An Update on Our Performance 

Incomes - A Four-Decade Long Report Card

The Incredible Shrinking Work Week

The Curious Case of Hourly Earnings

What a Difference a Week Makes

What's a Buck Worth?

Incomes Just Don't Buy What They Used To

Wow, I Didn't Know That!

Questions and Comments

Definitions

Take My TV Challenge

Tuesday, September 14^th marked the first anniversary of the collapse of Lehman Brothers. This historic event almost brought our financial house down and exposed a multitude of inherent Wall Street vulnerabilities in the process.  Only time will tell if the government response of throwing trillions at the problem to bail out industry giants like Fannie Mae, Freddie Mac, Citigroup, Bank of America and AIG, deemed "too big to fail," was the right move.

In this ProfitScore IQ, we will continue our inflation/deflation argument and we will examine real employment incomes, and the growth in household wealth compared to debt growth rates. How have wages fared during the inflationary times of the 1970s, on through the eighties and nineties, and into the new millennium?

What we found astounded us and will surely surprise you!

But first, I have some exciting news for our current subscribers and would like to welcome our new subscribers to the ProfitScore IQ.  If this is your first letter, I want you to know how much I appreciate your valuable time and that my staff and I put our heart and soul into publishing this letter.  We hope our thoughts help to make you a better and more knowledgeable investor. 

Over the past several years, we have gained a large and growing readership.  This is in a large part due to our loyal, long-term subscribers.  We recently added a new distribution partner for this letter.  This new relationship will push our readership over 1 million.  Thanks to all of our readers who have made this possible! 

Major economic changes are now happening at the speed of light.  To keep abreast of these rapidly changing circumstances, we will now start publishing our thoughts weekly.  We will call this weekly publication the ProfitScore Weekly Market Watch.  You will start receiving this weekly letter on September 28^th.  I, of course, will take a few weeks off for holidays, but you can expect to hear from me much more often. 

These weekly letters will be shorter, yet focused and full of thought-provoking content.  Once a month, we will also produce our traditional ProfitScore IQ containing more details about topics produced for the weekly letters and our regular update on our portfolios and other ProfitScore specific news. 

An Update on Our Performance

The only bright spot in last month's performance was once again our fixed income portfolio, which continues to make consistently positive returns and now sits at a new equity high.  In the long-term, we will be rewarded for these high probability decisions, but short-term, they can damage our equity curve.

Below are recent performance returns on the four portfolios we currently offer:

ProfitScore provides separately-managed accounts for individuals, advisors and institutions.  If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

1. Complete our Private Client Group request form by clicking here http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
2. Call us directly at (800) 731-5690.
3. Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.

Incomes - A Four-Decade Long Report Card           

According to the latest non-farm payrolls data from the Bureau of Labor Statistics (BLS), the number of jobs being lost fell to 216,000 in August. But before celebrating, we need to look more closely at the employment numbers and time spent working. BLS reported that the average hours worked was 33.1 hours in August, up marginally from a multi-decade low of 33 hours in June.

We also learned that the unemployment rate jumped to 9.7% in July, the highest rate since 1983. A statistic not widely discussed was BLS's all-inclusive U6 jobless rate, that includes those working part-time. It showed the loss of 336,000 full-time jobs in August, sending the U6 rate to an all-time high of 16.8% since the data was first recorded (and does not include the Great Depression).   

What about incomes? This begs our first question of the week - Are we better off than we were four decades ago? If so, how much better? And have real incomes kept up with the rate of inflation? In order to answer that question, we need to look at a BLS statistic called personal consumption expenditures (PCE), together with changes in average hourly incomes will determine an inflation-adjusted number.

PCE represents the cost of goods and services used for individual personal consumption and are measured differently by each country. This statistic is designed to provide a representation of the cost of living for the individual. (For a more detailed definition, please refer to the end of this newsletter.)

We will then adjust average hourly earnings by both the official and unofficial CPI to figure out how our incomes have changed.

The Incredible Shrinking Work Week

Our next chart shows average hourly earnings since 1970 adjusted for PCE inflation. In January 1970, the average hourly income was $3.31, and by December it had increased to $3.50, according to the U.S. Bureau of Economic Analysis (BEA). Contrast this with an average hourly wage of $18.43 in January 2009 and $18.56 by July in 1970 dollars.

Figure 1 - Chart showing average hours worked with big drops in the past 18 months of multi-decade lows.

In other words, since 1970 wages have increased 430%, which works out to an average annual compound increase of 4.3% per year. Here are my calculations.

