Taxable Estimated
Retirement Estimated
S&P 500 NASDAQ 100 Russell 2000
1st Qtr +8.03% +4.62 % +5.92% +7.06% +7.64%
2nd Qtr -0.40% -1.11% +0.09% +1.41% -1.91%
3nd Qtr -13.05% -15.29% -13.87% -11.50% -12.91%
YTD -6.67% -12.17% -8.69% -3.91% -8.95%

Major market disasters like Lehman Brothers in 2008 rarely occur when almost every observer is expecting one. European disunion and the impending bankruptcy of Greece have been expected now for months, along with spreading contagion throughout Europe. The non-transparent impact of Europe on American companies and banks has created uncertainty to be sure, but our U.S. companies and bank balance sheets are in excellent shape relative to Europe and relative to 2008. We believe the drumbeat of gloom out of the Eurozone has already been discounted in the poor third quarter performance of virtually all sectors of our stock market.

Our mid-September email blast to all FMR clients was our effort to put the recent deluge of headline-grabbing daily crises in the perspective of other recent sudden “black swan” events, and subsequent market corrections. Black swan events, by definition, are almost always unpredictable and create extra market volatility and uncertainty for long-term investors. However, we reiterate, that having a portfolio that meets your long-term investment objectives is the only way to control the urge to panic and dump your quality investments. We own very high quality companies with A+ managements, balance sheets, free cash flow, and commitment to either growing dividends and/or share repurchase to build value for shareholders. As contrarians, these erratic swings in the market allow us to build or add to positions in these strong businesses. A portfolio of well managed companies is highly likely to create more wealth than 10-year Government Bonds yielding less than 2%, or bank accounts at 1%. Many of our companies yield 3%-5% with growing dividends. The rush by investors to purchase government bonds should be short lived because a 1.9% return from the 10-year Government Bond does not keep up with an inflation rate of 2%-3% (negative real return). This simply means your return on your investment is less than inflation, so your purchasing power of real goods and services is reduced. An over commitment to low yielding fixed income is not prudent and will not build or grow wealth over the long-term to either maintain or increase your standard of living.

The S&P 500 declined 13.9% for the third quarter and is now down 8.7% year-to-date. Both our taxable and qualified (IRA) accounts moderately outperformed this 3Q down market as dividend stocks declined less in this severe correction. Our forecast at the beginning of the year for the S&P 500 was +9% (1350) on the low side, to +15% (1425) on the upside. While this forecast seemed conservative in January, we are quite sure that to most investors right now, achieving these numbers looks very difficult with one quarter left to the year.

However, with the vast majority of investors and the public already discouraged about what they see in the American economic and political landscape, we would argue that the market has discounted much of the malaise and defeatism in the public discourse. Remember, the economy is not perfectly correlated to stock market valuations because the market discounts future results, not past results. At the worst of our recent great recession in the first quarter of 2009, the market bottomed and then doubled with 14 months to go before there were any positive economic signals. Eurozone fiscal moves, slow as they may be to evolve, will remove the specter of contagion and ease some of the psychological pressure on our equity valuations. Furthermore, although our economy is growing at stall speed in the aggregate, many individual companies with multinational markets and strong business models are likely to continue to report earnings growth in the third quarter. While these growth rates and margins may be slower than past quarters, we believe the stock market has discounted that likelihood already.


1. The Eurozone/Greek crisis is now well recognized by all players, including Germany, who along with France, will control whatever solution is necessary to avoid contagion in Europe. Recently, the European Union (EU) announced the plan to strengthen the European Financial Stability Fund (EFSF) to a level of about $500 billion Euros. This is a start, but additional safeguards will have to be put into place. The banks will also need more equity capital on their balance sheets. We expect you will see sovereign wealth funds (China, Brazil, India, Russia) stepping up to inject capital into Europe at the right price.

2. Most investors already know that the economy is stalled at 0%-2% growth: that job growth is anemic and likely to remain so with current government policies; that the government deficit and government spending are too high and must be addressed; that we must have structural long-term reforms of Medicare, Medicaid, and Social Security entitlement programs; and that we have political gridlock until at least the November 2012 elections. A comprehensive long-term deficit commission compromise would be a big positive surprise for the stock market and is not expected. A double-dip recession is also not discounted in the marketplace and we think unlikely.

3. On the positive side, the offsets to slow or no growth in the U.S. economy include: our banks are stronger and have more capital versus 2008; our companies are more profitable; company balance sheets and liquidity have never been in a better position; housing is already at a historic bottom vs. 2008; consumer debt is down and savings are up; and the U.S. dollar will continue to be the reserve currency for the world, while FED policy keeps our interest rates low for the next two years.

