Early September 2009 Investor Update from Blake T. Todd

Crowell Weedon & Co.

Your Independent Investment Team

Established: 1932

Members SIPC / FINRA

Dear Fellow Investors,

In many of the conversations we have been having with investors it seems that there is a great deal of uncertainty and questions about what is really going on and where we are headed. While I do not profess to have a crystal ball, I am willing to put my opinions out there for you to consider. So for this investor update, let me pose three of those questions many have asked and see if I can provide some straight talk, and my opinion, on what the future may hold.

Question: How does this market compare to the traditional valuation metrics of the last 100 years?

Answer: One of the widest used valuation metrics for the market indexes has been the Price of the market divided by the Earnings of the companies comprising the index – or the PE Ratio. This number can be skewed by write offs and cyclical downturns and so as long ago as the 1930’s Benjamin Graham and David Dodd felt that it was best to average the earnings for the past ten years to get a better sense of the value of the market. Using this method we can look back through the market history as far back as the late 1800’s and make some observations covering every type of economic environment.

What we observe is that the market has traded at PE/10 levels as low as 4.8 in 1921, 5.6 in 1932, 6.6 in 1982 and 9.1 in 1949. It also has seen levels as high as 44.2 in 2000, 32.5 in 1929, 25.1 in 1901, and 24.1 in 1966. The average of the markets since the 1870’s has been approximately 16.3.

Presently, after hitting 13.4 in March, we are at about 18.3. Certainly, while above the average PE, not grossly overvalued by historical standards identified with market peaks. At the same time the market appears to be pricing in some optimism for earnings in the next few years. Should there be disappointments in the earnings going forward then we would expect that PE Ratio to decline along with the forward-looking sentiment. We believe at this point that there is more risk to market downside than there is for potential to the upside when strictly looking at the PE/10 valuation metric.

Question: There is an expression on Wall Street: “The Trend is Your Friend”. Certainly the trend since March has been up, do you see it continuing?

Answer: Being longer term oriented I have tried to focus on longer-term trends. One tool that we have liked to look at to determine whether we have a positive or negative bias to the market, based on the trend of price movements, is looking at the monthly close of the S&P 500 and comparing it to a ten month moving average. When the monthly close is above the ten-month moving average it would indicate a positive trend for the markets. When it is below that ten-month moving average then it indicates a negative trend for the markets. While not infallible given that fully a third of the changes in direction using this method have reversed back the other direction within a short period of time, it has had a remarkable track record of capturing major moves (both up and down) in the market.

This indicator turned positive at the end of July 2009 and presently remains in positive territory. So if you believe that “The Trend is Your Friend” then presently the trend is up.

Question: What about the demographics and the influence of the baby boom generation on the economy going forward?

Answer: Probably the best demographic economist of the past 20 years has been Harry Dent. He correctly identified the correlation between the number of people at specific ages in the populace and their spending patterns. Those spending patterns have a significant influence on our economy – especially as our economy has become more and more consumer based. Many years ago he predicted that the stock market would top out in the vicinity of 40,000 on the Dow in the year 2010 and then suffer a reversal for as many as four to six years after that. The year 2010 has not passed yet so I guess we cannot yet say that his prognostication of the upside of the market was not met. I find it hard to believe that we will achieve those lofty objectives he set so many years ago. However, the trends he identified have certainly been uncannily correct.

Does that mean that we are doomed to experience a significant decline for the next few years as he predicated so many years ago? Time will tell. But as you read his works keep in mind a few things that may have changed since his first observations. There has been more immigration than was anticipated in his initial studies. People have had children later in life than previously thought, smoothing out the spending cycle of the baby boom generation – heck, I am 54 and I am certainly not done spending on my two kids who are 14 and 13! And there is an increased awareness by many in America that the traditional retirement year of age 65 may not happen, either by choice or necessity. One last thing, two income families have created more disposable income for consumption beyond the years of peak spending of the last generation upon which the prognostications were made.

Certainly as the baby boom generation ages there will be shifts in what is consumed and in what quantity. In many respects the national debate on health care presently is driven by the obvious trend toward more needed health care for this demographic bubble that is working its way through the economy. That also means there are investment opportunities due to that same trend.

Question: So what do you think?

Answer: As always we will qualify our current thinking with the disclaimer that it is just that – our CURRENT thinking and is subject to change as time and events unfold.

While I am heartened that the panic in the markets and the economy of early 2009 appear to have abated, I am not of the opinion that we are witnessing the first stages of a new major move to the upside in the equity markets. The damage done to the economy will take time to heal. The solutions to the crisis that we have gone through are in themselves potentially the seeds of the next issues we have to deal with. Just how are we going to pay back all of the government borrowing that was done to prop up the financial institutions? Higher taxes would slow the economy down as would the traditional governmental solution of inflation and paying back the debts with cheaper future dollars. Add to that the lack of home equity that funded the consumer binge of the last 10 years, and a realization by the baby boom generation that they will need to save something unless they want to work until their last days. And that may be one of the solutions to the next set of issues we deal with – there just won’t be retirement.

All of this leads me to believe that the economy will be in slow recovery for a number of years going forward as we readjust to slower consumption, debt reduction, and increased savings. With such a slow growth economy the earning of most companies will also be slower into the future. The cost cutting is done and the earnings gains of the future will have to come from growth of revenues. If those revenues are growing slower then I believe the markets have currently priced in, I think they will trade at lower PE levels than the average for the past 20 plus years. I do not think that we have to have a major “double dip” in the market averages to get to those lower PE levels. Rather, I see there being enough of the “Green Shoots” in the economy blossoming over the coming quarters to keep us from entering another panic environment. And, the market will become “range bound” for a number of years. I think we are in the process of finding the upper and lower bands of that range right now. I know you want me to try and be clairvoyant as to what the boundaries of that range will be. Knowing that it is an educated guess and subject to change as information changes, I would have to predict the range will settle out at on the S&P 500 of 1,150 on the upside and 825 on the downside.

In a range bound market place (much like the last half of the 1970’s) dividends will become a very significant portion of the rate of return that investors will receive. The compounding of those dividends and the effects of dollar cost averaging through the volatility of the markets will create a positive rate of return in an otherwise lack luster marketplace. Additionally, paying attention to the valuations of companies and staying true to the disciplines of selling overvalued securities and purchasing undervalued ones will also add to the investor’s rate of return. Patience will be the key to investing for the next few years in my mind.

As with all of my letters I wish to remind my readers that these are my opinions and not those of Crowell Weedon & Co. Every investor has his or her own needs and objectives and tolerance for risk. Please keep those needs paramount in your mind as you consider my viewpoints. I welcome your comments and questions. You can email me directly at btodd@crowellweedon.com

Blake Todd

Portfolio Manager

The material herein has been obtained from various sources and is not guaranteed by us as to accuracy or authenticity. The opinions expressed herein are those of the financial advisor and do not necessarily reflect those of Crowell Weedon & CO., its managers and/or partners. Hubpages Inc. provides compensation for advertising from certain pages it maintains. The author of this Hubpage has agreed to give any advertising compensation directly from this Hubpage to charity.