Total return (for n years) (TR)                                4.30 or 430.0%

Number of years (n)                                               40.0

Average annual return (AR) =((1+TR^(1/n))-1 =    0.043 or 4.3%

But as we see from our next chart, this growth rate was anything but linear each year. Between 1970 and the early 1980s, PCE inflation-adjusted wages soared from $3.31 to a high of $5.58 by June 1982. However, over the next two decades real average hourly earnings growth stagnated and by July 2005, it had dropped to $4.93/hour, a 12% decline from the peak in the early 1980s.

In other words, real incomes actually dropped during the greatest bull market in history (1982 - 2000)!

The Curious Case of Hourly Earnings

Figure 2 - Monthly chart of real average earnings (1970 dollars) showing a fast rise between 1970 and 1983, after adjusting for PCE inflation. As of the most recent data (July), real earnings are down 0.1% from their 1983 peak. In nominal terms, average hourly earnings were $3.50 versus $18.56 in July 2009. 

As the above chart shows, in July 2009 real average hourly earnings were still below where they were in the summer of 1982.

But is this a realistic income picture since monthly incomes are determined by multiplying average hourly incomes by the number of hours worked? To answer that question, we gathered data from both the BLS and BEA to calculate average weekly PCE inflation-adjusted incomes.

This next chart shows our findings.

What a Difference a Week Makes

Figure 3 - Annual chart of real average weekly earnings that factors in the drop in average hours worked in a week. It recently hit an all-time low of 33. Real earnings are down 6.1% since the peak in 1982. 

We again see that average weekly earnings rose rapidly during the inflationary years of 1970 through 1982 from $125.80 to a high of $186.93 in 1970 dollars. However, due to a trend of falling hours being worked each week, incomes in 2009 are still 6.1% below where they were when the biggest bull market began in 1982. This is a 6% greater drop than in hourly earnings (Figure 2).

What's a Buck Worth?

Next, we calculate buying power for the average hourly income by deflating nominal hourly earnings by CPI. As a brief review, our next chart from our last monthly newsletter compared three different inflation estimates, the most benign of which is the official government consumer price index (CPI-U). It showed that the dollar is now worth about 18% of what it was in 1970, the alternate CPI (CPI-Alt) that calculates inflation before statistical changes were made post-1982, showing a drop in dollar buying power of 94%. According to the price of gold, the dollar has dropped more than 96% since 1970.  

Figure 4 - Chart of three different estimates on how the value of a dollar has changed since 1970. In 1982, government statisticians began making changes to the way inflation was calculated that had the effect of minimizing it. The official CPI (CPI-U) puts the value of a 1970 dollar at $0.18 today compared to $0.059 using the Alt-CPI (original CPI calculation) and $0.04 using gold. Source data - Bureau of Labor Statistics and ShadowStats.com 

Next is a chart that adjusts average hourly incomes by both the official CPI (CPI-U) and John Williams' alternate CPI (CPI-Alt) in 1970 dollars. The graph of average weekly earnings adjusted for both CPI-U and CPI-Alt is not included here shows an even greater drop in CPI adjusted earnings!

What also stands out is the difference between the Personal Consumption Expenditures and the Consumer Price Index. As we saw above, wage inflation (the total increase in wages) was 430% between 1970 and 2009. According to the PCE, inflation amounted to 338% over the same period while the official total CPI (CPI-U) was 450%. That's a big difference in inflation!

Incomes Just Don't Buy What They Used To

Figure 5 - Chart of average hourly incomes deflated by both the average annual official consumer price index (CPI-U) and the alternate consumer price index (CPI-Alt), showing the purchasing power of the average wage after adjusting for inflation.

Figure 5 provides us a long-term look at the buying power of the average hourly wage. If you are feeling more poor than you felt in the 1980s, you now know why!

Even before the big plunge in household incomes as a result of the credit crisis that started mid-2007 fueling a record loss of $13.7 trillion in household wealth (see article Shock May Put Global Relapse... below), incomes have failed to keep up with inflation. And if you use the alternate CPI, which calculates inflation as it was before all the changes made to the statistic post 1982, the drop in real incomes has been significant.

Wow, I Didn't Know That!

In 1970, the Dow Jones Industrial Average ended the year at 828.40. On Friday (September 18) it closed 9820.20, an increase of more than 1086% in nominal terms compared to a nominal (non-inflation adjusted) increase in wages of 430%. Why have real wages fallen as the stock market gains so much ground?

