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Making Money Stocks in a Long-Term Bear Market

A Historical Example, The 1966 to 1982 Bear Market

Deschaine & Company, L.L.C. © All Rights Reserved

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1) We’re in a Long-Term Bear Market 1) The history of the stock market is one of long alternating bull and bear market cycles.

In long-term bear markets, investment returns come primarily from income not capital appreciation.

2) Long-term bear markets do not end until price/earnings ratios reach single digit levels. The stock market’s current p/e ratio is about 13.5 on the S&P 500 index.

3) The stock market is “overvalued” making positive capital returns difficult to achieve. Protecting principal as price/earnings multiples erode during a long-term bear market is critical to portfolio results.

The Question is: “How do you make money in a bear market?”

SINCE DECEMBER 2000 we’ve managed client equity portfolios using the following primary assumption:

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The Current Long-term Bear Market (in Red)

What did the last Long-term Bear Market look like? . .

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1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035

“Inflation Adjusted” The Dow Jones Industrials Dollars: 1900 — 2008

1929 Stock Market Peak

1966 Stock Market

Peak

2000 Stock Market Peak

As you can see, the highest on record!

Our Market Forecast 2000—2035

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B A C

30 Years 37 Years 34 Years 35 Years ?

D?

December 31, 2008

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The last long-term Bear Market 1966 to 1982 (Standard & Poor’s 500 Index)

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STANDARD & POOR’S 500 1966 to 1982 Bear Market Results

  1966 1982 Index

Change Annual Return

S&P 500 Index at Year End  92.43  109.61  17.18  1.07% 

Dividends Received   67.70  3.49% 

84.88  4.16% 

Quarterly Dividend Rate  0.81  1.76  0.95  4.97% 

Total Return  

The 1966 to 1982 bear market had a 1.07% annual return on capital, and a 3.49% annual return from dividends. Annual compound total return 4.16%. The S&P 500 annual dividend grew from .81 cents to $1.76 or 4.97% annually. Not very compelling returns, wouldn’t you agree?

What would have a $1,000,000 earned over this Bear Market? . . .

S&P 500 Index

S&P 500 Quarterly Dividend

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Making Money in the 1962-82 Bear Market required patience and regular dividend reinvestment.

Anything we could do to enhance our returns? . . .

Yet, over the 16-year bear market a portfolio would have more than doubled from diligently reinvesting a growing dividend. In addition, portfolio income would have grown at a healthy 10.48% annual rate from $29,428 a year in 1966 to over $144,986 by year end 1982.Remember these returns are earned from passively investing in the S&P 500, which includes over 130 stocks that don’t pay a divi-dend! What would happen if we eliminated the 130 stocks that don’t pay a dividend?

Green: Cumulative capital return

Blue: Cumulative investment, $1 million initial investment and all reinvested dividends

Yellow line: Quarterly dividend income

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Yes! Step One: Eliminate S&P 500 Stocks that don’t pay a dividend.

Is there anything else we could do to enhance our returns? . . .

If we simply eliminate the stocks in the S&P 500 that don’t pay a dividend, the portfolio’s dividend yield goes from 3.05% in 1966 to 4.55%. The annual dividend growth rate goes from 6.12% to a healthy 11.19%. As a result, the portfolio’s quarterly income grows at a healthy 23.32% from $43,908 annually to over $1,256,634 per year. Which works out to an annual compounded total return from 1966 to 1982 of 12.13%!

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Enhancing Return: STEP TWO: Manage Stock Selection and the timing of dividend reinvestment

A Stock Selection and Dividend reinvestment example:

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We can identifying high yield stocks with a history of dividend growth (and good future prospects of increasing dividends) and selectively reinvest dividends periodically in the stocks in the portfolio with the highest current yield. We believe this step will add an additional 1% in annual yield. We also we can increase the annual dividend growth rate an additional 1% per year.. Now our annual dividend yield is 5.55% and our annual dividend growth rate 12.26%. Annual income grows 28.95% and the portfolio’s total annual re-turn: 16.10%. Since 2000, our EIP: Dividend Yield: 6.20%. Annual dividend growth rate:14.45%, and annual total return 9.50%. S&P 500 annual total return: -2.90% over the same period!

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Here’s how We Reinvest Dividend Income: ALTRIA CORP Dividend & Yield History March 1980 through December 2008

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MO Dividend Yield: Above 5.3% Is a Strong Buy Signal

Quarterly $ Dividend (right axis)

Dividend Yield is quarterly dividend rate annualized, divided by month end share price. The peak? March 2000 when tobacco litigation concerns depressed MO’s stock price.

NOTE: As of December 31, 2008, All date includes Kraft and Phillip Morris International MO was a buy (or an addition to with new cash) as its dividend yield (5.0%) was above it’s 5-year aver-

age 4.5%. (As was KRT and PM) A current yield above the green line is a screaming BUY!

