3rd qrt 2009 8 page final

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. Even though we face the same everyday challenges as everyone else; what to have for breakfast, when to nap, and how to make money in a stock market more volatile than a room full of eight-year olds hopped up on cup cakes and Mountain Dew, we somehow manage to get through the day. We do so primarily by plodding along, tirelessly putting one foot in front of the other. As boring as it may be, this me-thodical approach to life and investing has served us well over the last 30 years as we ventured forth each day to do battle with the investing dragon. All poorly constructed metaphors aside, to be suc-cessful such an approach to investing must be based first and foremost, in reality. Or, at least as close to reality as our delusional mind will allow. As we like to restate periodically in these pages, (lest you forget) our approach to investing is steeped in historical grounding. We be-gin the investment process by assessing where the cur-rent economic and financial market cycle is relative to over 100-years of economic and financial history. Does this always make us right? Well, of course not, but the way we figure it, it’s a tad better than stick-ing our finger in the air and making a wild—ss, guess. A historical foundation gives us a consistent frame of ref-erence that helps us gauge prevailing asset prices and more importantly, their potential risk.(1) We know from our own experience, that if we didn’t periodically check a historical frame of reference, we’re susceptible to the many erroneous and misleading short-term economic and market distractions affronting us daily.

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 the archaic media—and our task of filtering out the noise and distortions to get to economic reality becomes exponentially more difficult with each passing day. We’ve said it before and we’ll probably say it again (many times actually), we’re not interested in deluding ourselves about financial or economic matters.

The last nine months has been particularly difficult getting a read on economic reality for several reasons: the severity of the eco-nomic downturn, the enormous new gov-ernment spending—fueled by selling

trillions in new government debt and printing trillions of new dollars by the Federal Reserve—followed by a propaganda campaign of its effects—real or imagined. Throw in the relentless hyping of our celebrity President by an adoring antiquated-media followed by economically illiterate members of Congress helping sell the social reengineering program, (whoops we meant, economic recovery plan) to the great unwashed (that’d be us), and its little wonder we feel like we’re stuck in a bad “Twilight Zone” episode. There’s not a day that goes by where we’re not left shaking our heads in utter astonishment at the economic pronouncements from the White House or members of Congress, thinking; “What in the world are they talking about?” That’s because whatever economic snake oil they’re peddling that day simply doesn’t comport with anything we know to be true about economics or finan-cial markets.

(Continued on page 3)

Random Thoughts from the 3Random Thoughts from the 3Random Thoughts from the 3rdrdrd TeeTeeTee A Hodgepodge of Stuff Straight from the Twilight Zone

3rd Quarter 2009

Volume 10 Issue 3

1) The flip side of the investing equation often lost in the pursuit of riches.

Helping You Navigate an Uncertain Investment World

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The Front Seat 2

The History of Money 3

Warren Buffett Speaks 5

About ETFs 6

Eating Healthy in a modern environment 7

Some Rules on Buying Gold 8

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Deschaine & Company, L.L.C.

I DON’T HAVE TO TELL YOU its been a chal-lenging decade for equity investors—and the

decade’s not over yet. The rally in stock prices this year has taken some of the sting off of the market’s poor performance but, the reality is stocks have not provided investors with any capital appreciation going as far back as1998. The only positive contribution to stock returns over that period has been from divi-dends. Since the market peak in 2000, the S&P 500 is down about 5% annually in capital return while earning about 2.2% a year from dividends. That equates to a negative aver-age annual total return of about 3% since 2000. At the same time, dividends for the S&P 500 grew from $3.98 in 4th quarter 2000 to $5.44 for the quarter ending June 30, 2009. That works out to a modest an-nual growth rate of 3.7%. But that’s only part of the story. As re-cently as the 4th quarter of 2007, the S&P’s dividend was $7.62. So the S&P’s dividend growth from 2000 to its 2007 high was a healthy 9.7% annualized. It’s instructive to note that the 9.7% annual growth in dividends oc-curred in an environment where a large number of companies spent billions buying back their stock. Had they not spent all that money buying their stock—at inflated prices to boot—dividends might’ve grown faster than 9.7% . I point this out because I’ve never been a fan of companies buying back their own stock for a number of reasons. The most significant is that most company managers are no better at timing the stock market than the average inves-tor. Which is to say, not very good. Managers have consistently bought their stock at or near recent market highs and turned around and then issued new shares to in effect “re” raise the capi-tal they just spent on their stock, at or near mar-ket bottoms. The amount of shareholder wealth destroyed in the process runs into the billions. The last five years have been a text book example of why I think buy backs are a bad idea. The financial sector spent billions buying back stock just prior to the onset of the biggest finan-cial crisis in our lifetime. All that did was deplete their balance sheets of valuable liquidity at a time when liquidity has become the most pre-cious commodity on the planet. There’s not a

company that bought back stock over the last decade that wouldn’t love to have that money back to help them weather the downturn. Dividends Take a Hit The recession that began in December 2007 has taken a heavy toll on revenues and earnings for almost all public companies and dividends have suffered as the result. The 28.6% drop in divi-dend payments for the S&P 500 since December 2007 reflects the severity of the economic crisis.

