have cut staff significantly, and that staff is now having to do a lot more work. Employees are not as productive due to the increased set of responsibilities. Therefore, to get more done, employers are going to have to hire new workers. 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Inflation : 

Inflation 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com High unemployment and low manufacturing utilization will likely keep inflation in check for a while. There are a lot of tools we can use to be well ahead of this if / when there are concerns.

Inflation : 

Inflation 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com Base money for the economy increased dramatically during the recessionary period, but its growth has leveled off. This is one of the challenges for the Fed as we move into recovery.

Inflation : 

Inflation 10/5/2010 Copyright 2003-2010, All rights reserved. investwithcornerstone.com One of the reasons the money supply had to increase is the money destruction that had occurred. In addition, the velocity of currency slowed to a halt (remember the multiplier effect of money), so providing additional currency was partially a response to this phenomenon.

Outlook : 

10/5/2010 Outlook We believe that markets are reasonably valued based on the fundamentals and using macro economic trends to forecast potential growth. However, recovery will be uneven, and markets will oscillate between investors being risk-seeking and risk-avoiding. Be careful as you attempt to negotiate this minefield. Time horizon for investment decisions matters more now than ever. The recovery will be global and business-driven. American consumers will continue to moderate personal balance sheets and cannot be considered a primary driving force behind recovery. However, as this process continues, the consumer will cease to be a drag on the recovery. There are some potential issues that will cause tremendous volatility in the coming years, and returns are likely to be unexciting in aggregate (the market will be anything but unexciting). Housing is gradually being corrected but may suffer a second period of weakness. Location is important! (I hope you don’t own a lot in a distant subdivision with only a few houses built.) Employment is a lagging indicator, and we look for it to get better in 2012 as confidence returns to the markets. By then, it will be late to get in the game for stock investors. Inflation / government policy is the biggest challenge facing us as a society. We simply must deal with the issues associated with wealth transfers and entitlement programs in our country (and around the world). We have about ten years, and the clock is running. Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Parting shot… : 

10/5/2010 Parting shot… Let’s travel back in time to the heady days of the fall of 1999… a book was published with the title of Dow 36,000, and it was a best seller since only a fool would think the markets could go down. This lofty goal was to be achieved by 2005, but that has unfortunately not been the case. Fast-forward to a week ago when the Stock Trader’s Almanac for 2011 was be released. In it, the author asserts that in 2017, the markets will begin a strong bull trend and the ultimate value for the Dow will reach approximately 38,000 in 2025. Rather than being lauded as a genius with rare insight, this observation has been barely mentioned or viewed with skepticism. Copyright 2003-2010, All rights reserved. investwithcornerstone.com

Parting shot… : 

10/5/2010 Parting shot… But, here’s where it’s interesting… the annualized rate of return to achieve this value for the Dow is 8.9% over the coming 15 years. This is not out of line with the historic rate of return on equities. As a matter of fact, it’s rather low. We appreciate skepticism. It can make us think differently about our ideas. It forces us to understand and appreciate our beliefs (about the market or otherwise). Sometimes, it can even send a signal… It really is tough to be an optimistic contrarian. Copyright 2003-2010, All rights reserved. investwithcornerstone.com

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