2009 in Preview

This time of year is supposed to be one of hope and good cheer, so why look back at 2008? Enough news outlets will do that. Instead, after just a brief comment about 2008, let us take a look at what might be in store for 2009, and why we find reasons to be hopeful about the future.

2008… good riddance

Near the end of 2008, the only folks who remain largely unscathed are those who had invested in money market funds, Treasury securities, or who had the foresight to have sold stocks short. Even investors in municipal bonds or once-safe—then unsafe—now safer still—government agency bonds were hurt badly. The carnage was the result of many factors, all of which can be wrapped up under the title “Credit Crunch.” Some investors—probably too generous a term—were forced to liquidate securities to meet margin calls. This forced selling led to selling of whatever could be sold, including things like municipal bonds. Other investors unloaded any sort of security carrying credit risk (e.g. corporate bonds). In short, it was a huge flight to safety. As always, safety was found in U.S. Treasury securities, but their return reflects that safety. Even gold, a traditional harbor for spooked investors provided scant shelter, as it was being liquidated, too.

Suffice it to say that all sorts of records of the wrong kind were set in 2008. References to 1929 and the Great Depression were and are rampant in spite of many differences. Returns of virtually all asset classes were shocking. Risk tolerances will be reset, as will asset allocations. But 2009 offers much hope for a return to positive returns.


There are many reasons to be hopeful about 2009, not the least of which is that hope, contentment, and pleasure arise from more than numbers on account statements, but we shall concern ourselves here with the latter. Key reasons for being hopeful are the following, and we’ll examine each one in modest detail.

  • Security valuations
  • Investor sentiment
  • The money mountain
  • Implied returns

Security valuations

At 12.1x, price-to-earnings ratios (P/E) are at levels seen in 1985 and 1990. Since 1972, valuations have only been lower 30% of the time. Dividend yields are a more objective measure of valuation, and while the current level on the S & P 500 (3.22%) is below the 83-year median (3.70%), dividend yields are above the 50-year median (3.11%) and the 25-year median (2.44%). Furthermore, for the first time since 1958, dividend yields are higher than the yield on the 10-year Treasury note. Currently, the dividend yield is 0.91% higher than the 10-year note.


This refers to the feelings of the crowd—the herd—of investors. Charles MacKay wrote the treatise on crowd behavior in Extraordinary Popular Delusions & the Madness of Crowds, but Carl Jung summed it up like this: “masses are always breeding grounds of psychic epidemics.” In short, at extremes of sentiment, the crowd tends to be wrong. There are various ways of measuring sentiment, and we have access to a number from various sources. To sum up the majority of them, investor sentiment toward risk assets is at—or very recently was at—20-year lows. In the past, similar readings have marked major lows in stocks. Following the 1987 crash, however, sentiment remained very depressed through all of 1988, and it’s likely to recover very slowly this time, too. During that time, though, stocks slowly and steadily improved.

The money mountain

In the flight to safety that has occurred over the last three plus months, investors have flocked to the safety of Treasury securities and money market funds. The flight to money markets has been such that when compared to the Wilshire 5000 index, money market balances have not been higher since 1980, the beginning of the data available to us. Similar peaks in 2002, 1990, and 1982 marked the beginnings of strong market cycles. In addition money market rates are, in some cases, near zero. Presently, our most generous money market pays 1.78%, while the Treasury version yields a paltry 0.02%. In short, the money mountain is yielding little but safety.

Implied returns

This may be the most compelling of the four factors. Pension funds and others have hunkered down in the safety of zero-default-risk Treasury securities and money market funds, but whether it’s a pension fund with future retirees, one of the retirees themselves, or an endowment, there is no way that future obligations/distributions can be met with near-zero returns, in the case of money markets, or low single-digit returns, in the case of Treasury investments. The 30-year Treasury note yields just 2.63%, and one has to invest at least three years out to exceed just a 1% yield on Treasuries.

A more technical measure of implied returns for stocks comes from the equity risk premium. The risk premium is the excess return over risk-free Treasuries necessary to entice investors to own stocks. Presently, the equity risk premium (ERP) is the highest it has been since 1933. The ERP is still going up and hasn’t begun to reverse, but what can be said is that at no time since the Great Depression have investors in stocks been so handsomely rewarded for taking on equity risk.


This has been a trying year for investors of all stripes, and it’s easy to consider throwing in the towel, but we think now, more than ever, it’s important to be an investor. We are entertaining the notion that we could see a prolonged sideways stock market, which may require more nimbleness and different tactics, but that remains to be seen. If this environment has shattered your idea of asset allocation, diversification, and everything else investments, plan on revisiting each after the market has healed itself a bit. Consider availing yourself of the financial planning expertise offered by our advisory group, Tower Investment Services.

In the meantime, opportunities abound in select stocks, many selling at fractions of book value and low single-digit P/E ratios, in municipal bonds, where 5-6% yields on solid, essential-service bonds are commonplace, and in corporate bonds, where the very best companies are having to issue bonds with incremental yields far above historic averages, amply rewarding investors for the credit risk.

It has been our privilege to serve you for another year, and we greatly appreciate the confidence you continue to place with us. We very much value your business. We hope to become even more valuable to you in 2009.

This e-mail, its cynical style, ignorance of punctuation convention, and a host of other aspects, do not necessarily represent the views of Tower Bank or Tower Private Advisors. In fact, there are folks here who likely cringe upon receipt of it. If anything you have read here has offended your sensibilities, we regret it. Also, if there are typographical, grammatical, or stylistic errors above, you can see why we don’t teach English Composition. The passive tense, where used, is regretted. If you would rather not receive this e-mail, let us know. If you have suggestions for improvement, keep them to yourself. Just kidding… really; send ‘em in, along with some Alka-Seltzer and Pepto Bismol.

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