4. High quality companies are NOT expensive by historical standards and actually are inexpensive, relative to government debt. Stocks at current valuations are one of the best hedges against possible future inflation, even at “only” 2%-3%. Dividend growth for S&P 500 firms has been 5% over the last 50 years, easily beating the rate of inflation. Prior to the recent recession, there have been only five years in the S&P 500’s history when dividends declined (the maximum yearly decline was 3.3%). Dividend growth in the past two years has averaged over 10% per year, twice the long-term rate, as companies begin to return their record cash balances to shareholders. Dividends have accounted for over 40% of an investor’s return since 1926 and typically have lower volatility in bad markets. The recent third quarter performance of most of our dividend stocks going down less supports this point. Why? The inherent attractiveness of dividend-paying quality companies is that investors in these companies GET PAID WHETHER OR NOT THE MARKET IS UP OR DOWN.


In our past two letters we have commented both directly and indirectly on the most severe partisan political environment most of us have ever witnessed in our lifetimes because we expected it to get worse (it has), and we expected it to increase the volatility in the stock market affecting short-term returns in our equity portfolios (it has). One of our favorite lines is “the facts will set you free”, so we thought no matter where you stand on our government’s spending policies and taxes, the following data may help you process the political rhetoric for another 13 months.

From IRS Statistics of Income 2009:

1. The number of people reporting adjusted gross income of $1million or more was 390,000 in 2007 and declined 39% to 237,000 in 2009.

2. Those with $10 million or more in reported income fell to 8,274 (down 55%) in 2009 from 18,394 in 2007.

3. The loss of millionaires goes a long way to explaining why federal tax revenues shrank to 15% of GDP, as the loss of these taxpayers accounted for $130 billion of the higher federal budget deficit in 2009 (put in context of a $1+ trillion budget deficit, overspending not overtaxing is the main culprit, as we are borrowing 40 cents of every dollar the government spends). Our most public billionaire, Warren Buffet, has recently been quoted extensively that he wants to reduce the deficit by greater taxation of our millionaires and billionaires. What he should be encouraging are policies to create MORE millionaires (whose average tax rate in 2009 was 38%), not campaigning to tax them more. Fortunately he has recently backtracked and clarified his position.

Take a quick look at the following data:

• Taxpayers who make $200,000 or more a year accounted for 3% of all tax filers but paid 50.1% of the $886 billion in total personal income taxes in 2009. Of this top 3%, just 0.2% are taxpayers who earn over $1 million but pay 20.4% of all income taxes in 2009.

• This means that the top 3% of all taxpayers (paying their taxes at an average rate of 38%) paid over 50% of all income taxes collected. Yet this high earning group are the people that the President and Mr. Buffett claim don’t pay their fair share! The true scope of our uncontrolled spending spree is revealed from the fact that if the government decided to tax 100% of the income of the top earning group of millionaires, even this draconian measure would not close the $1.3 trillion dollar budget deficit!

We are confident that our recent failed fiscal policies will eventually be replaced with pro-growth, free market policies in the months and years ahead, and will create new job opportunities for the millions of our citizens who are unemployed and want to work.

We remain confident, persistent and calm in our disciplined approach to investing your long-term assets and we thank you for your support. Please do not hesitate to call, email, or write us with your concerns or financial questions.


Lee Todd Martha

*The foregoing information is not audited and has not been otherwise reviewed or verified by any outside party. While Five Mile River Investment Management, LLC endeavors to furnish accurate information, investors should not rely upon the accuracy or completeness of this information. Fourth quarter and YTD approximate performance ranges are due to the conversion to Royal Bank of Canada (RBC) in June. Individual performance reporting will be available shortly from RBC.

This letter is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendation concerning the manner in which any client’s accounts should or would be handled as appropriate investment decisions depend upon the client’s investment objectives. Any offer to sell or the solicitation of an offer to buy any interests in any securities may be made only by means of delivery of a Five Mile River Investment Management Agreement and or other similar materials which contain a description of the material terms and various considerations and risk factors relating to such securities or fund. Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be either suitable or profitable for a client’s or prospective client’s portfolio, and there can be no assurance that investors will not incur losses.

Please remember to contact Five Mile River Investment Management if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations. Please also advise us if you would like to impose, add, or to modify any reasonable restriction to our investment advisory services.