Monthly Market Review - June 2009

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We just read our June 2008 newsletter, and are amazed at how the world has changed. A year ago, our country was fully engaged in an unprecedented presidential campaign between Senators Barack Obama and John McCain, who were preaching very different values and priorities their respective presidency would pursue. Of course Senator Obama is now President Obama and is vigorously pursuing the change he promised. We will wait to weigh the evidence of his policies before reaching any conclusions, but have to admit a bit of worry as the US seems likely to accumulate debt at record levels to fund the new President’s agenda. While the actions of permanent bears such as Jim Rogers, who moved to Singapore and liquidated all his dollars based investments, may seem extreme, his warning of coming hyper-inflation is troublesome. Clearly the Fed has dumped an incredible amount of money into the system, and we will have to wait and see if it is capable of a Volcker like tightening as soon as the fear of recession wanes.

The Fed’s action is very important to how we should position ourselves in the market, as increasing inflation will move investor’s pre-tax required rates of return higher, leading to lower market multiples. Further, this will punish growth stock disproportionately, given the longer duration of their underlying cash flows. This may have a negative feedback effect on the overall market as growth stocks are the firms requiring innovating and paving the way forward to a better future.

A year ago it would have been hard to imagine:

1. The price of oil falling below $100 a barrel
2. The government owning GM
3. Citi and BAC almost being nationalized
4. Banks pleading to return money back to the government

The more things change, the more they seem to stay the same. Many of the issues we are debating today were debated in one form or another years ago, and will likely continue to be debated years from now. The access to information through the Internet may make the debates appear sharper or more urgent, but they were likely as passionate years ago. This year’s AFG Research Summit has a special treat for our attendees, as we will have Dr. Victor Davis Hanson as a keynote speaker. Dr. Hanson is a Hoover Institute Fellow, and an expert on Greek history, and he will lead a discussion comparing how many of the issues we are debating today were many of the same questions debated by the ancient Greeks. It should be a very interesting discussion. Also we are pleased to have Dr. Victor Canto, discussing the state of the Global economy and offering some of his views on asset allocation strategies for the coming year. Dr. Canto has a unique perspective to add on the current economic experiments taking place in Washington, as he was partners with Art Laffer, and close to the Reagan Administration as the Supply Side Revolution was launched in the early 80’s.

While many demagogue the concept of Supply Side Economics, it is interesting to understand the basis for such criticisms. Often, one argues that the Supply Side approach starves the government, and starts the country on its current habit of deficits and increasing debt. Others argue that cutting taxes across the board has led to extreme wealth dispersion and is thus inherently bad for the nation. While we will explore this discussion in more detail another day, lets offer a quick answer to each question. Regarding government revenues, and deficits, it is hard to argue that tax cuts were the cause of increased deficit spending. Looking at the Reagan years, government revenues increased rather than decreased as common media tends to portray. Thus deficits were the result of increased spending, not reduced revenues. There is not much more to say about that, as the facts are clear. The second question is much more interesting, and will require greater patience and prose to flesh out. However, here is our initial intuition on the subject. Income inequality is most likely a very silly metric to track after individuals have their basic needs met (food, shelter, general well being). Probably the correct question to ask is whether the quality of living is improving, how fast, and what are the alternatives. We promise that will be a discussion for the future, as it relates directly to our prior discussion on cost of capital and how increases in those costs affect growth firms more than value firms and likely suppress innovation.

For those of you attending our conference, we look forward to welcoming you, sharing some unique research, and having some vigorous discussions about stocks and the economy during our time together. For those of you that could not make it, we look forward to sharing our research with you in the months ahead and hope you put us on your calendar for next year.

Here are the returns for May 2009 (5/1 – 5/29), another good month for the equity market:

Here is an overview of which sector and style universes look the most undervalued:

Source(www.EconomicMargin.com)

 Download the complete version of the June Market Review.

Applied Finance Group’s (AFG’s) Value Score defined - Value Score represents the percentile rank of the percent to target (deviation between AFG’s current default target price and stock’s current trading price). A Value Score of 100 is the most undervalued and 0 is the most overvalued company in the universe.

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