Did households become increasingly dependent on stock market gains to provide income or was some other factor responsible for the growth in household wealth over this period?

And through this period, how quickly has debt grown - debt which one day will have to be repaid?

Here is what we found.

First we looked at the growth of household net worth between 1970 and 2009 (green) and then examined the annual change (red line). Net household wealth peaked (annual basis) in 2007 at $63.9 trillion, according to data from the Federal Reserve. By December 2008, it had dropped to $52.9 which was a 17.2% drop before recovering slightly to $53.1 trillion by Q2-2009. That was the biggest percentage dropping by a wide margin since the Fed first began recording the data in 1945 (see Figure 6).

Figure 6 - Annual household net worth and the yearly rate of change.

Figure 7 - Household debt and annual rate of change showing the first year-over-year decline in 2008 of 0.71% followed by a 1.05% drop in 2009 (to Q2-09), which were the first annual declines since 1945 according to the Fed.

Now let's put it all together and compare the overall growth rate in household debt, average wages and the Dow Jones Industrial Average versus three types of debt - household debt, total credit market debt (debt at all levels in the economy) and Federal government between 1970 and 2009. (For a more detailed discussion of Federal government and total credit market debt and a chart showing how quickly each has grown, see Figures 3 and Figure 4 in last month's newsletter.)

Here is what we found. As the chart shows, government and credit market debt have grown more than twice as quickly as household wealth and more than three times faster than the Dow in the 39-year period. Federal government debt grew seven and a half times faster than wages between 1970 and 2009!

Figure 8 - Comparison of the growth rates of wealth, the Dow and average wages compared to three types of debt from 1970 through Q2-2009.

We performed the same calculations for the last decade (1999-2009). Not surprisingly, Fed government debt grew the fastest at 130% over the decade with both credit market and household debt close behind (105% and 108% respectively). Wages were next at 41%, followed by household wealth (24%) then the Dow, which dropped 16% between December 1999 and September 18, 2009.

We watched an interview that featuring perma-bull Ken Fisher. His big message was that he wished we had more debt! Using what we consider rather twisted logic, he said that with an economy of approximately $13 trillion annually and debt where it is today (the latest estimate comes from Sprott Management puts total debt and unfunded liabilities at $118 trillion), means that the country in Fisher's opinion is returning 11% on its debt (investment).

It is important to point out that he made the same claim in June 2007 and also claimed that our economy AND homeowners needed more debt at the time, advice which those who took it to heart probably seriously regret today. Warning - relying on Fisher's logic to run your own financial affairs would be very harmful to your financial well being! However, somehow it's okay for a nation to be reckless in its financial affairs. (See both the recent and June 2007 articles below in Stories of Interest.)

Here is a little known fact.  Ken Fisher has a mutual fund called Purisima Total Return (PURIX).  You can look it up at Yahoo or any similar website.  I calculated how it performed during the current bear market and here is what I came up with:

• Equity High was on November 1, 2007 - $23.93 per share
• Equity Low was on March 9, 2009 - $9.99 per share
• Loss in dollars: $13.94 per share
• Loss in percentage terms:  -58.25%
• Increased required to get back to break even:  (100% / 41.75% = 240%)

I will let you be the judge if Ken is a better marketer or a better money manager.

But whether we like it or not, based on the growth rates in debt, Fisher will most certainly get his wish. The current debt level of $118 trillion works out to exactly $1 million per U.S. household, which most economists would argue is completely impossible to pay off anytime soon (more like within the next three or more decades). 

Next week we continue with this discussion to see how you can protect yourself and even profit from the challenges we face. Stay tuned!

Questions and comments

Do you have a question or comment? Please email us at info @ profitscore.com. Paste this email address but remove the blanks before sending. (We have to do this to reduce spam emails.)

DEFINITIONS

Personal Consumption Expenditures (PCE)

Personal consumption expenditures (PCE) are all funds spent on goods and services intended for individual consumption or use. It includes such items as food, beverages, clothing, and utilities. The PCE price index takes into account actual prices paid by households for durable goods, as well as non-durables and services. Even though the personal consumption expenditures price index makes constant adjustments for changing consumer spending habits, its conclusions are considered somewhat predictable and therefore has little impact on the markets. Source - InvestorGlossary.com

Consumer Price Index (CPI) 

