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Home , Nixon shock, Panic of 1901, Paul McCulley

Financial in Crisis: Past, Present and Future

From a webinar for the University of San Diego by Carl Wiese, CFA

Carl Wiese, CFA

Founder/Portfolio Manager

619-717-8008

San Diego, CA 92106

Funds LLC

GROW Funds LLC is a California registered investment advisory firm. Registration does not imply any level of skill or training. Neither the information within this email nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities. Investors should have long- term financial objectives. Past performance is no guarantee of future returns. About Me

• USD – BBA, SDSU – MSF • Member of the Chartered Financial Analyst (CFA) Institute since 1995 • CFA Society of San Diego since 1998, Education Chair • 30 years of Experience • William O'Neil and Company • Investor’s Business Daily • How to Make Money in Stocks by William Oneil – CAN SLIM • Hokanson Associates (Aspiriant) • Wall Street Associates • GROW Funds LLC www.growfundsllc.com • GROW Small Cap Equity Long/Short L.P. • Registered Investment Advisor with Mike Collins, Separately Managed Accounts • Sharp Healthcare – Investment Committee • Rancho Santa Fe Foundation, Board and Investment Committee • USD – Financial Markets and Institutions, Ethics, Intro to Hedge Funds, Financial Management

2 Disclosures

This presentation is solely for educational purposes only. This document does not constitute an offer to sell or a solicitation of an offer to buy any securities and/or any securities of GROW Small Cap Equity Long/Short L.P. (the "Fund"). An offer may only be made by the Fund's Confidential Offering Circular, which the Fund's general partner, GROW Funds LLC ("GROW"), will provide only to qualified investors.

3 Market Crisis: Past Present and Future

Factors affecting markets 1. Earnings 2. Valuation 3. ( and Discount Rate) 4. Government action 5. Investor Sentiment

Bear Markets Since 1900

Financial crisis compared: 1929, 1973-74, 2000, 2008

Present COVID Crisis 2020

Future Outlook: Earnings curve, Sentiment Gauges, Fed Balance sheet, Fiscal Policy, Jobs data Factors Affecting Markets Primary Secondary Earnings Government Action ◦ Fiscal Policy Valuations ◦ Regulatory Policy ◦ Price to Earnings Multiples ◦ Tax Policy ◦ Present value of estimated future cash flow or discounted cash flow ◦ Foreign Policy The Federal Reserve Board Sentiment/Behavioral Aspects ◦ Discount Rate ◦ Fear and greed ◦ Money Supply ◦ Volatility ◦ ◦ Contrarian opinion Earnings the Discount Rate and Valuations

퐶푎푠ℎ 퐹푙표푤 1 퐶푎푠ℎ 퐹푙표푤 2 퐶푎푠ℎ 퐹푙표푤 푁 푃푟푒푠푒푛푡 푉푎푙푢푒 표푓 퐹푢푡푢푟푒 퐶푎푠ℎ 퐹푙표푤푠 = + + ⋯ 1 + 푑𝑖푠푐표푢푛푡 푟푎푡푒 1 1 + 푑𝑖푠푐표푢푛푡 푟푎푡푒 2 1 + 푑𝑖푠푐표푢푛푡 푟푎푡푒 푁

Assume for simplicity:

Present Value = Price

Earnings (Revenues – Expenses – Taxes) are a proxy for Cash Flow, therefore: • If earnings are expected to go up, the present value or price should go up (numerator is larger) • If earnings are expected to decline, the present value or price should decline (numerator is smaller)

The interest rate on 10 year Treasury Note is a proxy for the discount rate (price of money/cost of capital), therefore: • If interest rates go down, prices should go up (denominator is smaller) • If interest rates go up, prices should go down (denominator is larger)

퐸푎푟푛𝑖푛푔푠 푌푒푎푟 1 퐸푎푟푛𝑖푛푔푠 푌푒푎푟 2 퐸푎푟푛𝑖푛푔푠 푌푒푎푟 푁 푃푟𝑖푐푒 = + + ⋯ 1 + 푌𝑖푒푙푑 10 푦푒푎푟 푇푟푒푎푠푢푟푦 푁표푡푒 1 1 + 푌𝑖푒푙푑 10 푦푒푎푟 푇푟푒푎푠푢푟푦 푁표푡푒 2 1 + 푌𝑖푒푙푑 10 푦푒푎푟 푇푟푒푎푠푢푟푦 푁표푡푒 푁 Stock Prices Follow Earnings S&P 500 Index 1926 to 2020 The market is a discounting mechanism “Speculation is a method now adopted for adjusting differences of opinion as to future values, whether products or securities” – Henry Clews