Before the credit bubble burst in September 2008, the financial sector was a major force behind the healthy growth in divi-dends. The credit crisis however, forced many of them to cut their dividend.

The severity of the crisis means the financial sector isn’t likely to contribute to dividend growth anytime soon. I note all this because since the inception of the EIP in December 2000, dividend growth has been one of the key factors behind the portfolio’s excellent total return and exceptional annual income growth. Which brings me to admit that the EIP has suffered its share of dividend cuts over the last two years, negatively impacting the portfolio’s performance and income growth rate. Since the financial crisis began, the EQUITY INCOME Portfolio’s had 13 holdings cut or elimi-nate their dividend. All but three of them were financial related. As a result, the EI portfolio’s investment income declined 22% from December 2007 to June 2009, compared to the S&P 500’s 28.6% drop over the same period. Although, to be completely accurate, a significant part of the EIP’s decline was due to holding fewer stocks in the portfolio as a direct result of the dividend cuts. That’s because we sell a stock if they cut the dividend—for whatever reason. Selling the 13 stocks (and some others), meant we held fewer stocks so fewer dividend payments. We also sell if a stock gets one standard deviation below its 5-year average dividend yield, which indicates to us the stock is “over-valued.” As you can imagine, we haven’t had much of a problem with “overvalued” stocks lately—even after the 50 plus percentage run up in stock prices since March.

Changing Strategy to Meet the New Reality Obviously, with a siz-able number of compa-nies reducing or elimi-nating their dividend, finding companies that are likely to raise them becomes increasingly more difficult. That’s likely to be true going forward when we look at recent results for corporate America. Casey Research estimates that revenues for the S&P 500 for the 12 months ending June declined from $9.1 trillion compared to $8.4 trillion for the calendar year 2008, a decline in revenue of more than $685 billion or 7.6%. Of the 500 companies, 363 of them, or 73% experienced declining revenues over the trailing 12 months. And 85 companies, or 17%, experienced a revenue decline of 15% or more! If you assume, as we do, that the eco-nomic recovery isn’t likely to generate signifi-cant economic growth, then corporate Amer-ica cannot be expected to show significant revenue growth. No revenue growth means little excess cash for dividend increases. That brings me to our strategy change, which isn’t really a strategy change so much as it’s a capitulation to reality. We certainly intend to continue searching for quality com-panies with a history of growing dividends; we just don’t expect to find as many as we did in the first nine years of the EIP. We also do not expect dividend increases will be any-where near the double digit annual rate of the period before the financial crisis. Instead, our modest expectation is the companies in the EI portfolio don’t cut their dividend. That’s the bad news on the strategy front. Although, unofficially we do expect to see some organic growth in dividends from the portfolio. While future dividend growth may not match past growth rates we expect to be able to increase annual income from com-pounding and by being able to reinvest divi-dends at higher yields as prices drop. Sadly, the economic environment implies lower revenues, lower net income, and higher inflation, which leads me to believe dividend payments going forward might be lower as well. If that’s the case, we’ll just have to grow income the old fashion way; by capturing higher yields from lower stock prices.

VIEW FROM THE FRONT SEAT by Mark J. Deschaine

Dividend Growth Revisited Tweaking our EQUITY INCOME Portfolio strategy to meet a changing investment environment.

Actual EIP Results 10-Year Forecast

Dividend Yield: 6.1% Dividend Yield: 6.0%

Dividend Growth: 22.0% Dividend Growth 10.0%

Reinvest All Dividends Reinvest All Dividends

Our Strategy for Maximizing Dividend Income

3rd Quarter 2009

That leads us to ask, “does the Obama admini-stration and its many well-worn, Clinton eco-nomic retreads really believe the crap their peddling about a nascent economic recovery?” Or is their ill-conceived economic plan some sinister plot to render our economy bank-rupt thus forcing millions of our fellow citizens, (read Democratic voters) dependent on govern-ment for their meager survival, thus perpetuat-ing Democratic control of the levers of power in Washington for generations to come? Or is it as we suspect, that the crowd now pulling the levers of our economy are so egotis-tically self-certain that they simply can’t com-prehend the inflationary consequences of a government spending, borrowing and printing money on a scale that’ll put the Germany hyper-inflation of the early 1920s to shame? Regardless of the answer, at this point in the economic cycle, even a complete rewrite of the script isn’t going to change the inflationary ending to this Twilight Zone episode. Why We Expect Inflation The main reason we’re expecting price inflation is the recent massive growth in the money supply and the deficit-driven likelihood that more such growth (in the supply of money) is coming. (Just take a look to the right.) As of July, the M1 money sup-ply (currency held by the public plus checking deposits) had grown 17.5% in a year’s time. That’s not just unusually rapid, it’s extraordinarily rapid. Since 1913, M1 has grown more rapidly in only one other 12-month period—and that was the one ending last June, when the M1 money supply jumped 18.4%. Even in the inflation-plagued 1970s, M1 never grew more than 10% in any 12 month period. Dropping large chunks of newly created money into the economy leads to price infla-tion, because the economy is flooded with cash. More dollars chasing few goods is the very definition of inflation. As they try to unload the excess, they bid up the prices of the things they buy, whether it be stocks, shoes, gasoline, silver coins, or granola. The sellers of those things then find themselves cash rich and start doing some buying of their own, and so the wave of excess money and the bidding it inspires propagate through the economy. The process isn’t instantaneous. It takes time. Just as each player in the economy has a sense of how much of their wealth they want to