The (official) Consumer Price Index (CPI-U) is released monthly by the US Department of Labor. It measures the price changes in a fixed basket of consumer goods in an attempt to measure economic inflation. A Consumer Price Index reading that excludes volatile food and energy prices (core CPI) is also published monthly. The basket of goods and services used to calculate the Consumer Price Index includes medical services and drugs, food, energy, recreation, clothing, education, housing and communications. The Consumer Price Index is widely viewed as a leading economic indicator. Cost of living adjustments in programs such as Social Security are based on the Consumer Price Index. GDP calculations also use the Consumer Price Index as an input. Because of its wide implications, the Consumer Price Index can affect interest rates and foreign exchange rates. Source - InvestorGlossary.com

Stories of Interest

Too Much Debt? Please. We Need MORE Debt, Says Ken Fisher!!

http://finance.yahoo.com/tech-ticker/article/334648/Too-Much-Debt--Please.--We-Need-MORE-Debt-Says-Ken-Fisher?tickers=tlt,tbt,spy,dia,%5egspc,udn,uup&sec=topStories&pos=8&asset=&ccode

Same sort of funny advice from Fisher in June 2007 with his numeric rationale...

http://globaleconomicanalysis.blogspot.com/2007/06/in-love-with-debt.html

Gain in U.S. Household Wealth Will Help Ease Strain on Spending

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=apwSioYuG_cI

Revealed: The ghost fleet of the recession anchored just east of Singapore

http://www.dailymail.co.uk/home/moslive/article-1212013/Revealed-The-ghost-fleet-recession-anchored-just-east-Singapore.html

Shock May Put Global Relapse Odds as High as 1-in-3, Roach Says

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a9odwc3.kFwM

Poverty Deepens as Recession Cuts U.S. Incomes, Census May Say

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aw6DvG14bU6s

U.S. Economy May See Its Slowest Recovery Since 1945

http://www.bloomberg.com/apps/news?pid=20601068&sid=aBj5AeyQqun8

Global Economic Crisis to Continue: IMF Chief

http://www.reuters.com/article/GCA-Economy/idUSTRE58B0K620090912

Record Plunge in U.S. Consumer Credit Signals Weakened Spending

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=avvF5aNtrCfc

U.S. Economy: Trade Deficit Widens Most Since 1999 on Imports

http://www.bloomberg.com/apps/news?pid=20601087&sid=aZcN_BCvBsAE

Consumer Sentiment Improves, Inventories Drop

http://www.reuters.com/article/GCA-Economy/idUSTRE58A3EM20090911?sp=true

Portfolio Performance Analysis

Risk & Reward

Each of our portfolios is strategically allocated across one or more of the Investment Pillars of Strength discussed below.  Each Pillar is managed by multiple, uncorrelated, absolute-return investment managers to produce a return stream that is consistent, negatively correlated with the major market averages in down markets and non-correlated with each of our core Pillars of Strength. 

Managing risk is our most important consideration and it is reflected in the way our portfolios are built and managed each and every day.

I would be lying to you if I could have imagined that the S&P 500 would be 60% above its March lows 6 months later.  Then again, the world has never seen so much liquidity pumped into the markets by governments around the globe.  During the past six months, the S&P has leaped from 20% below its 200 day moving average to 20% above it.  Has it come too far to fast?  Yes!  Here are some interesting statistics I pulled from Bespoke Investment Group the other day:

"Since 1928, it's happened three times--1932, 1938 and 1975--and each time, the S&P was lower one, three and six months later every time but--and this is a big 'ol but--the average return, one year later, was 13.3%, with positive returns two out of three times."

It is hard to argue against the liquidity effects of trillions of dollars, but I think those dollars are getting tired.  At this point, I am not sure how the next six months will play out.  With so much government intervention, it is hard to tell.  The only thing I am fairly confident in is that volatility is about to be reintroduced back into the equity equation. 

The other day I was playing a game called "Trouble" with my oldest daughter, Sarah.  The game is pretty simple and fun for younger kids to play.  The game has one die in the middle enclosed by a hard plastic see-thru shell.  When you press the shell, the spring in the bottom pops the die, which is the equivalent of rolling the die to determine your number.  To do well at the game, you need to roll a six.  Rolling six gets your man out of home and allows you to travel to your destination.  By rolling a six, you also get to roll again.  Tolerate me for a moment, because this helps me explain our performance in August. 

While Sarah and I were playing, I rolled 12 sixes in a row.  It was quite amazing-and boy do I wish I could have had that kind of luck playing craps.  I obviously won the game.  The very next night, the whole family played the game and unfortunately my luck had changed.  In this game, I wasn't able to roll one six.  I never got one man out of home before the game was over.