“Speculation, moreover makes a market for securities that otherwise would not exist. It enables Railroads to be built, through the ready sale of their bonds, adding materially to the wealth of the S&P 500 Earning 1926 to 2020 country, and opening a more profitable market to labor. In this it becomes the forerunner of enterprise and material prosperity in business” – Henry Clews S&P 500 P/E Ratio 1926 to 2020 • P/E (Price per share/Earnings per share) Ratio is a measure of the Value of those earnings

Source: 50 Years in Wall Street by Henry Clews, Stockcharts.com, GROW Funds LLC Interest rates up – price down Interest rates down – price up 10000.00

1000.00

S&P 500 Index 100.00

15.00% 13.00% 10.00 11.00% 9.00% 7.00% 5.00% 10 Year Treasury Yield 3.00% 1.00% 1.00 -1.00%1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Robert Shiller, GROW Funds LLC “Inflation is always and everywhere a $21,789,750,000,000

5000 monetary phenomenon.” Milton Friedman

M3 Money Supply 500 S&P 500 Index

50

$8,620,000,000

5 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 30%

M3 Money Supply YOY Change 15%

0% Consumer Price Index (CPI) YOY Change

-15% 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Milton Friedman and Anna J. Schwartz and by Robert H. Rasche, Robert Shiller, OF ST. LOUIS, Shadowstats.com Inflation – a general rise in the price level The Federal Reserve “Don’t fight the Fed”

The (ch. 6, 38 Stat. 251, enacted December 23, 1913, 12 U.S.C. ch. 3) is an Act of Congress that created and established the Federal Reserve System, the central banking system of the , and granted it the legal authority to issue Federal Reserve Notes (now commonly known as the U.S. Dollar) and Federal Reserve Bank Notes as legal tender. Maximize Employment, Price stability, Moderating long-term interest rates. - Set Interest Rates

Discount Rate interest rate the Federal Reserve charges on loans it makes to banks and other financial institutions Fed Funds interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight, on an uncollateralized basis (Interbank Lending Market) Federal Open Market Committee (FOMC) – sets interest rate policy All other interest rates are derived from the discount rate Monetary Policy Federal Open Market Operations (FOMO)

Open Market Operations Open market operations (OMOs)--the purchase and sale of securities in the open market by a central bank--are a key tool used by the Federal Reserve in the implementation of monetary policy. The short-term objective for open market operations is specified by the Federal Open Market Committee (FOMC). Before the global , the Federal Reserve used OMOs to adjust the supply of reserve balances so as to keep the rate--the interest rate at which depository institutions lend reserve balances to other depository institutions overnight--around the target established by the FOMC.

The Federal Reserve's approach to the implementation of monetary policy has evolved considerably since the financial crisis, and particularly so since late 2008 when the FOMC established a near-zero target range for the . From the end of 2008 through October 2014, the Federal Reserve greatly expanded its holding of longer-term securities through open market purchases with the goal of putting downward pressure on longer-term interest rates and thus supporting economic activity and job creation by making financial conditions more accommodative. During the policy normalization process that commenced in December 2015, the Federal Reserve will use overnight reverse repurchase agreements (ON RRPs)--a type of OMO--as a supplementary policy tool, as necessary, to help control the federal funds rate and keep it in the target range set by the FOMC.

https://www.federalreserve.gov/monetarypolicy/openmarket.htm Inflation, Interest Rates, and Valuation 10-yr Interest Rates 16% 14% 12% 10% 8% 6% 4% 2% 0% 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020 P/E Multiples 70x 60x 50x 40x 30x 20x 10x 0x 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

20% CPI YoY Change 10%

0%

-10%

-20% 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

Source: Robert Shiller, GROW Funds LLC Government Fiscal Policy Government Spending – Favored Industries

Regulatory Policy Regulation Up, Earnings Down, Stock Prices Down Regulation Down, Earnings Up, Stock Prices Up

Tax Policy Taxes Up, Earnings Down, Stock Prices Down Taxes Down, Earnings Up, Stock Prices Up

Foreign Policy Varied impact depending on industry

The law of unintended consequences is what happens when a simple system tries to regulate a complex system. The political system is simple, it operates with limited information (rational ignorance), short time horizons, low feedback, and poor and misaligned incentives. Society in contrast is a complex, evolving, high-feedback, incentive-driven system. When a simple system tries to regulate a complex system you often get unintended consequences. - The Law of Unintended Consequences by Alex Tabarrok