hold in the form of money, everyone will move at thier own speed to make adjustments when their actual cash holdings seem to be off target. And the process can seem to stall, especially when fear is growing. When people are wor-ried or otherwise feel a heightened sense of uncertainty, they will gladly hold on to abnor-mally large amounts of cash—for a while. But when fear abates, as it will when the economy begins to recover from the recession, that temporary demand for extra cash will also fade, and the process of paring down cash bal-ances will emerge to do its inflationary work. Yes, But When? The speed at which the public tries to unload excess cash and the timing of the effects have actually been measured, in the work of the late Milton Friedman and his monetarist col-leagues. The method was indirect and round-about, and so the results, unsurprisingly, were

nothing as precise as nailing down the value of a physical constant. What the monetarists (or the first of them to be equipped with computers) found was that when the growth rate of the money supply rises:

• The initial effect is on the prices of bonds and stocks, an effect that comes within a few months. • The peak effect on the growth rate of eco-nomic activity comes about 18 to 30 months after the pick-up in the growth rate of the money supply. (2010, 2011 maybe?) • The peak effect on consumer price inflation comes about 12 to 18 months after that, which is to say it comes 30 to 48 months after the peak growth rate in the money supply.

As Friedman famously put it, the lags in the effects of changes in monetary policy are “long and variable.” He might have said, “It’s a big, wide blur, but we’re sure it’ll come.” And even that picture exaggerates the

precision that’s available to us. The emergence of money substitutes, such as NOW accounts and money market funds, has added its own muddiness to the picture of how growth in the money supply translates into a rise in the level of consumer prices. It is only because the re-cent episode of monetary expansion has been so extreme that we can look to the results just listed for an indication of what’s to come. If we apply Friedman’s findings to the present situa-tion, here’s what we get. The peak growth rate in the money supply occurred last December, so based on the general monetarist schedule:

• Some of the effect on stocks and bonds should already have been felt. (Stock market rally since March.)

• The peak effect on economic activity should come between the middle of 2010 and the middle of 2011.

• The peak effect on consumer price should come between the middle of 2011 and the end of 2012. A More Particular Schedule This time around, should we expect things to move more rapidly or more slowly than average? Our bet is on slow which would push the peak inflation rate out toward the end of 2012. One reason for slow is that the government’s rescue pack-ages are delaying the process. Rescu-ing banks that are choking on bad loans postpones the day of reckoning for both the banks and the loan cus-

tomers. It retards the pace of foreclosure sales (whether of real estate or other collateral) and puts the deleveraging that has been going on since last fall into slow motion. A wilting of the re-cent stock market rally would confirm this. The Inflation Process This excellent explanation by Steve Saville, of Speculativeinvestor.com. of how monetary injec-tions into the banking system affect not only the general price level but the very structure of the economy itself will help further explain our inflationary outlook.

1) When the money supply is increased by, say, 10%, the result is not a 10% across-the-board increase in prices. This is because the new money is spent in specific areas and on specific projects, rather than spread evenly throughout the economy.

2) Resources get drawn to the areas where the new money is spent, but no new resources

(Continued from page 1)


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The Growth of Money Supply Since 1913, the year the Federal Reserve was Founded.

Ah, should we be worried?


were conjured into existence along with the new money. Consequently, existing re-sources get sucked away from some parts of the economy towards the initial benefici-aries of the monetary injection. For exam-ple, let’s assume that the government de-cides to spend a pile of new money on the construction of bridges. When it does so it bids away resources, including construction engineers and bridge-building materials, from other parts of the economy. Which has the effect of increasing the operating costs of companies outside the bridge-building sector that also employ construc-tion engineers and use similar materials. These companies will likely find them-selves in financial difficulty due to the gov-ernment’s decision to direct resources to-wards bridge building, and some will go out of business. For another example, let’s assume that plowing new money into one segment of the economy causes the compa-nies within that segment to consume more oil, leading to an increase in the oil price. This imposes an additional financial burden on all other oil consumers, curtailing some expansion plans which causes some busi-nesses that would otherwise have been viable to go under.

3) The idea that the government can target the spending of newly created money to-wards so-called “idle” resources is a fantasy, but even if it were true it wouldn’t prevent monetary injections from changing the structure of the economy in an adverse and unsustainable way. This is because the act of spending the money that has been created out of nothing transfers existing purchasing power from the overall economy to the first recipients of the new money.

