Tom McCandless's presentation with stock recommendations

04/23/10 Financial Planning & Investments 1

“How worried should I be?”“Is it really different this time?”“What actions should I take, if any?”

Thoughts from a long-time, long-term investor

Tom McCandless 914-572-1887


What are the Current Market Conditions Like?


Unchartered Territory!


Tonight’s Agenda

• Background of stock market• Economics: Key Linkages• Individual Asset Classes• Diversification• Equity Investing• Conclusions


Timeline of US Stock Market • 1685 – Surveyors lay out Wall Street along the lines of the stockade (12’ wall erected

in 1653 to protect Dutch settlers from British & Indian attacks).• 1792 – First 5 securities are traded in NYC: 3 gov’t bonds and 2 bank stocks.• 1792 – Buttonwood Agreement: 24 prominent merchants & brokers agree to trade

securities on a commission basis, marking the beginning of the NYSE.• 1817 – NY Brokers formally establish the NY Stock & Exchange Board. (NYS&EB)• 1836 – NYS&EB prohibits its members from trading in the streets.• 1857 – Panic. Collapse of Ohio Life Insurance & Trust. Prices fall 8-10% in a single

session, culminating in 45% drop year-to-date.• 1861 – Civil War. Securities of seceding states suspended.• 1863 – NYS&EB becomes NYSE.• 1867 – First stock ticker created.• 1869 – Watering Stocks prohibited (secretly issued shares); All shares must be

registered.• 1871 – Continuous trading via Specialists begins.• 1873 – NYSE closes for 10 days due to collapse of Jay Cooke & Co., a prestigious

banking due to speculation in railroad stocks.• 1892 – NYSE establishes clearing house.• 1895 – Annual Reports, incl. income statements and balance sheets, required for all

NYSE listed.• 1896 – WSJ publishes DJIA for first time. Value = 40.74, 12 stocks, incl American

Cotton Oil and Standard Rope & Twine.


Timeline of US Stock Market – Pt. 2

• 1907-- Panic of ’07. Knickerbocker Trust rumors trigger massive run on NYC banks; JP Morgan, Sr. infuses cash into banks.

• 1911 – Blue Sky Law adopted by Kansas.• 1913 – Federal Reserve System created.• 1914 – WWI causes longest exchange shutdown ever at 4 ½ months.• 1920 – Centralized clearing system established.• 1923 – Fraud Bureau created; start of historic Bull Market.• 1929 – Black Thursday (10/24/29). Stocks crash on record vol of 13m shares; 5 days

(Black Tuesday) later stocks fall by 11% on vol of 16m shares. Marks start of Great Depression.

• 1932 – DJIA hits bottom, falling 89% for 1929 Peak.• 1933 – Securities Act. Mandates registration & disclosure requirements. FDR

inaugurated. FDIC created under Glass-Steagall Act. US abandons Gold Standard & US Dollar begins to float (managed)in FX markets.

• 1934 – Securities Exchange Act. Creates SEC. FHA created. • 1935 – Social Security created, funded by FICA.• 1943 – Women begin working on the stock exchange floor.• 1944 – Bretton Woods Agreement. US Dollar begins to float freely in FX markets.• 1945 – Exchange closes for VJ Day.• 1949 – Beginning of longest Bull Market run in history (8 years).


Timeline of US Stock Market – Pt. 3

• 1954 – DJIA surpasses its 1929 peak for the first time.• 1959 – NYSE adopts policy to discourage securities transactions between a

listed company & its officers / directors.• 1963 – JFK assassinated (11/22/63).• 1966 – Securities Investor Protection Corp. created.• 1972 – Securities Industry Automation Corp. formed.• 1975 – Fixed minimum commissions banned.• 1982 – First 100m share volume day for NYSE.• 1987 – Largest 1-day % drop (10/19/87), DJIA falls 23%.• 1988 – Circuit breaker introduced by SEC.• 1995 – 3-day settlement period for stocks begins.• 1997 – Wireless data system & trading in Sixteenths begins; volume tops

1bn shares for NYSE.• 1998 – New circuit breaker rules, trading halts on drops of 10/20/30%.• 1999 – DJIA Tops 10,000.• 1999 – Graham Leach Bliley Act. Repeals much of Glass-Steagall Act.