“Suckers think that you cure greed with money, addiction with substances, expert problems with experts, banking with bankers, with , and debt crises with debt spending” ― Nassim Nicholas Taleb, The Bed of Procrustes: Philosophical and Practical Aphorisms “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” – Warren Buffett

Source: Forbes.com Questions ? “History doesn’t repeat itself, but it does rhyme” Mark Twain “THOSE WHO CANNOT REMEMBER THE PAST ARE CONDEMNED TO REPEAT IT.” GEORGE SANTAYANA 22 Bear Markets 22 Bear Market1900 -2020Declines 1900-2000 100

90

80 1949 1966 1982 70 1962 1980

1970 2020 60 1933 1917 2002 1987 AVERAGE MEDIAN 1942 1921 1974 1903 50 1914 1929 1938 1907

2009 Decrease Decrease inValue

40 (all markets markets (all indexed 100) to

1932 30 1931

20 Median Decline 42% over 75 Weeks 10 Average Decline 43% over 86 Weeks

0 0 25 50 75 100 125 150 175 200 225 250 Duration in Weeks

Source: William O’Neil and Company, GROW Funds LLC Source: GROW Funds LLC

Panic of 1901 1907 Banker’s Panic DOW Jones Industrial Average Index WWI

Crash of 1929 –

Recession of 1937-38 WWII

Kennedy Slide of 1962

1973-74 Oil Crisis

1987

1997 AC 1998 RFC Dot Com Bust 9/11

2008 Housing Bust

2020 COVID Crash possibility a highly of undesirable especially isimpending of affairsa decisivechange whichin unstablean stateor timecrucialor Cambridge English Dictionary confusion a • • • outcome Source: RobertShiller, GROW Funds LLC time EarningsDecline UnemploymentHigh Major PriceDecline of – great , or : Merriam Webster one with the distinctwith one suffering Crisis disagreement : - ,

From .04% to 25% Unemployment

From 10% to 20% Unemployment S&P 500 IndexS&P 500 to1926 2020 EarningsDeclines Unemployment

From 5% to 9% Unemployment

From 6% to 11% Unemployment

From 5% to 8% Unemployment

From 3.8% to 6% Unemployment

From 4.5% to 10% Unemployment

From 3.5% to 15% Unemployment “Stability breeds instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits. Success breeds a disregard of the possibility of failure.”- Major collapse of asset values preceded by: • Sudden major collapse of asset values which is part of the or preceded by:

• 1. long periods of prosperity and increasing value of investments lead to 2. increasing speculation using borrowed money 1. Long periods of (margin) prosperity • The 3. spiraling debt incurred in financing speculative investments leads to cash flow problems for investors. The cash 2. Increasing speculation generated by their assets is no longer sufficient to pay off the debt they took on to acquire them using borrowed money (margin) • Losses on such speculative assets prompt lenders to 4. call in their loans. This is likely to lead to a 5. collapse of asset values

3. Spiraling debt leading to • The over-indebted investors are forced to sell even their less-speculative positions to make good on their loans. (all assets cash flow problems decline)

• At this point no counterparty can be found to bid at the high asking prices previously quoted which starts a major sell-off, 4. Lenders call in their loans leading to a sudden and precipitous collapse in market-clearing asset prices, a sharp drop in market liquidity, and a severe leading to demand for cash 6. )

5. Collapse of asset values • Paul McCulley of PIMCO in 1998, to describe the 1998 Russian financial crisis, and was named after Dr. Hyman Minsky, who noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze 6. Liquidity crisis Crash of 1929 "Stock prices have reached what looks like a permanently high plateau.“

1. Prosperity: Roaring Twentys Long period of prosperity: 2. Speculative boom had taken hold in the late 1920s. DJIA up approximately 495% and Money Supply up 62% from 1921 to 1929. Steel production, building construction, retail turnover, automobiles registered, "Babson Break" Roaring Twenty's railway receipts advanced from record to record 3. Spiraling debt favoring farmers and lending to foreign governments/businesses, margin lending to buy stocks 4. Collapse of asset values Speculative boom: DJIA up LSE Crash 5. Liquidity Crisis 495%, Money Supply up

62% from 1921 – 1929 "Black Thursday" -6%

Spiraling debt favoring “Black Monday" -13% farmers, foreign March 25, 1929, after the Fed warns of excessive speculation, a “Black Tuesday" -12% governments and business, mini crash. Call money to 20%. Margin lending small investors more than two-thirds margin lending to buy stocks of the face value of the stocks they were buying. Over $8.5 billion was out on loan, more than the entire amount of circulating in the U.S. at the time Lenders call in their loans American economy ominous signs of trouble: steel production declined Collapse of asset values: construction was sluggish automobile sales down DJIA down 48% consumers high debts/easy credit

