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WURTS & ASSOCIATES

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October 17, 20083rd Quarter Research Conference Call

Eric J. Petroff, CFADirector of Researchepetroff@wurts.com

2

Agenda for Today’s Call

1. What Just Happened?• A brief recap of market activity from an historical perspective

• What caused recent market volatility?

• What are our options?

2. Looking Forward• Domestic vs. international equities

• Currency considerations

• US large vs. small & value vs. growth

• US fixed income markets

• Distressed debt

3. Concluding Remarks

3

What Just Happened?

4

Summary of Recent Events: Irrationality & Panic!

800

900

1000

1100

1200

1300

1400

1500

1600S&P 500 Daily Values (as of October 13, 2008)

Government induced psychological turnaround

Source: Yahoo Finance

Irrationality & Panic!

5

Market Behavior is by No Means Unprecedented

6 5

15

32

74

125

0

20

40

60

80

100

120

140

Down >50% Down 40-50% Down 30-40% Down 20-30% Down 10-20% Down 0-10%

History of Rolling 1 Year Losses: # of Observations

S&P 500 = -33.8%(Oct. 13, ‘08)

S&P 500 = -22%(Sept. ‘08)1 Jun-32 -37.7

2 Sep-31 -33.6

3 Dec-29 -27.8

4 Sep-74 -25.2

5 Dec-87 -22.5

6 Dec-37 -21.4

7 Jun-62 -20.6

8 Mar-38 -18.6

9 Sep-46 -18.0

10 Jun-70 -18.0

11 Jun-30 -17.7

12 Sep-02 -17.3

13 Jun-40 -16.9

14 Mar-39 -16.1

15 Dec-30 -15.8

16 Sep-01 -14.7

17 Mar-33 -14.1

18 Dec-31 -13.8

19 Sep-90 -13.7

20 Jun-02 -13.4

38 Sept. '08 -8.4

Top 20 Worse Quarterly Losses for the

S&P 500

1 Sep‐31 ‐29.72 Mar‐38 ‐24.93 May‐40 ‐22.94 May‐32 ‐22.05 Oct‐87 ‐21.56 Apr‐32 ‐20.07 Oct‐29 ‐19.78 Feb‐33 ‐17.79 Jun‐30 ‐16.310 Aug‐98 ‐14.511 Sep‐37 ‐14.012 Dec‐31 ‐14.013 Oct‐32 ‐13.514 Mar‐39 ‐13.415 Sep‐30 ‐12.816 May‐31 ‐12.817 Nov‐29 ‐12.518 Mar‐32 ‐11.619 Sep‐74 ‐11.520 Jul‐34 ‐11.331 Sept. '08 ‐8.9

Top 20 Worse Monthly Losses for the

S&P 500

S&P 500 Month to date/4th QTR to date(Oct. 13 ‘08) -13.8%

Source: Ibbotson; Wurts & AssociatesSource: Ibbotson; Wurts & Associates

6

Changing by the Day…by the Minute

Source: MSCI; S&P; Wurts & Associates

This is why we shouldn’t focus on the short term.

09/30/0810/10/2008 (estimate)

10/13/2008 (estimate)

P/E RatiosS&P 500 22 17 19MSCI EAFE 11 8 9MSCI Emerging 11 8 9Dividend YieldsS&P 500 2 3 3MSCI EAFE 4 6 5MSCI Emerging 3 4 4Earnings YieldsS&P 500 5 6 5MSCI EAFE 9 12 11MSCI Emerging 9 13 11Prospective ReturnsS&P 500 6.9 9.0 8.0MSCI EAFE 13.5 18.0 15.6MSCI Emerging 12.5 17.5 14.4

Huge intra-month fluctuations in return expectations

-50

-30

-10

10

30

50

70S&P 500 Rolling 1 Year Returns (Sept. '08)

Strong corrections are typically followed by strong recoveries.

7

The Root of the Problem: A Debt Driven Society

Source: Federal Reserve; Wurts & Associates

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

8%

9%

10%

11%

12%

13%

14%

15%

16%

17%Household and Non-Profit Cash & Deposits as % of Total Assets

Cash Instruments as % of Total Assets Cash as % of Total Assets

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.2

1.4

1.6

1.8

2.0

2.2

2.4Societal Debt to GDP Ratios: Financial & Non-Financial (June 2008)

Ratio of Domestic Non-Financial Debt to GDP Ratio of Domestic Financial Debt to GDP

Source: Federal Reserve; Wurts & Associates

Source: Federal Reserve; Wurts & Associates

0.78

0.8

0.82

0.84

0.86

0.88

0.9Household and Non-Profit Net Worth (June 2008)

An 11-12 fold increase in financial debt!

An ever diminishing cash position

Steady erosion of net worth.

