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The title of this memo, as investors, says it all! It is audacious to be hopeful, these days, for anything. However, this is exactly why we must begin to adjust our thinking.

While we can’t know what will happen we can at least observe. With that in mind, we’ll observe the period from 11/20/1998 to 11/20/2008. The total return for that period matches the period from late 1928 to 1938! An annual compound loss of (2.58) or a cumulative loss of 23%; dividends included. By this calculation and observation, the stock market may have already discounted a 1929 –1933 type depression.

It is hard, even in our media-hyped fear mongering modern world, to envision that future circumstances would produce a depression with a total earnings wipeout and unemployment soaring to 25%.

Compare the current financial crisis to the war years: 1938-1942

Keeping in mind that the stock market deals with the future and what might happen while the news deals with what has happened, let’s look at the war years 1938 to 1942.

From the time global war was visible in 1938 to the blackest days of 1942, when the risk of losing the war was the greatest, the U.S. stock market fell 60%. This compares to a 52% top to bottom decline 10/09/2007 to 11/20/2008.

Some facts:

• 430,000 American lives were lost in that war.
• Between 50 and 72 million civilians/combatants were killed in that war.
• From 1939 through 1942, Germany and Japan were winning the war, perhaps soon to occupy and control the Pacific Rim, Europe and the Americas, including the U.S.
• In Europe, only England and Russia were not occupied and London was being bombed nightly.

From the actual start of the war in the Fall of 1939 thorough the critical turning point in 1942, the U.S. stock market fell 44% compared to the recent 52% decline. Now, some perspective, does this imply the risk of life, fortune, freedom, future prosperity and well being is greater now than it was back then? I think not.

• Is there any real risk of being ruled by foreign despots?
• Is there now the real risk of total confiscation of personal assets and wealth?
• Are our very lives now at risk?

To say today’s stock market risk factors are the greatest since the depression is absurd.

As a model for the current crisis the great depression does not stand up to even a cursory examination.

Catastrophic policy mistakes following the 1929 stock market crash

Two catastrophic policy mistakes transformed a severe economic downturn following the 1929 stock market crash into a deflation depression:

• General adoption of aggressive trade protectionism – There are no significant pressures now
• Federal Reserve allowed both widespread bank failures and a severe contraction in money supply, exacerbated by the gold standard.

It is clear from the speed, scale and radicalism of the Fed’s ongoing response to the “credit crunch” that they intend to not repeat that mistake. Clearly, they have learned something; with a different set of consequences that we’ll cover in 2009.

Other differences between the current financial crisis and that of the 1930s

There are other crucial differences with the 1930’s. Most bank deposits are now federally insured. Government spending forms a much larger part of the economy and significant components of it automatically rise if the economy declines. These “automatic fiscal stabilizers” are much larger than they were then. Furthermore these factors are replicated across the global as fiscal stabilizers exist in every economy now and bank deposits are widely protected.

Looking beyond

So this leaves us, like the stock market, looking forward to 2009 and beyond, looking to the “audacity of hope” and what can surprise us.

• The new president and leadership from Washington
• So far, crisis responses have been monetary. For 2009 they will be fiscal; evidenced by the President elects plan to create 2.5 million jobs. This is been repeated around the world.
• A plan to end the Iraq war
• Much lower interest rates
• Much lower fuel prices

While 2009 will have news headlines almost too unbearable to read, as investors, I am hopeful we have much to be optimistic for.

Today we are going to speak about what has been going on in the stock and bond markets here in October and November of 2008. What is going on is what I call liquidation sales.

When a store (or any other business) closes its doors and all assets are sold/auctioned off; it is called a liquidation sale.

These sales, sad for the seller, create opportunity for the buyer. Seasoned shoppers – those who are knowledgeable about what the merchandise being liquidated ‘usually’ costs – become excited about finding and buying good, quality items at deeply discounted prices.

Rarely does someone else’s liquidation sale prompt us as consumers to liquidate our own holdings even if we might have paid more for the same or similar assets in the recent past.

Quite the opposite – If we have the cash, we buy more. Liquidation sales are always for cash.

Investors join the selling frenzy

These recent weeks have witnessed many investors having exactly the opposite reaction to liquidation sales of financial assets. They are drawn to join the selling frenzy, rather than look for bargains to buy. Irrational behavior at its most obvious.

The liquidation sales have been made by various holders of financial assets – Investment banks, banks, hedge funds, investment funds, etc…

These holders are either going out of business due to excessive debt or forced to shrink the size of their portfolios due to customer defections.

Forced sellers must sell, usually at any price!

“Real money” investors are never forced sellers

All Pension Partners LLC clients are what I consider “real money” investors.

A “real money” investor:

• Owns the investments outright, without debt
• Has a longer-term time horizon
• Has good liquidity (cash) in the portfolio.

The above ensures that you are never a “forced seller” or forced into a liquidation sale.

It is strange to observe that many investors who hold diversified portfolios of financial assets suddenly feel a need to compete with the forced sellers in a crowded marketplace – thereby forcing prices even lower!

But that is exactly what happened in early October through November of 2008.

Bulk of the decline likely behind us

Many of you have asked me, “Is it over yet?”

Though there are no shortages of opinions about this, nobody really knows the answer.