BUY

HOLD

SELL

Want to really juice portfolio returns? . . .

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A critical part of the return equation? Patience!

Throw More Money at the Portfolio: STEP FOUR: Invest Regularly and Often

When it comes to investing, nothing beats the simple magic of compounding! Throwing money into the portfolio to augment the cash flow from a growing dividend exponentially increases an investor’s return. Adding $10,000 a quarter to our $1 million initial deposit grows the portfolio’s annual dividend income from $53,662 in 1966 to over $3,389,918 MILLION in 1982. That’s an annual income growth rate of 29.58%!! As a result, annual total return jumps to 16.66%. This example demonstrates the power of steady and growing cash flows regularly reinvested at bear market prices. The bear market advantage: Capturing higher dividend yields as prices decline!

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The last long-term Bear Market 1966 to 1982 (Standard & Poor’s 500 Index)

The Results of a $1,000,000 investing in the S&P 500 on December 31, 1965 and all dividends reinvested

STANDARD & POOR’S 500 1966 to 1982 Bear Market Results

5.50% 6.60%  

12.26%  

1.07%  

$ 53,662  

$ 5,684,536  

$ 19,746,656  

5.50% 6.60%

12.26% 1.07%

$ 53,662 $ 3,134,960

$ 10,890,069

Beginning Dividend Yield (YE: 1965) 3.51% 4.55% Average Dividend Yield 4.10% 5.60% Annual Dividend Growth Rate 6.12% 11.19% Annual Capital Return 1.07% 1.07% Beginning Annual Income $ 29,428 $ 43,908 Ending Annual Income $ 144,986 $ 1,256,634 Ending Portfolio Market Value $ 2,290,593 $ 6,246,914

 S&P 500  

S&P Dividend Stocks Only 

Select Dividend Stocks  and Time Dividend Reinvestment 

Select Dividend Stocks,  Time Dividend Reinvestment Plus $25,000 per Quarter 

Annual Compounded Rate of Return 5.32% 12.13% 16.10% 16.66%  

S&P 500 Dividend Yield 1982 6.42%  

Total Invested Capital $2,050,365 $ 6,198,952 $ 11,327,048 $ 18,968,672  

Current Yield on Invested Capital 7.07% 20.11% 27.68% 29.97%  

 

Total Capital Return $ 240,228 - $ 49,962 - $ 436,979 $ 777,985  

Total Dividends Received $ 1,087,090 $ 5,198,952 $ 10,327,048 $ 17,968,672  

What would have a $1,000,000 earned over this Bear Market? . . .

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STANDARD & POOR’S 500 1966 to 1974 Results

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Change Annual Return

S&P 500 Index at Year End  92.43  63.54  ‐28.89  ‐ 4.58% 

Dividends Received   26.48  3.20% 

‐ 2.41  ‐ .33% 

Quarterly Dividend Rate  0.81  0.89  0.08  1.18% 

Total Return  

STANDARD & POOR’S 500 1974 to 19782 Results

  1974 1982 Index

Change Annual Return

S&P 500 Index at Year End  63.54  109.61  46.07   7.05% 

Dividends Received   37.79  6.01% 

83.86  11.09% 

Quarterly Dividend Rate  0.92  1.76  0.84  10.19% 

Total Return  

Many investors got of the market at the bottom in 1974 and missed excellent long-term re-turns as prices recover and dividends almost double! Just like today, the 1973-74 bear market was scary, but long-term investors were eventually rewarded.

But the Dividend Growth Strategy doesn’t work if we’re not patient! The 1966 to 1982 bear market is a tale of two markets: 1966 to 1974 and 1974 to 1982

Where do we stand in the current bear market? . . .

X Note the market bottomed in September 1974, a modest economic recovery began in late 1976. It wasn’t so much that the economic recovery was strong that drove the stock market, it’s that it started from such a low level. Sound like today, maybe?

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Are investors selling today getting out at exactly the WRONG time. The Red line is the S&P 500 index, the orange is the dividend. While the current credit crisis is far from over, we think with careful selection, dividend yields on stocks offer attractive long-term appeal. The risk is the weakening economy causes otherwise sound companies to cut their dividend. If you have ten years to wait, the stock market quite possibly offers the buying opportunity of a lifetime!!

The Current Bear Market (2000 to 2008)

Are we in for a repeat of the second half of the 1966 to 1982 bear market? We think it’s certainly possible.

To Summarize . . .

The S&P 500 on January 31, 2009

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A Plan for Achieving Superior Results in a Long-term Bear Market

STEP ONE: Buy high yield dividend stocks

STEP TWO: Diligently reinvest dividends at the highest current yields available in the portfolio at the time.

STEP THREE: Invest early, regularly and invest often—capturing higher yields as prices continue to weaken throughout the bear market cycle.

LAST: Be patient! We’re only half way through the current bear market!

For long-term investors, keep investing all the way to the bottom!