In summary, when the central bank or the private banks inject new money into the econ-omy the net result is that some businesses are helped, some businesses are hurt, resources are transferred, wastage occurs due to the less efficient use of resources and the govern-ment's take, and a new economic structure evolves based on monetary illusion. The distortions and the wastage caused by monetary inflation will be revealed after the flow of new money is constricted. When that happens, many of the activities that sprang up on the back of the money supply expansion will collapse and the economy will be forced to reallocate resources based on sustainable consumption trends (as opposed to the consump-

tion trends prompted by the monetary illusion). On the other hand, if the flow of new money is not constricted (if, instead, the central bank chooses to perpetuate the monetary inflation), then the end result will be hyperinflation. Analysis of the 1936-1939 period is instruc-tive. Many people believe that the Fed erred by tapping on the monetary brake during 1936-1937, and that if policymakers had sim-ply kept the money flowing then the US econ-omy would have avoided the 1937-1939 col-lapse (the depression within a depression). How-ever, the collapse of 1937-1939 was the inevi-table consequence of the fact that the preced-ing economic rebound had no real foundation. The rebound was based on monetary inflation and increased government spending, rather than on increased private investment in pro-jects that made economic sense. It was there-fore a foregone conclusion that any slowdown in monetary and/or fiscal stimulus would soon be followed by a collapse. The only question was when. If the stimulus had been maintained for an additional year or two, then the ensuing collapse would have been even more devastating; and if policymakers had attempted to make the stimu-lus never ending, then the US dollar would have been destroyed. Shortly after today's policymakers slow the pace at which the economy is being “stimulated” by new money and increased government spending, the economic rebound will unravel with startling speed. Alterna-tively, if policymakers attempt to maintain the stimulus indefinitely, then they will create hyperinflation. Why is Mr. Saville correct? Because govern-ment creates no wealth of its own. Everything it has, it has to get from us, one way or another. It can tax. It can borrow. And, finally, it can inflate by means of credit-market manipulation. This third option is the most disguised and poten-tially the most harmful and it’s what being done on an unprecedented scale. When people hear the words “monetary policy,” they figure that this is something they will leave to experts. And central bankers have an astonishing talent for obfuscation to the point that no one knows with certainty precisely what they are doing. The unvarnished truth is that when the Fed artificially lowers rates, it’s creating new money that waters down the value of the existing money stock, lowering the purchas-ing power for the dollar in the process. Thus, inflation is, “the increase in the money supply that causes general price levels to rise.”

New money also distorts production schedules. At the very time when the market is pressuring long-term investment to pull back, the lower rates encourage expansion in ways that prolong the crisis. It only delays and worsens the inevitable. The Great De-pression and Japan’s experience since 1989 have taught us that government is capable of doing this to the point that the crisis can last for 17 years. So this is no small matter. A gov-ernment determined to prevent recession is a government that might end up sustaining one to the point of the collapse of civilization itself. The belief that Washington can conjure up billions of dollars in new assets without anyone having to do anything to make those assets appear is perverse, but pervasive none-theless. It is held by both political parties, the president, the media, and the Congress (except for Ron Paul). It is a reflexive belief, one that reflects a failure to think abstractly between stages and recognize the unseen and unforesee-able negative effects of government intervention. Some Comments from People who Actually Know what they’re talking about. Austrian School economists argue from the logic of scarcity: “There are no free lunches. There is no free capital.” When an investor buys a government bond, he’s deciding against investing in a private business. He’s also decid-ing not to lend to a private consumer. The government then allocates this money to fur-ther the government’s political agenda. That agenda is clear: to expand the power of the government over the private sector. Over time, the allocation of capital to the public sector reduces the productivity of the private sector. The private sector must pay higher interest rates, or offer more profitable opportunities than the government. People who want safety buy government debt. People who want to accept risk and uncertainty do not. Over time, those who want safety outbid those who want more risk. Why? Because the amount of capital available to the risk-takers declines compared to the risk-avoiders. Private capital is “crowded out” of the market place. At that point, corporate retained earnings become the main source of new capital. However, retained earnings decline as government grows and regu-lation increases. The reality of crowding out is evident to those who pursue the logic of economics, meaning the logic of scarcity. Scarcity is over-come by economic growth. Economic growth depends on these factors: 1) increased thrift per



3rd Quarter 2009

capita; 2) increased capital per capita; 3) increased retained earnings; 4) a lower rate of interest that comes from greater future orientation among inves-tors; and 5) a profit-and-loss system that eliminates the inefficient producers and or investors. The expansion of government erodes all five factors. 1) Thrift falls when people trust the gov-ernment for their future income. 2) Capital in-vestment in private ventures falls as the govern-ment absorbs invested funds. 3) Retained earn-ings fall as a result of reduced capital and in-creased regulation. 4) Interest rates rise because of reduced concern about the government-guaranteed future. Present-orientation increases. 5) The profit-and-loss system fails because the government bails out the biggest, least efficient firms, above all large banks. The bottom line of it all: more government begets more government all to the determent of private wealth creation and a rising standard of living for the rest of us. Buffett Speaks the Truth—Finally Buffett recently piped up on the subject of gov-ernment financing and offered the following analysis. Since he is a high profile Obama sup-porter, we thought, in the interest of fairness, we include his comments. Buffett noted: “An increase in federal debt can be financed in three ways:”