I do know that the top to bottom decline of the S&P 500 from the 10/09/2007 peak to the 10/27/2008 recent low was about – 46%. This ranks the decline as the third biggest decline in the post WWII era.

No decline has been greater than 50% in the last 65 years. Not one.

This suggests that the bulk of the decline is behind us, not in front of us.

Central banks and governments around the globe are fighting the financial crisis and in January, the country will have new leadership.

It is not the time to join panicky sellers.

Eventually, fears subside, and the focus shifts back to fundamentals and values.

What else do we know?

Risk assets in the U.S. and throughout the world are cheaper than usual, because prices have declined so sharply during 2008.

By virtue of this cheapness, we believe the probabilities of favorable financial outcomes for today’s buyers of financial assets are much improved compared to most times.

We have the same belief for current holders of financial assets.

I appreciate your time - and in our next segment, we will be speaking about the “Lost Decade,” the decade from 1998 to 2008.

Hi. Thank you for tuning into 21st Century Income. Today we are talking about what we hear in the news called the subprime “mess,” the subprime “fiasco,” mortgage “meltdown,” and the many fixes that you are seeing on TV, put forth by the president or Treasury Secretary Paulson. So without taking too much of our time talking about how we got to this place, suffice it to say that the simplistic reason is that for the first time on any grand scale, you have the people who lend money being separated from the people who are actually going to pay that money back.

Securitization allows banks to disregard repayment of loans

In previous times, when a bank lent money, the bank cared deeply about whether they were repaid or not. Today, in the modern world, we have something called—a process—that’s called securitization. Securitization means that the bank makes the loan and then the bank sells that loan off, packages it up with other loans and sells it off to investors. When the bank completes that sell, they have now been paid back. What actually happens to that loan—and whether the borrower can actually afford it or not—is really not of consequence to the bank, certainly at the time they made the loan. What we are learning now is that it may in fact have consequences for them.

How can we be opportunistic?

What I want us to focus on, as 21st century investors: how can we be opportunistic? What’s obvious is that we live in a time of great turbulence, financial turbulence, and a time of many financial excesses. As a result of those excesses and the turbulence that comes from them, it creates opportunities and it creates chances for good investors to be opportunistic.

If you recall and you go back and look at some of my previous blogs, if you are a 21st century investor, what that means is that you have to think in terms of decades. You have to think in terms of, how do I build a stream of income that is going to last me for many years into the future—what might be decades.

Think like a ‘real money investor’

That immediately makes you start to think, or should make you start to think, like what we call a ‘real money investor’. What’s a ‘real money investor’? A big pension fund, insurance companies, endowments, people like Warren Buffet. It means people who are not buying with borrowed money. People who are buying with long-term time horizons. As a result of this turbulence, there are great investments to be made right now that will bear fruit three years from now, five years from now. That’s how a real money investor thinks. That’s how a big insurance company or a big pension fund thinks.

In the 21st century, generating 21st century income means, you have to be opportunistic; it means you have to have very flexible thinking. And it also means that you need to think a little bit differently. By thinking differently, it means—when you have a very long term time horizon, you can make opportunistic investments.

Portfolio lenders do not engage in securitization

So there are very, very interesting finance companies, interesting banks, small banks (Banks that were doing this whole securitization were many of the big banks, the household names that you know.) But the smaller banks, the banks you might see in your local town, small community banks, which are called portfolio lenders—being portfolio lender means that they don’t actually sell those loans. They keep those loans on the books. Kind of the old-fashioned way, so to speak.

Investing in portfolio lenders is great way to generate income for future years

Now, one of the consequences is that as everyone has become scared of subprime, scared of CDO (Collateralized Debt Obligation), all these acronyms, they of course have sold all the stocks of all the banks. Many of the smaller, regional banks have very good dividends, dividends in the range of four, five, six percent with a history of increasing dividends. Remember, 21st century income—you have to generate ever-increasing income for years out into the future. Well, what a great way to do that—by opportunistically buying very, very conservative, well-run banks that have a history of increasing their dividends, whose stock prices have been absolutely decimated because we live in a very fast-paced world, where as soon as there are any of these disturbances, pretty much everything gets sold immediately.

Cost of money for portfolio lenders will decrease

Let me go back to being opportunistic and thinking. One of the consequences of this whole subprime, CDO dislocation, for lack of a better word, is going to be, rightly or wrongly, a lowering of interest rates. A lowering of interest rates means that what’s called the yield curve—shorter rates versus the longer rates—becomes more positively sloped; it looks sort of like a hockey stick. Banks lend money long term, and their cost of money is a short term rate. So what is going to happen is as the short term rates go down, the banks are going to be able to make more money going forward. If you think about some of these smaller banks we are talking about, these regional banks, they are going to have a lower cost of money in the future, in the very near future. Their cost of money is going to go down. The rate that they are going to charge is going to either stay the same or perhaps even go up because some of the bigger banks might be pulling back in some of these various mortgage-lending areas. It’s a great way for portfolio lenders to step in and provide loans, provide liquidity.

So being a 21st century investor, thinking like a real money investor, you can think opportunistically about acquiring some of these companies at what I believe, three or five years from now, are going to look like bargain basement prices. These are companies, banks that have a history of increasing dividends, that are conservatively run. You can put them in your portfolio and enjoy those dividends for many, many years to come. That’s one example [of strategies to generate retirement income]. We will be back with more. Thank you.