Liquidity crisis

Source: Reminiscences of a Stock Operator by Edwin Lefevre, America’s Great Depression by Murray Rothbard Run on Banks: Bank Liquidations "Stock prices have reached what looks like a permanently high plateau.“ Irving Fisher 1930 1350 Bank Failures, $837 mil deposits 1931 2293 Bank Failures, $1.6 bil deposits 1932 1453 Bank Failures, $706 mil deposits Massive monetary easing 1933 4000 Bank Failures $3.6 bil deposits program in the form of $140 bil in deposits lost, “Bank Holiday” DJIA down 89% increased bank reserves President Hoover institutes Hawley-Smoot tariff which hurt Earnings Collapse Influx of federal cash in the exports and international trade form of increased bank reserves Unemployment rate reaches 16% of population

Influx of federal cash in the form of bond purchases Bankruptcy laws become less stringent

Hoover declares war on NYSE for aiding in the economic fear. Causes paranoia among investors. Hoover Program: Convinced Industrialists to maintain wage rates, expand construction, and share any reduced work. Great Britain goes off the Public works programs (DAMs). Farm subsidies. Protectionism. Banned immigration. Withheld standard plummeting loans for short selling the European markets

Overproduction of agricultural produce created widespread financial despair among American farmers throughout the decade. Wheat Volatility Heavy tax increases on gas, toiletries, telephone messages and income Wheat market was flooded, and people were too poor to buy. Farmers were unable to earn American economy ominous signs of trouble: back their production costs and expanded Reconstruction Finance Corporation established to steel production declined their fields in an effort to turn a profit -- they combat depression and loaned out over 2 billion construction was sluggish covered the prairie with wheat in place of the dollars to failing businesses across all industries automobile sales down natural drought-resistant grasses and left any Influx of federal cash in the consumers high debts/easy credit unused fields bare. Dust Bowl form of “veterans bonus”

Source: Reminiscences of a Stock Operator by Edwin Lefevre, America’s Great Depression by Murray Rothbard, PBS Nixon 1973-74 Inflationary Bust • Wage and price freeze • Surcharge on imports • Cancellation of United States Long period of prosperity: Post dollar into Gold WW2 Bull Market of the 1950s and 1960s DJIA up 492% from 1949 to 1966

Increasing speculation: Nifty Fifty Growth Stocks with high PE multiples

Cash flow problems:

Collapse of asset values: DJIA down 45%

Liquidity crisis 1. Prosperity 1/11/1973 “As time goes on, the economy is becoming less and less April 30 (Dow, 921) Greenspan writes vulnerable to big booms and big busts,” says L.O. Hooper, of the W.E. Hutton & Co. in the Wall Street Journal: “Controls brokerage, in the current Forbes. “Competent economists, constantly more influential can't stem inflation, only fiscal and in government and in money management, are doing more and more to keep trends in Oct 6. War breaks out in the Middle East monetary policy can.” control.” between Israel and its foes. Government spokesmen try to dispel rumors of an 2. Increasing Speculation 1/11/1973 Nifty Fifty lead the way. Among them are June 14 (Dow, 903) Nixon imminent fuel crisis as a result of Arab McDonald's--at $74, it's selling for a staggering 83 times its earnings per share for the orders prices frozen for up to attempts to form a joint oil policy. previous 12 months. Avon is at $133 (with a price-earnings ratio of 63). Eastman Kodak 60 days as tighter system of October 11 (Dow, 976) Vice- commands $148 (P/E, 47), Coca-Cola is $148 (47) and IBM is $415 (38). These are all wage-price controls created. President Agnew resigns. Cops steadily growing companies, and the thinking is that they deserve the high P/Es June 9 (Dow, 920) September 22 (Dow, 928) Over 300 a plea to income-tax evasion. because their potential for growth seems limitless CPI up 8.8% January 23 (Dow, 1019) stock offerings withdrawn as The Justice Department is Ends unsalable. Concludes Business preparing to bring charges of Week: “The stream of equity capital bribery and extortion. to U.S. industry has run dry.”