8

Credit Markets Tightened Strongly

0

2

4

6

8

10

12

14

16

18

20Annualized Growth Rate in Home Mortgages (June 2008)

Annualized Growth Rate in Home Mortgages Average

Source: Federal Reserve Source: Federal Reserve

0

1000

2000

3000

4000

5000

6000Total Lending/Borrowing in Credit Markets – Billions (June 2008)

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

TED Spread: 3 Month LIBOR Less 3 Month T-Bills(October 9, 2008)

Source: Freelunch.com; Wurts & Associates

A 60% drop in lending through June alone

An unprecedented drop in mortgage growth

9

The Cause for Pessimism: As Goes Demand so Goes GDP

Source: Bureau of Economic Analysis; Wurts & Associates

Source: Bureau of Economic Analysis; Federal Reserve; Wurts & Associates

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0Rolling 1 Year GDP & Aggregate Demand (June 2008)

Aggregate Demand - Rolling 1 Year GDP - Rolling 1 Year

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

0.0

1.0

2.0

3.0

4.0

5.0

Growth in Lending vs. Growth in Aggregate Demand over Rolling 5 Year Periods (June 2008)

Rolling 5 Year Aggregate Demand Rolling 5 Year Growth in Lending

Debt growth is essential to aggregate demand

Growth in demand is essential to GDP

10

What are Our Options?

1. Abandon Asset Allocation/Market Timing

• Inconsistent with Fiduciary responsibility

• Committees are ill-equipped for such practices

• Difficult for even the best and brightest

2. Do nothing

• Akin to abandoning asset allocation

• Ignores opportunity to acquire discounted assets

3. Rebalance

• Integral to maintaining asset allocation guidelines

• Bolsters prospective returns through acquisition of discounted assets

• Takes advantage of market irrationality

• Positively participates in wealth redistribution

4. Incorporate Recent Events into Portfolio Structure

• When conditions change, portfolio strategy should change

• Opportunities always arise as a result of market dislocations

• Now is no exception

• Rational long term investing is not marketing timing

YTD ReturnTargeted

Volatility

Mellon Global Alpha II -12.6% 5%

First Quadrant GTAA 0.9% 30%

AQR Absolute Return 1.0% 20%

Goldman Sach GTAA -8.2% 15%

Select GTAA1 Managers - Sept. '08 YTD Estimates

1 GTAA – Global Tactical Asset Allocation

11

Looking Forward

12

1.5

10.8

6.4

4.2

13.4

2.2

16.5

9.2

2.4

8.4

1.8

10.7

6.8

3.2

12.6

0

4

8

12

16

20

Price/Book Value Price/Earnings Price/Cash Earnings

Dividend Yield Earnings Yield + Dividend

MSCI Global Valuation Ratios: EAFE, Emerging, & US (September 2008)

MSCI EAFE U.S.A EMERGING MARKETS

Equities Have Become More Attractive

Source: MSCI

Dec. 2007 TTM Sept. '08 TTMOctober 13, '08

TTM

Price to Earnings Ratio 22.2 23.0 19.8

Earnings Yield 4.5% 4.3% 5.1%

Dividend Yield 1.9% 2.5% 2.9%

Implied Expected Return 6.4% 6.8% 8.0%

Source: Standard & Poors; Wurts & Associates

S&P 500 Domestic Large Cap Valuations

Source: Yale/Schiller data; Wurts & Associates

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%S&P 500 Dividend & Earnings Yield vs. Subsequent Rolling 10 Year Return

Dividend + Earnings Yield Subsequent Rolling 10 Year Return

0

5

10

15

20

25

MSCI EAFE Earnings & Dividend Yield vs. Subsequent Returns (September 2008)

Earnings Yield + Dividend Subsequent Rolling 10 Year Returns

Source: MSCI, Ibbotson, Wurts & Associates

Earnings Yield = 1/PE Ratio

13

Does History Back Up Return Expectations?

16.8

14.7

13.513.0

9.4

7.8

9.5

4.4

0

2

4

6

8

10

12

14

16

18

6-10 10-12 12-14 14-16 16-18 18-20 20-25 25-30

Trailing 12 Month S&P 500 P/E Range vs. Subsequent Average 10 Year Returns (since 1946)

Source: Yale/Schiller; Ibbotson; Wurts & Associates

Price to Earnings Ratio Ranges

Current range of valuations

14

The Caveat to International Equities: Currency

Source: Federal Reserve; Freelunch.com; Wurts & Associates

-8

-6

-4

-2

0

2

4

6

8

10

12

75

85

95

105

115

125

135

US Dollar Real Valuation (Major Currency Index) vs. Subsequent Returns (September 2008)

Price Level Average Price Level Subsequent 5 Year Annualized Return

Dollar appreciation subtracted 6.5%from US investors return in the MSCIEAFE index during the 3rd quarter.