1. Borrowing from foreigners, 2. Borrowing from our own citizens or, 3. Through printing money.

Let’s look at the prospects for each individually, and in combination. The current account deficit—dollars that we force-feed to the rest of the world and that must then be invested—will be $400 billion or so this year. Assume, in a relatively benign scenario, that all of this is directed by the recipients—China leads the list—to purchases of United States debt. Never mind that this all-Treasuries allocation is no sure thing: some countries may decide that purchasing American stocks, real estate or entire companies makes more sense than soaking up dollar-denominated bonds. Rumblings to that effect have recently increased. Then take the second element of the scenario - borrowing from our own citizens. Assume that Americans save $500 billion, far above what they’ve saved recently but perhaps consistent with the changing national mood. Finally, assume that these citizens opt to put all their savings into United States Treasuries (partly through intermediaries like banks).

Even with these heroic assumptions, the Treasury will be obliged to find another $900 billion to finance the remainder of the $1.8 trillion of debt it’s issuing this year. Washington’s print-ing presses will need to work overtime. Slowing them down will require extraordi-nary political will. With government expendi-tures now running 185 percent of receipts, truly major changes in both taxes and outlays will be required. A revived economy can’t come close to bridging that sort of gap.” Welcome to the real world, Warren. Some of us have been preaching for years that deficits, if unchecked, will ultimately lead the government to put the printing presses in overdrive, in an attempt to inflate our way out of debt. This will eroded the value of the dollar. Buffet ended with the following tidbit: “Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of our currency to melt. The dollar’s destiny lies with Congress.” And, President Obama too. Right Warren? Thomas G. Donelan Editor, Barron’s October 5, 2009

M ore regulation can make Americans safer, stronger, happier, better informed, and

less free. Or so it seems. Insufficient regulation has been the diagnosis offered this year to iden-tify what ails banks, brokers, health care, drugs, medical devices, securities, business competition, transportation, and the Internet. We can’t deal with them all in one week, so we take special note of the regulators on our turf. Although the Securities and Exchange Commission was founded in the 1930s, its efforts to protect con-sumers have not yet succeeded. But it knows why: All it needs is a little more power. We’ve heard that a government with enough power to do a lot of good is a government that equally has enough power to do a lot of harm. After examining a recent report from the SEC’s inspector general on their mishandling of the Madoff mess, we must add a codicil: A govern-ment pretending it can do a lot of good automati-cally will do a lot of harm.” Income Inequality Without Class Conflict By Irving Kristol(2)

The Wall Street Journal, Dec 18, 1997

I t is often said that capitalism—that is, a mar-ket economy—is morally obnoxious because

its “trickle-down” economics inevitably creates inequality of income and wealth. Now it is cer-tainly true that “trickle-down” economics” has that effect. It is also true, however, that if you want eco-nomic growth and greater affluence for all, there is simply no alternative to “trickle-down economics,”

which is just another name for growth economics. The world has yet to see a successful version of “trickle-up economic,” an egalitarian society in which the state ensures that the fruits of eco-nomic growth are universally and equally shared. The trouble with this idea—it is, of course, the socialist idea—is that it does not produce those fruits in the first place. Economic growth is pro-moted by entrepreneurs and innovators, whose ambitions, when realized, create inequality. No one with any knowledge of human nature can expect such people not to want to be relatively rich, and if they are too long frustrated they will cease to be productive. Nor can the state substi-tute for them, because the state simply cannot engage in the “creative destruction” that is an essential aspect of innovation. The state cannot and should not be a risk-taking institution, since it is politically impossible for any state to cope with the inevitable bankruptcies associated with economic risk taking. Do Share Buybacks Benefit Shareholders?(3)

T here’s a school of thought that companies engage in share buybacks to support the

share price to the general benefit of shareholders. Share buy backs indirectly return excess cash generated by the business to shareholders by bidding up the share price when buying their stock. We’re not convinced. A study by Standard and Poor’s might help to explain our position. Here are some highlights from the study. For the three years ending December 2007, the companies in the S&P500 index spent:

• $1.318 trillion in share buybacks; • $1.276 trillion in capital expenditures; • $376 Billion on research and development; and • $605 Billion for common dividends.

To put these numbers in perspective, at the time the entire market capitalization of the S&P 500 was approximately $14 trillion. We were under the impression that corporate America spent more on R&D than share buybacks. Share buybacks was the highest expenditure while dividends came in last. Over the last ten years, dividends were approximately half what was shelled out in share buybacks. But are share buybacks really returning value to the sharehold-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-portunity for their stock in years. Shareholders need downward price support “now.” Instead companies are preserving cash. Why didn’t they



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 Tree.com.