October 19 (Dow, 964) Several oil- March 31 (Dow, 951) After letting the exporting nations of the Middle 1/12/1973 Nixon Phase 3 Econ money supply grow by 8% in 1972, East cut off exports. By December plan. Failed prior econ controls Fed clamping down on growth of June 30 (Dow, 892) The September 24 (Dow, 937) CPI the price of oil will rocket to as wholesale prices up 19% and money to quash inflation. Scarce Nifty Fifty aren't so nifty in August exploded at 22.8%, between $14 and $19 a barrel, up food prices up 60% in Dec. money means higher interest rates, anymore. McDonald's in a the steepest monthly ascent from $2 to $3 a barrel a year and this hinders . free fall--dropping to $56 in almost 26 years. earlier January 31 (Dow, 999) Inflation from its 1973 high of $77-- worrisome. Nixon's Council of June 5 (Dow, 901) Treasury Secretary but its P/E ratio is still a Economic Advisers predicts inflation says prolonged stock- lofty 54. Disney, which August 22 (Dow, 852) Nixon in 1973 will be held to 3%. (The market slump puzzles him. Insists that sold for 70 times earnings accepts all blame for actual rate will approach 9% by year- there are “bargains galore”. “I almost last December, is trading , won't end.) wish I weren't in my present position for 51 times earnings now. resign . so I could get my hands on some money and invest it,”

Diary of a Bear Market By BOB FRICK, April 14 (Dow, 845) An editorial in the Wall Street Journal sums up growing economic and August 9 (Dow, 777) Nixon market mess: “DJIA recently been hovering around 850. It first reached that level in 1964, October 1 (Dow, 605) Capitulation. Story resigns. vows to make which means that an investor with average timing and luck has had no gain for a decade. . . in Fortune titled “A Case for Gloom About November 15 (Dow, 875) Oil fighting inflation top priority. “In . The immediate problem is high interest rates. With corporate bonds yielding 8% or even Stocks” lays blame for bear market on situation now a crisis, fears of many ways,” writes Alan Abelson 9% . . . competing for an investor's attention takes an attractive common stock indeed.” inflation and says fall might not be higher inflation/fuel of Barron's that week, "Mr. Ford finished. In a few months anticipated shortages. strikes us as extremely lucky. . . . July 2 (Dow, 791) Interest/inflation rates up, profits down. Air of inflation for 1974 has risen from 5% to 8% December 15 (Dow, 816) Securities There's nowhere to go but up.” resignation settles over Wall Street. “The markets now reflect the and new projections coming in even higher. Industry Association, brokerage is indifferent to possibility of a major financial crisis," says Business Week. “Rates on Prime lending rate of banks stands at a industry's trade group, buys newspaper resolution of the Watergate crisis. CDs/commercial paper are now so high that even when they do prohibitive 12%, and rumors circulate on ads to boost investor confidence. finally start to come down, they will still be extraordinarily Wall Street that another Arab oil embargo attractive in comparison with sickly bonds and hazardous stocks.” is in the works. Fortune sees more gloom and doom ahead--this from the magazine September 2 (Dow, 679) Despair that less than two years earlier had abounds. Newsweek article (“Is There No proclaimed, “The flush of robust prosperity Bottom?”) asserts: “The plain fact is that is suffusing the economy.” there is simply not enough good economic news to sustain a real market comeback.” Fri., Oct. 4, becomes, figuratively January 26 (Dow, 859) speaking, the last down day. On December 22 (Dow, 819) 30 H. Ross Perot puts Mon. the Dow will rebound stocks in DJIA trading at lowest duPont Glore Forgan, June 29 (Dow, 802) Anyone smartly, and go up again on 4 of P/E in 20 years, says Business the second-biggest with courage admits that next 5 days. Bear market of 1973- Week. “Nor is there any Wall Street brokerage nobody knows what's going 74 is over, after 21 months. At 585, evidence that the market has after Merrill Lynch--up on or what will happen next. the DJIA is off 44% and won't yet hit bottom--or any solid for sale. Says BusinessWeek: regain 1051 level set on January 11, June 15 (Dow, 843) Big-name, clue as to when it will. ” “Economists will remember 1973, for another 8 yrs. All around high-priced stocks continue 1974 for many things: the Aug. 23 (Dow, 687) Kodak lies wreckage left by financial long fall to earth, January 14 (Dow, 840) No consensus on squeeze on energy, the drops 4 points. Other blue storm. You can buy McDonald's for accompanied by yet more what new year will bring. breathtaking rise in prices chips take similar hits. Dow $21 (down 72% since Jan. 11, 1973) wishful thinking that the October 4 (Dow, 585) Another down Says Barron's columnist Alan Abelson: and perhaps for events yet plunged 110 points in past and Coke for $46 (down 69%). If worst has passed. Avon has day--11th in a row. Seems to be no “Never have so many said so much to to come. But mainly they 12 trading days as Disney was a good value when its fallen from its 1973 high of bottom, sense of defeat on Wall Street such little purpose.” Oil cutoff having will remember 1974 as the , inflation and P/E stood at 70, on this day it's a $140 to $51 with a current almost palpable. Word on floor of profound economic effects, but how deep year the forecasters blew it.” high interest rates pound steal at only 13 times earnings. P/E of 22. Coca-Cola has slid NYSE that some institutional stock it will cut into the country's industrial the life out of the Nifty Avon, down 85%, saw its P/E plop from $150 to $115, with a portfolios for sale in entirety. muscle is unknown. Sight of cars lined up Fifty. Coke, IBM and Kodak from 63 to 9. No longer will P/E of 31. But the bargain for blocks waiting to buy even a few have dropped about 50% investors refer to such stocks as the basement is still several gallons of gasoline is unsettling. from their 1973 highs. Nifty Fifty. For that matter, a lot of floors down. McDonald's is down 60%. people will never dip their toe in the stock market again, those who do stay in will bear invisible scars from this experience for decades.