US Dollar Price Level

Scenarios:

10 Year Outlook

Current PriceAverage Price

Level

Estimated

2018 Price

Level

Subsequent

10 Year

Annualized %

Return

Reverts to Average 86 95 95 1.1

Reverts to 2002 Levels 86 95 115 3.3

Reverts to 1985 Levels 86 95 125 4.3Source: Federal Reserve; Freelunch.com; Wurts & Associates

Sensitivity Analysis for US Dollar Appreciation - September 30, 2008

-17% -19%

-11%-15%

-33%

2% 0%

-17%

6%

-19%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

British Pound Euro Japanese Yen Australian Dollar

Swiss Franc

Current & Historic US Dollar PPP Premium/Discount (September 2008)

Current PPP Discount/Premium

Historic Average PPP Discount/Premium

Source: Organization for Economic Cooperation and Development 2007 data PPP data; Federal Reserve; Freelunch.com; Wurts & Associates

15

Relative Opportunities Within Domestic Equities

-13

-8

-3

2

7

12

0.7

0.9

1.1

1.3

1.5

1.7Russell 1000 vs. Russell 2000 P/E Ratio Comparison (September 2008)

Small P/E as % of Large P/E Average Relative Comparison Subsequent 5 Year Rolling Returns

Small Expensive

Source: Russell; Wurts & Associates

Sept. Price/Earnings

Ratio

Sept. Price/Book

Ratio

Russell 1000 (large) 15.0 2.3

Russell 2000 (small) 21.8 1.8

Comparative Ratio (2000/1000) 145% 80%

Historic Average 123% 81%

Source: Russell; Wurts & Associates

Russell US Large vs. Small Cap: Current & Historic Comparison

Small Cheap

Small outperforms

Small underperforms

Sept. Price/Earnings

Ratio

Sept. Price/Book

Ratio

Russell 1000 Value 14.0 1.7

Russell 1000 Growth 16.1 3.4

Comparative Ratio (Value/Growth) 87% 49%

Historic Average 68% 42%

Source: Russell; Wurts & Associates

Russell US Large Value Vs. Growth: Current & Historic Comparison

Large value looks expensive Small caps look expensive

16

Opportunities Within Fixed Income Markets

0.40.8

0.4

2.7

0.91.8

0.9

5.7

1.8

3.8

1.4

10.2

0

2

4

6

8

10

12

Lehman Aggregate Index

Lehman Credit Index Lehman MBS Index Lehman High Yield Index

Option Adjusted Spreads Relative to US Treasuries (September 2008)

Dec-06 Dec-07 Sep-08Source: Lehman

4.9 5.4 5.6 5.6

7.9

3.74.9

5.6 5.4

9.7

3.0

5.2

7.2

5.5

13.9

0

2

4

6

8

10

12

14

16

Lehman Treasury Index

Lehman Aggregate Index

Lehman Credit Index

Lehman MBS IndexLehman High Yield Index

Nominal Fixed Income Rates (September 2008)

Dec-06 Dec-07 Sep-08Source: Ibbotson

The compensation for bearing credit risk has risen substantially

17

TIPs – The Best Risk Free Exposure

Source: Bureau of Labor Statistic; Wurts & Associates

Source: Federal Reserve; Bloomberg; Wurts & Associates

Average Rolling Value

% of Rolling Periods < 1.6%

% of Rolling Periods > 1.6%

Rolling 10 Year Periods

CPI (since 1948) 4.0 8% 92%

CPI x-F&E (since 1958) 4.6 0% 100%

Average Rolling Value

% of Rolling Periods < 1.0%

% of Rolling Periods > 1.0%

Rolling 5 Year Periods

CPI (since 1948) 3.9 1% 99%

CPI x-F&E (since 1958) 4.3 0% 100%

Historic Inflation Data (August 2008)

0.0

1.0

2.0

3.0

4.0

5.0

5 Year Treasury

5 Year TIP 10 Year Treasury

10 Year TIP 5 Year Implied Inflation

10 Year Implied Inflation

Nominal vs. Inflation Indexed (TIPS) Treasury Yields & Implied Inflation

Jun-08Sep-08October 13, 2008

Seemingly silly valuations for TIPs… a compelling opportunity

18

An Opportune Time for Distressed Debt

Source: Moody’s

0

2

4

6

8

10

12

Moody's Issuer Weighted Speculative Default Rates

Trading Strategies

Impact theReorganization

Control Class ofSecurities

AcquireIssuer

Distressed Investment Spectrum

Hedge Fund Oriented Private Equity Oriented

Passive Involvement Active Involvement

A reversal in this credit cycle seems likely

19

Concluding Remarks

20

Concluding RemarksRecap

• Concerns over prospective economic growth drove markets lower

• Though severe, recent market activity is not unprecedented

• The US economy is driven by debt

• Low interest rates and ample access to credit are essential

• Unfortunately high money supply ultimately leads to inflation

• Capital markets have changed

• Prospective equity returns have risen

• Relative opportunities exist in global and domestic equity markets

• Credit risk is being handsomely reward

• TIPS offer a compelling risk free fixed income investment

• The best window for distressed debt investing in years

• Inflation is on the horizon

Recommendations

• Maintain existing portfolio structure and rebalance

• Adapt asset allocation in light of changing capital market conditions