Is there a Ray of Light?

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• Is there a Ray of Light?
• Economic and Markets Outlook
• Spring 2009

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Tim Frey Vice President Portfolio Manager

• Investment Management Trust Services
• Tower Private Advisors

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Where are we? What is the End Game?

• Economy
• Recession or Expansion?
• Inflation or Deflation?
• Capitalism or Socialism?
• It has been decades since we have
• faced so much uncertainty!
• Like a game of chess where strategies change
  until there are few pieces left on the board
• We are in historically new territory It will
  evolve!

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What is the End Game - continued

• Where we are at now?
• Unemployment approaching 9 in coming months
• Negative GDP growth 4th qtr 2008 (-5) and
  probably (-2) or more for all of 2009
• Longest Recession since Great Depression
• Consumer spending to be off at least 3 for both
  2009 2010
• Housing prices can fall another 5-10 yet in 2009
• Consumer sentiment at historical lows
• Corporate earnings going to be dismal for the
  next few quarters
• Global trade has been falling as recession turns
  global

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Lots of things to fix!
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Scenario 1- Deflation

• By definition decline in price levels often
  caused by a reduction in the supply of money or
  credit and/or contraction in spending (personal,
  Govt, investment).
• Government and Central banks have to reflate the
  economy and stop the velocity of money from
  falling - then economy starts to emerge from
  recession stimulus to help!
• We will create new technologies and jobs!
• Compare to the 1970s didnt know then where
  the jobs were going to come from- but they did.
• Estimates are the FED to provide more stimulus
  later in year.
• The U.S will fight to avoid deflation or worse!

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Deflation-

• Aye, Captain, Im Giving Her All Ive Got!!

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Scenario 2 - Liquidity Trap

• The massive debt and irrational leveraging of the
  past has hit a wallwith deleveraging a painful
  process
• Country has lowered rates to avoid recession but
  liquidity isnt restored to markets fast enough
  to stimulate- borrowers stay in cash and dont
  invest
• This liquidity trap can lead to even worse
  recession or deflationary depression
• There are those that contend this could be the
  perfect stormhigh unemployment, consumer
  excesses, Govt deficit spending, stock market
  losses, and calamity in the pension, insurance,
  and endowment worlds.

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Liquidity Trap continued

• Again, the Govt wont let this happen!
• However, change will take time!
• Private credit markets may develop to compete
  with banks
• Govt will print money and run deficits until
  economy reflates!

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Scenario 3 - We Muddle through

• Most likely scenario to happen after we climb out
  of recession we muddle through for an
  extended period
• Will take approximately 2 more years time for
  housing and credit markets to heal
• Consumer psyche is beaten down to spend
  less/save more (1 to maybe 6)
• Govt stimulus to have little short term effect
  as lower property income taxes will lead to
  continued spending cuts everywhere and on
  everything!
• Rationalization will be the word going forward
  reduce the number of retail stores, car
  plants, restaurants, banks, etc,to match the
  capacity of our economy!

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Muddle Through - continued

• There are signs of life out there!
• Credit markets are starting to thaw Fed buying
  mortgages, student loans, credit card debt
  hopefully at rates that attracts private capital
  going forward.
• Other countries are providing aggressive stimulus
  and watching us!
• Economies will reset themselves with a new level
  of consumer spending made it through the 70s
  and will do it again in the future.
• New technologies (wireless, biotech, energy,
  green tech, etc,.) will deliver new paths to
  profits and JOBS!
• Low P/E ratios of the 80s gave way to new
  technologies and a bull market --- History should
  repeat itself again! Just not sure when!

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S P 500 Trend- Positive Note!
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Avoid Groupthink

• "Men, it has been well said, think in herds it
  will be seen that they go mad in herds, while
  they only recover their senses slowly, and one by
  one." Charles Mackay
• While the crowd is usually right, it is almost
  always wrong at extremes. Ned Davis
• If you must panic, at least do it when others
  arent. Graig Stettner

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Graig Stettner, CFA, CMTVice PresidentPortfolio
Manager