Diary of a Bear Market By BOB FRICK, 2000 Dot.com Bust/ 9/11 TMT BOOM Nasdaq Composite Index Long period of prosperity: Bull MSFT market starting in 1982, lasting ORCL throughout the 1990s NADSDAQ AAPL Composite Index up 3128% CSCO QCOM Increasing speculation: internet mania. Many companies had no or AMZN with very little revenue Pets.com GOOG NFLX Cash flow problems: many of the FB .coms had no cash flow

Collapse of asset values: Nasdaq Composite Index down 77%

Liquidity crisis 9/11 Pets.com began operations in November 1998 and liquidated in November 2000. A high- profile marketing campaign: 1999 Macy's Thanksgiving Day Parade and an advertisement in the 2000 Super Bowl. Its popular sock puppet advertising mascot was interviewed by People magazine and appeared on Good Morning America. Nasdaq Valuations Off the Charts 2000: Over $160 million originated in subprime Early 2006: More warning signs of mortgages: Subprime mortgages are loans for housing impending problems. AIG stopped selling purchases issued to risky borrowers with poor credit ratings. credit protection swaps. Commerzbank Housing Bubble began limiting positions in the subprime. 2002 to 2007: Billions extended to high-risk borrowers Ameriquest, a major lender, began closing Increased housing In 2003, 85% loans prime, 15% subprime. 2004, 64% branches and laying off employees. speculation using borrowed prime, 36% subprime. 2005, 44% subprime. In 2006, 48% subprime. Almost half of the loans during 2006 had been money (subprime mortgage extended to people who were at a much higher risk of loans) default. NINJA (No Income, Job or Assets) loans. Spiraling debt leading to cash From 2003 to 2007, subprime mortgages increase by 292% flow problems: • Banks leveraged 30 to 1, investing in mortgage Fed raised discount rate to 6.25% from 2% in Late 2006: The collapse: backed securities 2004. Many of the subprime loans were In late 2006, the walls started coming adjustable-rate mortgages that fluctuate with down. the rise of interest rates 1.On September 25th, 2006, housing • High household debt – prices fell over 10% — the first price 2004: Banks began investing in mortgage-backed drop since the 1990s. Many house as an ATM securities as investors became fond of the homeowners found themselves owing securitized investment derivatives known as more on their homes than they were mortgage-backed securities. Led to loans time and worth. Interest rates increase causing again to those who had no business purchasing a 2.In November of the same year, new home at that time. home permits fell by 28%. This mortgage defaults signaled a major slowdown in new 2004: Homeownership peaks at 70% up from 65% in 1995. homes and new mortgages for the Banks call in their mortgage Not all of the people who owned homes were financially next six to nine months. qualified to do so. loans leading to Collapse of asset values Liquidity crisis