Timeline of US Stock Market – Pt.4

• 1999 – Independent Directors required for NYSE Listed companies (min 3).

• 2000 – Decimal pricing begins. First ETF.• 2001 – Terrorist attacks on WTC. NYSE closes for 4 days—longest

since 1933. Reopened 9/17/01 on record vol of 2.37bn shares.• 2002 – Sarbanes – Oxley Act enacted, aimed at improving accuracy

& reliability of disclosures.• 2005 – High bid for NYSE membership (seat) $4m. Seat sales end.• 2006 – NYSE goes public, merges with ArcaEx, owner of major

ECN & PacExch; launches enhanced options and bond trading platforms.

• 2007 – NYSE merges with Euronext NV, marking a major milestone for global financial markets; opens office in Beijing, China.

• 2008 – NYSE announces acquisition of Amex.


Global Markets

• Stocks -• Fixed Income - • Commodities - • Money Markets - • Foreign Exchange -• Derivatives -


Global Markets – Mega Trends

• Globalization• Institutionalization• Innovation• Consolidation• Communication


Economics: Key Linkages

• Monetary Policy – control of money supply which influences short term interest rates only (Fed Funds)

• Fiscal Policy – government borrowing (treasury issuance), spending & taxation.

• Policies can be expansionary, neutral, or contractionary.

• Direct impact on aggregate demand or economic growth (GDP)


Outstanding US Private & Public Debt

Mortgage Fed Money Asset- Annual Mortgage Fed Money Asset-Municipal Treasury (1) Related (2) Corporate* Agencies Market (3) Backed*(4) Total Municipal Treasury (1) Related (2) Corporate* Agencies Market (3) Backed*(4) Total

1985 860 1,438 372 777 294 847 1 4,587 1985 19% 31% 8% 17% 6% 18% 0% 100%1997 1,319 3,660 2,680 2,359 1,023 1,693 536 13,269 1997 10% 28% 20% 18% 8% 13% 4% 100%2002 1,763 3,469 4,686 4,100 2,293 2,546 1,543 20,400 2002 9% 17% 23% 20% 11% 12% 8% 100%2007 2,619 4,856 7,269 5,825 2,946 4,159 2,472 30,146 2007 9% 16% 24% 19% 10% 14% 8% 100%2Q08 2,662 4,677 7,554 6,158 3,139 4,162 2,499 30,849 2Q08 9% 15% 24% 20% 10% 13% 8% 100%

22 Yr CAGR 5.2% 5.7% 14.5% 9.6% 11.0% 7.5% 43.3% 8.9% Average 12% 25% 19% 18% 8% 14% 4% 100%

10 Yr CAGR 7.1% 2.9% 10.5% 9.5% 11.2% 9.4% 16.5% 8.6% Average 9% 19% 22% 19% 10% 13% 7% 100%

5 Yr CAGR 8.2% 7.0% 9.2% 7.3% 5.1% 10.3% 9.9% 8.1% Average 9% 17% 23% 20% 11% 13% 8% 100%

*The Bond Market estimates.

(1) Interest bearing marketable public debt.

(2) Includes GNMA, FNMA, FHLMC mortgage-backed securities and CMOs and non-agency MBS/CMOs.

(3) Includes commercial paper, bankers' acceptances, and large time deposits.

(4) Includes public and private placements.

Source: The Bond Market Association.