preserve cash when they had piles of the stuff? Standard and Poor’s noted the following: “Traditionally, companies have used buybacks to offset the issuance of employee options, M&A activity, to temporarily support their stock and to reduce their share count. Over the past decade the option portion has accounted for the major use of repurchased shares and actual share re-ductions the least. Companies usually highlight and lump these expenditures, along with divi-dends, and present them as a return to investors of shareholder value.” A majority of the buybacks were used to offset the shares related to the exercise of stock op-tions by managements and employees. Typi-cally, the majority of the options are held by management, while employees’ have a minuscule percentage. Buying back stock helps keep prices at higher levels, so that management gets more value for their shares. This is an indirect way to pay themselves. In addition, the reduction in shares out-standing helps increase EPS (assuming controlled buying through-out the year). In the study, S&P looked at a num-ber of stocks, we’ll look at three: PEP, INTC, and GE. Pepsi (PEP): From 2003 to 2007, PEP spent $10.3 billion in share buybacks and $8.1 billion paying quarterly dividends. During each of the last four years, dividends were consistently lower than buybacks. Now the conventional wisdom says the number of shares outstanding should have been reduced by now. The share count went from 1.705 billion in 2003 to 1.605 billion in 2007 or about 100 million fewer shares. Did $10.3 billion buy only 100 millions shares? The math says, $10.3 billion/100 million shares, is approximately $100 per share. But during this period PEP market share price never went near $100 per share. Intel (INTC): From 2003 to 2007, INTC spent $22.4 billion buying shares and $8.4 billion on dividends. During the four years we looked at dividends were consistently lower than buy-backs. The share count went from 6.5 billion in 2003 to 5.8 billion in 2007, or about 669 million shares. So does $22.4 billion buy 669 millions shares? The math says, $22.385 billion/669 million shares, is approximately $33 per share. But again, during this period, INTC was well under $33 (it peaked at 33 for brief period in December 2004). General Electric (GE): From 2005 to 2007, GE spent $25.7 billion in share buybacks and

$31.3 billion on dividends. It’s important to note that during the period reviewed, GE’s dividends were higher than their buybacks. The share count went from 10.5 billion in 2005 to 10 bil-lion in 2007, or a drop of approximately 500 mil-lion shares. So does $25.7 billion buy 500 millions shares? The math says, $25.7 billion/500 million shares, is approximately $51 per share. But during this period GE stock price never reached $51. The study tells us PEP, INTC and GE bought back their shares primarily to offset the options exercised by management thus transfer-ring profits more to management then share-holders. It appears that management at the three companies were more intent on balancing the options pricing than create shareholder value. Cash for Clunkers Just one more bad idea from government With the administration and Democrats in Con-gress hailing the “Cash for Clunkers” program such a huge success, we thought we’d take a look at the

results of the program for our-selves. Here’s what we found:

• Number One. The rank of the Ford Explorer as the most-traded-in clunker. Also the rank of the Toyota Corolla as the most purchased new car in cash-for-clunkers deals. • $2.878 billion, total cash dis-pensed by the program. • 15.8 mpg, the average mpg rating on the clunkers traded in

compared to 24.9 mpg average of the new cars sold.

• 80%, the percentage of U.S. auto makes traded in and the percentage of foreign auto makes pur-chased under the “CFC” program.

• 28 days’ supply of Chrysler’s inventory at the end of the program compared to the usual 60 days.

• 55 days, the total length of time the program was in effect.

• 690,114 total number of “Cash for Clunkers” transactions.

• And the most notable stat of all, drum roll please: 40%, the average drop in auto sales for U.S. Auto makers in the 30 days after the program ended.

How Did It Happen? How did it come about that Americans, long respected for independent thinking and a strong sense of individualism, hand over the reins of the nation’s destiny to an entrenched bureaucracy—busybodies who take no career risks, who care for little other than tenure, and think nothing of taking their daily bread from the mouths of the productive sector while simultaneously interfer-ing with their ability to produce? We’ll tell you how: one insidious step at a time. As always, thanks for reading. MJD



“One key point to pay attention to going forward is the expira-tion of the Bush-era tax cuts, schedule to end in 2011. Even if Obama didn’t add a single new tax or increase those we al-ready pay, the expiration of those tax cuts will amount to one of the largest tax increases in U.S. history.” — “The September 2009, Casey Report”

About Exchange Traded Funds (ETFs) By Matt Powers Vice President & Portfolio Manager

E XCHANGE TRADED FUNDS, more com-monly known as ETF's have increasingly

become a key investment vehicle for individu-als as well as institutions. From 2000 to 2008, total ETF investments grew from under $100 billion to close to $600 billion in the U.S. alone. With a growing pool of ETF options and the strategies available to employ them in a portfolio, it can be difficult for an individual to determine which ETF suits them best. In this article we will give you a brief introduction to ETFs. In future issues of Viewpoint we’ll go into more detail including our strategy for using them in portfolios. What Exactly are ETF's? An ETF is very simply a hybrid of an index fund and a stock. The fund itself is usually created to closely track an index or an individ-ual market sector (i.e. S&P 500, Russell 2000, or financials) but it trades like a stock in that you can buy and sell the ETF all day long as with a common stock. One advantage for investors is they instantly gain exposure to a sector or asset class--index-like diversification--with one trade. This is similar to an open-end mutual fund.