Source: Timeline by Jason Wesley, William O’Neil and Co., GROW Funds LLC 3.46%

3.96%

3.12%

3.23%

3.86%

Assets – Liabilities = Equity (ALE) $3000 – $2900 = $100 What happens when your assets go down by 5%? $2850 – $2900 = -$50 BK Global Financial Crisis of 2008 MERRILL LYNCH reports worst-ever qtr, $16 bil mtg-related writedowns. • Lack of Liquidity: Run on shadow DZ Bank 1.36 bil euros in writedowns. banking system (investment August BNP Paribas terminated withdrawals banks and other non-depository from three hedge funds citing "a complete financial entities) evaporation of liquidity" • Major panic broke out on inter- bank loan market • Loss of Confidence (People Bear Stearns Collapse TARP Enacted withdrew deposits) February 20 - BNP PARIBAS - reveals 898 million euros (708 million pounds) in writedowns in Q4 March 23, 2009, FDIC, Fed, US 2007 CREDIT SUISSE marks down Lehman Brothers Collapse (BK) Treasury announced Public–Private Feb. 8 - HSBC blames U.S. subprime defaults for the value of asset-backed AIG Collapse (Bailed out by Treasury/Fed) Investment Program to provide first-ever profit warning. investments by $2.85 bil, liquidity "toxic assets" on balance April 2 - NEW CENTURY - New Century Financial BARCLAYS raises 2007 sheets of financial institutions. Corp. filed for bankruptcy amid a surge in writedown to 1.6 billion homeowner defaults pounds July 30 - HSBC says its charge for bad debts was March 3 – HSBC IB arm takes a $2.1 bil writedown UBS writing down $18 $6.35 bil in the first half of the year, up 63 percent April 1 - UBS doubles writedowns to $37.4 bil, billion in bad loans. Aug. 9 - BNP PARIBAS - French bank bars investors Deutsche Bank reveals a 2.5 bil euro writedown from redeeming cash in 3 funds as it was unable to calculate their value due to credit market turmoil. CITIGROUP 1st loss since Sept. 13 - NORTHERN ROCK - suffers after creation in 1998, $18.1 bil of Fed lowers discount needing emergency funding/nationalised by BOE subprime-related rate to .50% Oct. 15 - CITIGROUP Q3 profit fell 57% due to losses. writedowns. Oct. 19 - WACHOVIA CORP - posts 10% decline in Q3 profit, $1.3 bil of writedowns MORGAN STANLEY posts Oct. 24 - MERRILL LYNCH writes down $8.4 bil in $3.59 billion Q4 loss/$9.4 bil Fed steps in bad investments due to subprime lending. of mtg.-related writedowns. October 26 - COUNTRYWIDE - U.S. mortgage lender posts a $1.2 billion Q3 loss, writing down $1 bil in subprime loans. October 29 - MITSUBISHI UFJ, Japan’s largest bank, says it would write down subprime investments by as much as 30 billion yen 6 times more than previously announced.

Source: Reuters, William ONeil & Co, GROW Funds LLC Moral Hazard More Money, Chasing same amount of Assets, Prices go up Moral Hazard

"Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.“

Ben Bernanke Fed Chairman 2006 - 2014 GOLD – Barbarous Relic? 1929 Bear Market $35 $5.00 $4.50 $30 $4.00 $25 $3.50

$3.00 Earnings $20 $2.50 Price $15 $2.00

$10 $1.50 $1.00 $5 $0.50 $0 $0.00 9/30/1929 9/30/1931 9/29/1933 9/29/1935 9/28/1937 9/28/1939 9/27/1941 9/27/1943 9/26/1945 9/26/1947 9/25/1949 9/25/1951 9/24/1953 Date

Price Earnings 1973 Bear Market $140 $25.00 1929 - 9 Years for earnings to

$120 Recover 12.5 years for the $20.00 market to recover $100

$15.00 Earnings $80 1973-74 - 0 Years for earnings

Price $60 $10.00 to Recover 8 years for the $40 market to recover $5.00 $20

$0 $0.00 1/31/1973 1/31/1974 1/31/1975 1/31/1976 1/30/1977 1/30/1978 1/30/1979 1/30/1980 Date

Source: Robert Shiller, GROW Funds LLC $1,600 2000 Bear Market $200.00 $1,400 $180.00 $160.00 $1,200 $140.00 $1,000 $120.00 2000 – 6.75 Years for earnings

$800 $100.00 Price

$600 $80.00 Earnings and the market to recover $60.00 $400 $40.00 $200 $20.00 $0 $0.00 8/31/2000 8/31/2001 8/31/2002 8/31/2003 8/30/2004 8/30/2005 8/30/2006

2008 Bear Market $1,800 $200.00 $1,600 $1,400 $150.00

$1,200 Earnings $1,000 2008 – 5.5 Years for earnings $100.00

Price $800 $600 and the market to recover $400 $50.00 $200 $0 $0.00 10/31/2007 10/30/2008 10/30/2009 10/30/2010 10/30/2011 10/29/2012

Price Earnings

Source: Robert Shiller, GROW Funds LLC Crisis Build Up of Credit/Debt Speculative Excess Shock Fed Action Government Action Unintended Consequences