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

1985 1997 2002 2007 2Q08

Municipal Treasury Mortgage Related Corporate Fed Agencies Money Market Asset-Backed

Less Reliant on Treasuries While Mortgages & Corporates See Increased Demand

$Bill

ions


Gross Domestic Product

• Negative Growth in ’09 Likely• 2 Qtrs of Neg Growth = Recession (BEA)


Interest Rates & Yield Curves• Negative lending spreads of ’06, ’07 & ’08 have recently turned

sharply positive…but need & should widen further.• Yield curve changes appear surprisingly normal & similar to prior

business cycles.• NBER will likely determine in 2H09 that nation entered recession

beginning in 4Q08 & lasting at least 2 more quarters.

-3.50-3.00-2.50-2.00-1.50-1.00-0.500.000.501.001.502.002.503.003.504.004.50

1976 1977 19781979 1980 1981 1982 1983 1984 1985 1986 1987 1988 19891990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Recession 2 Yr Tres less Fed Funds 5 Yr Tres less 90Day Bill 10 Yr Tres less 90Day Bill

Steepness of the Yield Curve


Retail Sales

• Falloff in sales – unprecedented?


Building Permits

• Severe Correction – Worse than Normal?


Employment Growth

• More downside likely


Individual Asset Classes

• Though most people have either direct or indirect ownership in stocks, it is often not their largest personal asset.

• Assets include: primary residence, bank accounts, life insurance cash values, annuity surrender values, collectibles, jewelry/art, brokerage accounts, retirement accounts (401-ks, IRAs, private equity, etc.), college savings fund, business ownership.


Individual Debt Classes

• Home Mortgage(s)• Auto / Card / Student Loans• HELOC• Back Taxes• Investment-related debt• Business borrowings


Cash

• Emergency Savings – enough to fund your family’s living expenses for at least 2 years.

• Sources of liquidity – most bank accounts, paid up life insurance, securities in brokerage accounts, saleable collectibles.


How much of my total assets should be in stocks?

• Depends on many items, including some rough calculation of your net worth (assets minus debts).

• Risk Tolerance – How much can you stand to lose?

• Old, old rule of thumb ==> 100 – current age = % of overall assets in equities.


Diversification

• Perhaps the most important rule of all!• Across and within asset classes.• Allocation – determining how big each

asset class should be.• Correlation – Key to diversification as

most “financial” assets are positively correlated: Precious metals vs. stocks & bonds.


Age-Based Diversification

• A person in their 40s should have:– 50—65% Domestic / International Stocks– 15—25% Domestic / International Bonds– 25—35% Alternative Invests (REITs, TIPs,

Private Equity, Venture Cap Funds, LPs)– 5—10% Cash Equivalents(for all financial assets)



• A person in their 50s should have:– 45—60% Domestic / International Stocks– 20—30% Domestic / International Bonds– 20—30% Alternative Invest (REITs, TIPs,




• A person in their 60s should have:– 35—60% Domestic / International Stocks– 25—40% Domestic / International Bonds– 20—30% Alternative Invest (REITs, TIPs,



Equity Investing

• Two primary schools of equity analysis: technical analysis and fundamental analysis. Both combine art and science.

• Technical Analysis – Analyzing price & volume movement in stock price charts for specific patterns. Frequently used by traders.

• Fundamental Analysis – Analyzing business prospects, profitability, financial strength, competitive positioning, management capabilities & including projections of financial statements and the use of a variety of mathematical equity valuation models to determine a stock’s intrinsic value.


Technical Analysis

• Detecting chart patterns to signal buy, sell or hold recommendations for equities.

• Common chart pattern terms: breakout, confirmed upturn, confirmed downturn, head & shoulders, cup & handle, double bottom, double top.


Technical Analysis–Double Bottom?

• 1 of 5 key basing chart patterns.

• Base Length = 7 weeks to +15 months.

• Buy point occurs as stock price surpass middle of the “W” as it is coming up from its 2nd bottom. Volume should increase.


Fundamental Analysis

Key Definitions to know1) Earnings Per Share or EPS:

Last 12 months? Current Quarter annualized? Estimated next 4 quarters?