Why invest in ETFs? First, ETF man-agement ex-penses are usu-ally lower than those of tradi-tional mutual funds, sometimes much lower. For example, the average “Large-


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2000 2001 2002 2003 2004 2005 2006 2007 2008

The Growth of ETFs 2000 to 2008 (in billions)

Source: (IShares)

First Rule of Healthy Eating, Do No Harm Bad food is more harmful than good food is helpful

From Women for Well Families new cook book, “The Art of Eating Well.”

I n today’s processed food world, it is almost impossible to eat healthy 100% of the time. The center isles of our supermar-

kets are filled with processed, FDA approved “foods” that are devoid of nutrients and filled with toxins that can actually be chemically addictive. Think Cheeto’s Cheese Puffs. In fact, most of the things people eat today are so devoid of any benefi-cial ingredients that arguably they’re not even food. Sadly, even the produce-section of the average grocery store is a mine field of unhealthy eating. That’s because over the last 50 years the advent of pesticides, genetically-modified foods, and depleted soil means even healthy raw fruits and vegetables have significantly less nutrients then they did in our grandparent’s day. For example, did you know that baby car-rots are dipped in a solution of water and chlorine to preserve them! Consequently, making better food choices like fruits and vegetables alone will not be enough to restore and maintain your family’s health. It will be equally important (if not more so) to identify and eliminate, where possible, the harmful foods and habits. A salad at lunch will not compensate for poor food choices the rest of your day. As with anything in life, the bad will drive out the good. And so it is with food as bad food will do many times the harm than the good food will help to restore you and your family’s overall health. Making this even more critical is the realization that the current generation of children are almost certainly born under-nourished from the poor eating habits of their parents. It was unavoidable. Since birth, this same generation has experienced little in the way of health building nutrition, but rather we’ve been subjected to health depleting meals, beverages, medica-tions, toxins and emotional stresses. With all this working against us in achieving health for our family, wouldn’t now be a good time to begin reversing the effects of unhealthy eating by switching to more nutritional and less harmful foods and habits? Here is a table of suggestions on how to begin making the transition from harmful to helpful eating. Remember, the most important thing is to begin.

See front page for information on buying a copy:“The Art of Eating Well.”

3rd Quarter 2009

MAN MADE & HARMFUL REPLACE WITH GOD MADE Eliminate artificial sweeteners: consider them the poison they are.

Raw sugar, Agave, Honey or Brown Rice Syrup.

Eliminate all microwave cooking. It literally turns healthy food into poison.

Buy a teapot, and use your cook top.

Limit lattes, cappuccinos and macchiato. Black organic coffee or use organic half and half and one of the above sweeteners.

Strictly limit white sugar and flour. Whole wheat and white whole wheat flours. Above sweeteners.

Eliminate soda, diet soda, Crystal Light, bottled sweetened teas, colored flavored waters, sports drinks, and Dasani, Nestle and Aquafina waters. These will not provide the desperately needed hydration to cells.

Pure, filtered and pH balanced water (between a 7.0-7.8 ph). Fiji and Evian bottled water is best. Or use a Brita pitcher. Do not alkalize with artificial additives. Too muchalkaline is just as unhealthy as too little. Make your own green tea.

Strictly limit preservatives, dyes and fillers in packaged and canned foods. The longer the list of ingredients and the harder to pronounce—the less healthy.

Grandma’s canned food. Fresh and if not fresh than frozen. Real oatmeal vs. instant. Avoid shopping in the middle aisles. Try organic whenever possible.

Strictly limit animal protein: red meat, chicken, fish, eggs, all dairy. Animal protein creates an acid environment (read Alkaline Reserves). Like fake sugar, avoid completely margarine and egg beaters! They do much more harm than good!

Organic, range - fed, hormone and antibiotic free animal protein and dairy 3-4 days a week. Eat only 40-50 grams per day. Or-ganic beans and raw nuts on a salad, in soup and in brown rice. Hummus on whole grain wraps and crackers. Small amounts of real organic butter or organic eggs can be healthy.

Avoid Soy unless you are menopausal. Soy milk should be avoided, especially by chil-dren. Today, our over stressed livers cannot handle the excess estrogen promoted by soy.

If you want to use soy as an animal protein substitute, use it in its whole form—edamame (soy beans). They’re in the pro-duce section. They look like pea pods.

PESTICIDES AND PRODUCE

BEST TO BUY ORGANIC NO NEED TO BUY ORGANIC Apples, bell peppers, carrots, celery, cher-ries, lettuce, nectarines, peaches, potatoes, spinach and strawberries.

Asparagus, avocadoes, bananas, broccoli, cabbage, eggplant, kiwi, mangoes, onions and pineapples

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 does its repair and maintenance between 1and 3 a.m. The hot lemon water will help the liver detoxify and stimulate enzyme release. You may add a bit of Agave if too sour. Rub 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, lemongrass, sesame and cilantro.