1929 Money Supply increased DJIA Up 497% from 1921 Market crash Federal Reserve in Hoover Program: Industrialists to Production, stock and 62% from 1921 to 1929 to 1929, Margin lending to Margin calls Oct. added $300 maintain wage rates, expand commodiy prices, foreign favored credit to Farmers, buy stocks Overproduction in million to the reserves construction, and share any reduced trade, and employment all Foreigners commodities of the nation’s banks. work. continued to decline. Crisis ComparedDust Bowl Lowered discount rate Public works. Farm subsidies. Raised to 4% from 6.5% tariffs. (Smoot Hawley). Protectionism. Banned immigration. Withheld loans for short selling

1973-74 Inflationary Bust Nifty Fifty Nixon Shock – Price controls, Wage/price freeze Off , $ no longer backed by Gold Vietnam War Raised Interest Rates Oil Embargo Watergate Inflation 2000 Dot Com bubble DJIA up 1428% from 1982 9/11 to 2000, Dotcom Boom

2008 Housing Housing Boom Collapse of Bear ZIRP Stearns, Lehman TARP Brothers, AIG … QE1,2,3

2020 FAANG Stocks, Corporate DJIA up 308% from 2009 COVID Debt, BBB, Junk Bonds to 2020, FAANG Oil Crisis Questions ? “Everyone has a plan 'till they get punched in the mouth” – Mike Tyson COVID19 Crash

Prosperity: Post Banking Crisis recovery, S&P 500 Up 409% from 2009 lows

Speculation: FAANG stocks, Technolgy

Build up of Debt: Quest for yield: Build up of BBB Debt, Borrowing to buy back stock

Russell 2000 Growth Index Down -43% Oil Crisis Investor Sentiment

Flight to safety. So investors wanted to be in very short-term instruments and they wanted them to be in major . And so they buy Treasury Bills, for example. They didn't even want to buy longer-term Treasuries because those can move around in value. So it was an extraordinary moment.

Source: CNN Fear and Greed Index, 60 Minutes Interview Federal Reserve Balance Sheet Fed Vice Chair CNBC interview 5/5/2020: It is his forecast that Q3 GDP is positive; Additional support could be needed by Fed or fiscal officials Mr. Clarida said: $7,037,258,000,000 • There will be a sharp retraction, but recovery could begin in the second half of the year. • The course of the economy will depend on the course of the virus. • It is his forecast that Q3 GDP is positive. • The Fed will keep rates at zero as long as its needed. • Additional support could be needed by Fed or fiscal officials. • Fed will continue to act forcefully and aggressively. • There is no "statutory limit" to what Fed can do.

PELLEY: Fair to say you simply flooded the system with money? POWELL: Yes. We did. That's another way to think about it. We did. PELLEY: Where does it come from? Do you just print it? POWELL: We print it digitally. So as a central bank, we have the ability to create money digitally. And we do that by buying Treasury Bills or bonds for other government guaranteed securities. And that actually increases the money supply. We also print actual currency and we distribute that through the Federal Reserve banks.

Source: Briefing.com, CBS 60 Minutes Build up of Credit: BBB Bonds, Junk Bonds, Fallen Angels

NY Fed releases additional information on primary market and secondary market corporate credit facilities in preparation for series of may launches The Primary Market Corporate Credit Facility (PMCCF) was established to support credit to large employers for bond and syndicated loan issuance. The PMCCF will allow companies access to credit so that they are better able to maintain business operations and capacity during the period of dislocations related to the pandemic. The Secondary Market Corporate Credit Facility (SMCCF) was established to support credit to large employers by providing liquidity for outstanding corporate bonds. As detailed in the FAQs released today, the SMCCF is expected to begin purchasing eligible ETFs in early May. The PMCCF is expected to become operational and the SMCCF is expected to begin purchasing eligible corporate bonds soon thereafter. Unemployment

“They have passed $3 trillion in stimulus, which is 14% of GDP. It is vastly larger than anything they've ever done. And also very, very quick. So a lot of that money is just starting to flow through the economy. And it's going to help households and businesses in coming months. The thing is that the coronavirus shock is also the biggest shock that the economy's had in living memory.” JPowell Questions ? Future Flattening the curve

Source Bios Research, Johns Hopkins Fed Actions

Unintended Consequences

Earnings

Source: GROW Funds LLC S&P 500 Earnings Expectations: Flattening the Curve

S&P 500 At $3045 Today Earnings Growth 20 PE % 15 PE % Estimates Multiple Change Multiple Change Target Target $126.46 -23% $2529 -17% $1897 -38% $162.77 +29% $3255 +7% $2442 -20% $185.30 +14% $3706 +22% $2780 -9%

Source: Factset, Raymond James RISKS

Zombie Companies

No creative destruction

Structurally High Unemployment

How states and cities deal with debt – higher taxes

Protectionism: we have imported from China

Inflation ?