• 2) Price / EPS, or P/E ratio. A measure of “affordability”. Impacted by EPS growth rates, management competency, industry dynamics. Consistent EPS growth = Higher P/E & vice versa. Key driver to Executive compensation.

• 3) PEG. P/E-to-Growth (EPS). Look for a ratio < 1.0.• 4) Market Cap: Current stock price x outstanding common

shares.• 5) Return on Equity: Net Income / Shareholder’s Equity…a

key measure of profitability that can be broken down into other supporting financial ratios.


EPS & P/E Valuation Dynamics – RIMMWhy EPS Matter So Much!

• RIMM ($42.50--down 70% from $148 in June) (March 1 Fiscal):

LTM EPS = $3.07 P/E = 13.8xCurrent Qtr x 4 = $3.48 P/E = 12.2xEst next 4 Qtrs (avg) = $3.55 P/E = 12.0x

Year Ago EPS = $2.26

Est’d EPS of $3.55 (+57% yr/yr – sustainable?)Latest Qtr-to-Qtr EPS Growth = 18% PEG = 0.67


EPS & P/E Dynamics – RIMM - Pt 2

• If RIMM “beats” current qtr EPS est of $0.91 by $0.04, then $3.55 EPS est likely increases to $3.65, then EPS is growing at 62% yr/yr & 37% qtr/qtr (accelerated).

• Current P/E of 12.0x would represent a PEG of 0.32 & could expand quickly to 13—13.5x P/E.

• Price would likely “pop” to $47--$50.


EPS & P/E Dynamics – RIMM - Pt 3

• If RIMM “misses” current qtr EPS est of $0.91 by $0.04, then $3.55 EPS est likely decreases to $3.45, then EPS is growing at 52% yr/yr & 5% qtr/qtr (decelerated).

• Current P/E of 12.0x would represent a PEG of 2.4 & could collapse quickly to 11—11.5x P/E.

• Price would likely “drop” to $38--$41.


Volatility

• All time high – 60% higher than prior spikes.


DJIA – Price Wtd

• Prices Collapse – Unprecedented?


S&P 500 – Market Cap Wtd

• Recent Selloff Dramatic – Unprecedented?


S&P 500 – Sector Breakdown134 Industries / 500 Companies

• Info Technology – 16.0% (15 Industries)• Financials – 15.9% (20)• Energy – 13.4% (7)• Health Care – 13.1% (10)• Consumer Staples – 12.2% (13)• Industrials – 11.1% (18)• Consumer Discretionary – 8.5% (33)• Utilities – 3.6% (4)• Materials – 3.4% (13)• Telecom Services – 3.05% (2)


Cyclical Trends – Leading Indicators for Commercial Banks

Source: Federal Reserve, Bureau of Economic Analysis, ISM, TDM Investment Services.

Note: Updated through 3Q08.

25.0

30.0

35.0

40.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

80.0

1976197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009

(20.0)

(15.0)

(10.0)

(5.0)

0.0

5.0

10.0

15.0

20.0

Recession VPI Biz Inven C&I Lo

(10.0)

(5.0)

0.0

5.0

10.0

15.0

20.0

197719781979198019811982198319841985198619871988198919901991199219931994199519961997199819992000200120022003200420052006200720082009

(15.0)

(10.0)

(5.0)

0.0

5.0

10.0

15.0

20.0

Recession C&I Loans (left) Business Fixed Investment + Business Inventories (right)

Inventories and C&I Track Closely; VPI Leads Inventories

(and C&I)

Demand for C&I Loans: Driven by

Inventory and Capital

Expenditures

year/year change

Future Inventory Demand

year/year change


Banking Sector Valuations

Source: S&P, TDM Investment Services.

Note: Updated through November 2008.