Cap” equity mutual fund’s expense ratio is 1.43% while the Vanguard Large Cap ETF's expense ratio is only .13%, well over a 1% difference. This can result in a significant savings over the life of the investment, particularly in the low return environment we’re in today. ETF's have a real-time quoted unit price during regular stock mar-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 which are calculated and priced daily after the market closes. This makes it difficult when making a purchase or liquidation as the true share price of a mutual fund is not known until market close. The current share value is known immediately with an ETF.

Traditional mutual funds have the flexibility to shift from one stock to another, or even out of stocks to hold cash. Index based ETF's always track their respective index, no moves to cash. This is one of the advan-tages of ETFs in a portfolio designed to meet a specific asset allocation, because we can be certain the fund will remain true to its sector or asset class and will not undermine our asset allocation by changing theirs.

Designing a Portfolio with ETFs Next quarter, in the year-end edition of VIEWPOINT, we will explore our process of selecting and our method and strategy for utilizing ETFs in a portfolio. In the mean time, please feel free to contact us and we would be happy to sit down with you to discuss how ETFs might fit into your overall portfolio strategy. MTP


Deschaine & Company, L.L.C. A REGISTERED INVESTMENT ADVISOR

128 South Fairway Drive Belleville, Illinois 62223 [email protected] deschaineandcompany.com

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 [email protected] and we would be happy to add you to one of our mailing lists.

Looking to Buying Gold, We Suggest: “Proceed with Caution” By Jason Loyd, Vice President & Portfolio Manager

T HERE’S NO WAY AROUND IT, gold is a popular topic of discussion among investors these days. Yes, gold certainly is a “hot commodity,”

no pun intended. One would have to be living in a cave (or at least not watched television in the last decade) to not be aware of all the hype now sur-rounding gold. If I had a dime for every commercial I’ve seen in the past year trying to convince me to buy gold, I’d be, well, rich. At the same time, with all the uncertainty in the economy, it’s under-standable why folks are jumping into gold. The rapidly weakening US dollar is one of the reasons investors have been flocking to the yellow stuff. The dollar is weak because of a growing concern about the potential for inflation, as a result the price of an ounce of gold has skyrocketed to an all time high. Gold has averaged a healthy return of 12.96% per year over the past 10 years, while at the same time the S&P 500 has lost about 3% of its value. The US Dollar continues to weaken against other currencies, and it doesn’t take a PhD to figure out why. Take a look at the chart of the his-tory of the US money supply on page 3. When our government creates, prints, and shovels this much money into the economy this quickly; it di-lutes the value of the dollar. Since there is not a corresponding increase in the stock pile of gold its price rises. Customarily, the dollar and gold have an inverse correlation. That means that when the dollar goes down, gold usually rises. Historically, as inflation rises, gold has risen with it. Let me first say that gold is not the answer to all of the worlds’ finan-cial problems. There have been many times we recommended reducing a gold position rather than increase it, for one simple reason—risk. While many indicators point to the price of gold going higher, it is still prudent to remain diversified, regardless of the conviction you may have on a particu-lar investment. Second, we have to remember that while gold can be an important store of value in these times of potential inflation it is not par-ticularly useful as every day currency. It may not be convenient to carry around, but enough gold can buy almost any good, service, or currency we want, in nearly any economic scenario. Gold can however, act as a hedge against inflation, (or hyper-inflation possibly?), stock market meltdowns, and economic or global turmoil. Let’s briefly look at the different ways to buy and own gold:

1) Physical Ownership: Physically buying gold bullion is relatively 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 catch for you as a potential investor in physical gold is that you have to be able to make sure you are getting the highest quality gold content in your asset at the right price. Certainly one trustworthy place to go to buy gold is the US Mint. 2) Gold Certificates: These provide you with a certificate of owner-ship of gold without hassle and cost of physically storing and safekeeping. 3) Gold Bullion Exchange Traded Funds: These recent develop-ments are an innovative and cost effective way to invest in gold without having to find a mattress or digging a hole. Gold ETFs capture the price of gold minus a nominal administration cost. To buy a gold-tracking ETF can be done through your brokerage account. Since ETF’s are traded on the stock exchange as discussed on page 6; they provide liquidity and transparency. 4) Gold Stocks: Buying gold mining companies is certainly a viable option; although it should be noted that it does tend to have higher risk to return ratio than just buying gold because there is the added risk of mar-ket fluctuations that often have little to do with the fluctuations in the price of an ounce of gold itself. Additionally, there’s the usual amount of security research, knowledge, and monitoring that goes along with any equity investment.

Just as with any investment, it’s important to take a long hard look at the potential downsize before investing in gold. We think one of the pri-mary downside to gold right now is this; it’s just too darn popular. Our experience tells us we should get nervous when an investment or asset class gets too fashionable. Over the past five years, about 65% of the de-mand for gold has been for making jewelry. India is the largest buyer of gold, as they buy up 25% of the world’s gold supplies. With a slow world economy, what happens to the price of gold if the Indians decide that silver or platinum is more in vogue? The key is to remember that no single investment is a sure thing. Thus, our advice to anyone buying gold today would be to proceed, but with caution. Meaning? Maybe get your toe wet buying a little and see where the price goes. If it drops from here you would always have the op-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

3rd qrt 2009 8 page final

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