Mutual Success Your Fund of Information

R & D – A Reality Check

October 15 2008

I was asked at Thanksgiving Dinner how much lower and how much longer the declines in the stock market could go. Believing like most people that a drop of this magnitude will generally not be sustained forever and there may be value to be found just around the corner I decided to see what history has to teach us. On the Dow Jones website I found the two tables below, the ten largest annual declines and the ten largest annual gains: DJIA 10 Largest Annual Declines (Percentage Terms) Rank Year Close % Change 1 1931 77.90 -52.67 2 1907 58.75 -37.73 3 1930 164.58 -33.77 4 1920 71.95 -32.90 5 1937 120.85 -32.82 6 1914 54.58 -30.72 7 1974 616.24 -27.57 8 1903 49.11 -23.61 9 1932 59.93 -23.07 10 1917 74.38 -21.71 DJIA 10 Largest Annual Gains (Percentage Terms) Rank Year Close % Change 1 1915 99.15 81.66 2 1933 99.90 66.69 3 1928 300.00 48.22 4 1908 86.15 46.64 5 1954 404.39 43.96 6 1904 69.61 41.74 7 1935 144.13 38.53 8 1975 852.41 38.32 9 1905 96.20 38.20 10 1958 583.65 33.96   Following the Crash of 29, there were three straight years of declines each of which was not only double digit but rank in the top ten years of biggest declines. You may observe that at the end of 1928 the index closed at 300.00, but by the end of 1932 it closed at 59.93 down over 80% from its high. Despite this being followed by three positive years, two of which are included in the top ten annual gains for the index, the close at the end of 1935 was 144.13 still down 52% from the high.  Volatility is not the friend of sustained returns as the following charts from the website further suggest. Days with large upswings are not a good omen, as with the exception of  March 15, 1933 all of the other top ten days with greatest gain percentage occurred in losing years.   Days with Greatest Percentage Gain Rank Date Close Net Change % Change 1 03/15/1933 62.10 8.26 15.34 2 10/06/1931 99.34 12.86 14.87 3 10/30/1929 258.47 28.40 12.34 4 09/21/1932 75.16 7.67 11.36 5 10/13/2008 9387.61 936.42 11.08 6 10/21/1987 2027.85 186.84 10.15 7 08/03/1932 58.22 5.06 9.52 8 02/11/1932 78.60 6.80 9.47 9 11/14/1929 217.28 18.59 9.36 10 12/18/1931 80.69 6.90 9.35   Days with large losses like today, which was the ninth worst percentage drop in the history of the index, are generally in the company of losing years. Following the ebullience of the markets on Monday in response to the European Initiatives on the weekend which resulted in an 11.08% jump in the Index on Monday following rallies in Asia and Europe, it has been a short breath before the Bears have driven this so sharply in the opposite direction.   Days with Greatest Percentage Loss Rank Date Close Net Change % Change 1 10/19/1987 1738.74 -508.00 -22.61 2 10/28/1929 260.64 -38.33 -12.82 3 10/29/1929 230.07 -30.57 -11.73 4 11/06/1929 232.13 -25.55 -9.92 5 12/18/1899 58.27 -5.57 -8.72 6 08/12/1932 63.11 -5.79 -8.40 7 03/14/1907 76.23 -6.89 -8.29 8 10/26/1987 1793.93 -156.83 -8.04 9 10/15/2008 8577.91 -733.08 -7.87 10 07/21/1933 88.71 -7.55 -7.84   We need to understand that we are watching history being made. The table below shows the top ten daily net declines in the Index since its inception.   You will note that five of the worst daily declines have occurred in this year, and all within the last 30 days.   Days with Greatest Net Loss Rank Date Close Net Change % Change 1 09/29/2008 10365.45 -777.68 -6.98 2 10/15/2008 8577.91 -733.08 -7.87 3 09/17/2001 8920.70 -684.81 -7.13 4 10/09/2008 8579.19 -678.91 -7.33 5 04/14/2000 10305.77 -617.78 -5.66 6 10/27/1997 7161.15 -554.26 -7.18 7 08/31/1998 7539.07 -512.61 -6.37 8 10/07/2008 9447.11 -508.39 -5.11 9 10/19/1987 1738.74 -508.00 -22.61 10 09/15/2008 10917.51 -504.48 -4.42   Anecdotally, my table companions were expressing the impact on retirement savings accounts, kids education funds, and savings for a home. Saving every dollar has become a priority for many, and restaurants have reported a drop in both client spending and attendance.  The cost of credit has increased, as have spreads between the banks’ borrowing rate from the Bank of Canada and their prime lending rates. A projected contraction in the global economy is reflected in the nosedive of commodity prices. The global intervention of governments to nationalize, sure up or underwrite major banks and financial institutions, (including tossing out rules which were set in place to protect commercial banks from speculation, and potentially changing how they have to account for their assets to protect against further colossal write-downs) points to the fact that this is not a normal cyclical bubble that has burst, but is rather a systemic failure. Unlike 1929 the governments of the world recognize that in order to avoid a repeat of a sustained depression, they have to become the lender of last resort. By this we mean that they have to be willing to acquire the good quality debt within the financial institutions in order to create liquidity to permit “normal functioning”.   With this in mind I remind my family, my friends and my clients alike. Do not be deceived that the worst is over. If you would not buy the stock or funds you are holding today, sell them.  There is no question in my mind that we are already in recession.  I cannot see how a protracted recession cannot lead to depression, both mentally and economically. In fact if market behaviour is any mirror of human behaviour, I am not sure we are not already in a depression, based upon the level of conversation concentrated upon this subject, and despite the official statistics. One thing of which I am sure, no one can predict with any certainty what is going to happen tomorrow, let alone next week or next year. With this in mind a winning game depends upon a good defense. We have progressively trimmed the risk exposure of clients over the last eighteen months and try to concentrate our strategy upon risk management.   If  you are uncomfortable with your current level of risk or want to discuss strategies for long term capital protection please call us. Best Regards,

Victor Whang      Malcolm Ross       Violet Smith 604.331.2524  604.331.2521    604.331.4465 PS on a lighter note it seems almost flippant faced with the gravity of the financial markets but if we do not smile we shall certainly become depressed, so in the effort to raise a smile I share the financial advice I received from a friend today:   If we had purchased $1000 of AIG stock one year ago, we would have $42 today.  With Lehman, we would have $6.60. With Fannie or Freddie, we would have less than $5. But if we had purchased $1,000 worth of beer one year ago, drank all the beer, then turned in the cans for the aluminum recycling refund, we would have $120. Based on this, the best current investment advice is to drink heavily and recycle. (This way we might also have a reason for the headache!) DISCLAIMER: E&OE: Investment Fund values change frequently and past performance is not indicative of future performance. No guarantee is given or implied and there is risk of loss as well as the opportunity for gain when investing in mutual funds. Sterling Mutuals Inc. © 2008