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

'58 '60 '62 '64 '66 '68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

22.0

'58 '60 '62 '64 '66 '68 '70 '72 '74 '76 '78 '80 '82 '84 '86 '88 '90 '92 '94 '96 '98 '00 '02 '04

Relative P/E

Absolute P/E(12 month forward EPS)


PNC Bank Valuation

Source: TDM Investment Services

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

'76 '77 '78 '79 '80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

1.30

1.40

1.50

1.60

1.70

1.80

PNC P/E RELATIVETO BANK GROUP P/E

(Left Scale)

PNC PRICE RELATIVE TO BANK INDEX(Right Scale)

PNC's CURRENT RELATIVE P/E = 1.36Dec '04 = 0.80 or 20% discount

"PNC's CURRENT LOW RELATIVE P/E TO THE BANKING SECTOR DOES NOT REFLECT TRANSFORMATION TO A MORE CONSISTENT GROWTH COMPANY"

Dec 2004


Conclusions

• Take the long-term view when investing in the stock market. Discounts growth by about 6--9 months.

• Diversify all personal assets by different asset categories: real estate, stocks, bonds, cash, etc.

• Diversify all assets within each asset category: For stocks – see S&P Sectors.

• Current Stock Market appears priced at an attractive entry point by historic standards for long-term investors. More downside is possible.

• The stock market continues to be dominated by mob psychology – (Behavioral Finance) reinforced hourly through various media outlets.


Conclusions – Pt 2.

Investment Environment Positives:

• Excessive valuations have corrected dramatically• Earnings expectations deflated• Common share buybacks increasing• Proactively managing costs better• Interest rates are low• Unprecedented liquidity & financial backstop measures

by Federal Reserve, US Treasury, & FDIC• Many economic measures are near ‘74—’75 levels,

commonly regarded as rock bottom.


Financial Stock Positives

• Institutions have clearly purged holdings.• Financial stock only Hedge Funds have

collapsed.• Ongoing discussion to adjust the massive

current negative mark-to-market accounting hits to earnings. Future markups possible?

• A steeper yield curve is often a precursor (6—9 months) to a rebound in the bank stocks.

• Financial stocks tend to lead the overall market direction (up & down) and are regarded as “early cycle” stocks.


Other Advice – Pt 1

• Know your pain (loss) threshold!!• Avoid first hour of trading (9:30am open)• Avoid 12 noon—2pm – very thin trading • Trading during last hour (3—4pm) can

greatly influence the next day’s direction.• Seasonality: selling in Oct and Dec &

buying in January. August can be erratic due to vacations.



• During a recession or near quarter-end, companies tend to announce bad news after 4pm on Fridays.

• Market does not differentiate during a bear market: good companies get hit just as hard as bad companies.

• Market never tolerates a slowing rate of EPS growth, especially if P/E is high: DELL, MSFT, WMT & SBUX.

• Always enter a stop loss when buying stocks, typically about 10% (max loss).



For mutual fund investors:• Try to avoid actively managed funds with +$50bn in

Assets Under Mgmt. Too big to outperform.• Morningstar and Forbes publish rankings for funds that

do well in BOTH bear & bull markets.• More mutual funds than stocks.• Since most mutual fund portfolio managers struggle to

outperform the S&P 500, the timing of your purchase of the fund (when the market is low) becomes even more important. “Timing is Everything!”

• Otherwise, one can invest in a broad variety of funds that mimic the broad market indices.


Best Seats on a Train WreckLong-Term Large Cap Buys

• Financials: NTRS, BAC, PNC• Energy: CVX, RIG, BP• Health Care: JNJ, PG, MRK, BMY, SYK• Consumer Staples: COST, MO, ADM, SWY,

WAG • Industrials: GE, DOW, UNP, BA• Technology: AAPL, RIMM, HPQ, CSCO, ADP• Consumer Discretionary: NKE, DLB, TIF, COH


Summary

• Diversify your assets.• When investing long-term in the stock

market: a) know your pain threshold &b) Timing your entry is THE most

important investment decision.• At the earliest, the stock market may not

be poised for a sustained upturn until 1Q09…above norm volatility will continue.

Tom McCandless's presentation with stock recommendations

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