• Investment Management Trust Services
• Tower Private Advisors

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How to alienate people and lose friends. By Graig
Stettner
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The case for a buy-and-hold approach
Never a 20-year period with a negative return.
So buy and hold stocks.
Time heals all wounds.
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The problem with it
Monte Carlo simulation of 100 equity portfolio,
using historic results from 1926 2006.
Beginning value 100(K).
More (and worse) negative outcomes than the
Ibbotson results suggest.
Time wounds a lot of heels.
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Overlay the two charts . . .
Percentage returns narrow over time, but dollar
returns widen over time.
Returns
Returns (stylized)
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DJIA history is punctuated with distinct bull and
bear periods . . . and the present one could last
through 2015
Indexing works
Indexing works
Indexing doesnt work
Indexing doesnt work
Indexing doesnt work
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Still, even in bear (and sideways) markets its
possible to make money. Swings within the range
are wideboth up and down.
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Key determining factor in bull and bear markets
is valuation (i.e. P/E ratios.) In secular bull
markets P/E ratios riseusually to very high
levels. Secular bear markets correct the problem.
P/E Cycle
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The market needs to fall further to get to a
secular bull market P/E level
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The market needs to fall further to get to a
secular bull market P/E level
Shaded bars correspond roughly with the periods
on the prior chart.
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The S P 500 at 650 (-12.5) is a reasonable
target. Perhaps it becomes the lower bound of
our sideways/bear market.
Trendline connecting low valuation extremes.
This chart highlights previous valuation extremes
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Some investment ideas

• Theres always a bubble somewhere
• Finding the next one thats forming can be very
  profitable
• Some candidates China, alternative/energy,
  gold/commodities
• Gold miners are higher-risk gold proxies
• Its also possible to make decent returns in
  sideways markets . . .

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What works until a secular bottom is reached?

• Buying stocks with
• Low PriceEarnings ratios
• Nice, solid dividends
• Above-average earnings growth
• Being willing to part with stocks when they no
  longer meet the above criteria

Borrowed heavily from Active Value Investing
Making Money in Range Bound Markets, by Vitaliy
Katsenelson
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From 1972 - 1981 dividend paying stocks handily
outperformed non-dividend payers
earliest available date
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What to do right now

• Hold above-average level of cash. Dont fear
  missing out on a rally.
• Have a plan ready for 650
• 401(k) investor emerging markets, small-cap
  stock funds
• Individual investor ditto stocks fitting
  previous page criteria
• Own/look for some bubble candidates
• Consider selling covered calls on owned/purchased
  positions high volatility high option prices
• Buy gold on a pullback as an eventual inflation
  hedge.

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Something light Top 100 searches on Google,
2/25/09
What recession?
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Zach HigginsPortfolio Manager

• Investment Management Trust Services
• Tower Private Advisors

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Economics 101

• Monetarism the supply of money affects aggregate
  demand (spending) in the economy.
• Government (fiscal) spending crowds out private
  investment
• Drag on economy through higher interest rates
• Quantity Theory of Money
• MVGDP
• Mmoney
• Vvelocity of money (stable in normal
  environment)
• Ben Bernanke
• Keynesian Economics (John Maynard Keynes) demand
  driven model for money that supports fiscal
  spending and a stable money supply

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The Great Experiment

• Milton Freidman (July 31, 1912 - November 16,
  2006)
• Proposed that the Great Depression could have
  been avoided if the money supply had not
  decreased by 1/3
• The money supply influences and supports the
  velocity of money
• Ben Bernanke supports Freidmans view

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Money Supply
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Money Multiplier
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Debt as a of GDP
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The Great Experiment

• Irving Fisher (April 27, 1867 - April 29, 1947)
• Discredited early in career for incorrectly
  forecasting the Great Depression, which led to
  his work on debt deflations
• Referred to by Milton Freidman as the greatest
  economist ever produced by the US
• The Debt Deflation Theory of Great Depressions
  (1933)
• After periods of extreme over indebtedness a
  price shock will set in motion a deflationary
  spiral that cannot be reversed. One of the
  effects will be a drop in the velocity of money
  as people hoard (save).

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Rational vs. Adaptive Expectations

• Adaptive
• expectations for the future are based on past
  events
• Rational
• macroeconomic models based on consumers, workers,
  and business expectations about future economic
  conditions
• best guess based on all available information
• Lesson
• our human tendency is to be adaptive
• be critical of economists

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Pulling it all together

• Prevention of a deflationary spiral
• restore confidence
• Consider your asset allocation (heavy cash,
  bonds)
• Be active, disciplined, and willing to trade
• Look for income producing opportunities
• Call options
• Dividends
• Be critical of economists and the main stream

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Timely Information

• To be added to our weekly market recap please
  send
• an e-mail request to
• Graig.Stettner_at_towerbank.net
• If you would like a copy of todays presentation
  please
• visit
• www.towerbank.net
• - Scroll down and click on investment research