If you flip a coin and it lands on heads 20 times in a row, the chances of it landing on heads on the 21^st flip is still 50%.  Unlike investing, with flipping a coin, the chances of lading on heads or tails is always 50%.  It is common to experience long winning or losing streaks, but your chances are always 50%.  Trading is different in that you can win more than 50% of your trades.  Our overall average is around 65%, but in the past 16 months we have seen some months better than 80%. 

In August, our equity trading accuracy dropped below 30%.  It felt like we couldn't buy a positive equity trade.  There are more reasons for this besides just statistics, but probabilities do play a big role in return distribution.  This is one of the reasons that we trade so many different asset classes. 

Our fixed income models had another impressive month, helping to offset our difficult month trading equities.  Month-to-date, we are still a little shy of 50% with our equity trading accuracy, but our distribution is starting to skew back to the positive side of our historical averages. 

Below is a performance summary for the indices we track and benchmark our portfolios to:    

Index Advantage:

As explained above, we experienced a larger than normal loss for the month with the majority of our trades experiencing losses.    

For the month, this pillar gained -9.94. 

Strategic Balance:

We also experienced a small loss trading U.S. sectors and international markets for the month.  Our overall investment exposure remained low and thus our losses were muted.      

For the month, this pillar earned -0.61.      

Dynamic Income:

This makes our 5th winning month in a row for this important diversifying allocation.  September is also showing impressive gains currently leading all investment allocations. 

For the month, this pillar earned 1.08.

Our portfolios are built using varying distributions to the strategic allocations discussed above.  To view detailed performance and risk statistics information about our investment portfolios for the month, please click on the links below: 

• Income Builder Portfolio
• The Guardian Portfolio 
• Harmony Plus Portfolio
• The Expedition Portfolio

If You Are a Client, Don't Be Confused.

Actual management and performance fees are incurred monthly but are deducted from client accounts in the first month of every quarter (January, April, July, and October).  For performance reporting purposes, we deduct fees monthly as they incur and not quarterly, as they are reflected in client statements.  It all washes out in the end, but this may cause your account performance to deviate from our published performance reports on a month-to-month basis.  To be conservative, we also deduct the maximum fees we charge from our performance reports and your actual overall fees paid may be less than our maximum. 

Take My TV Challenge

When I grew up, the only time to watch cartoons was once a week on Saturday morning.  There just wasn't much on TV for kids back then, so we did what most kids did - go outside and play.  Well that was when my dad gave us time from our farm chores to play with our friends.  Remember what your parents used to say when you went outside to play, "Be home by dark."  Ah, those were the good old days.  Now-a-days there are multiple channels for kids to watch.  Some of them are good; Discovery, History Channel, etc.  However, many are bad. 

After much discussion with my wife, we decided to unplug cable TV about two years ago.  I can say today that it has been one of the best family decisions we have made.  It has taught my kids how to entertain themselves and they play with each other and their friends all the time.  Our neighbor's kids are the same age and they don't allow their kids to watch much TV either, so it has been a perfect situation for both of our families. 

In June, we decided to unplug the TV altogether.  I have been getting all my news from the internet for years, so I had no business reason other than entertainment to watch TV.  In Idaho, there are lots of ways to be entertained without watching TV, so staying busy and entertained is not a problem.  I can say for certain that we have grown closer as a family because we simply spend more time together.  In America, fathers spend on average 15 minutes a week talking with their daughters.  I now spend at least an hour a day.  It hasn't been easy missing Monday Night Football or missing my favorite college football team, but it has been one of the most rewarding family decisions we have made. 

I encourage you to take my challenge and try turning off the tube.  If you are like me, you have grown so addicted to TV that you can't simply turn it off.  You'll have to have your cable turned off to kick the habit.  My guess is that the thought of turning off your TV is unimaginable, even scary to you.  I know because I felt the same way.  Sadly, there's no other word for the feeling other than addiction.  Your friends will think you are weird because they can't imagine their life without TV.  I now enjoy watching the expression on peoples face when they find out I don't have a TV.  Now that I have kicked the habit, I actually feel sorry for other people who haven't.

I will make a deal with you if go without watching TV for three months, I will manage your money free of charge for three months (this will apply to new clients only).  If you need help kicking the habit, send me an email and I will talk you down off the cliff.     

Working to grow your wealth,

John M. McClure

President & CEO

ProfitScore Capital Management, Inc.

P.S. If you would like to hire us to help you navigate this difficult bear market, below are three ways to contact us:

• Complete our Private Client Group request form by clicking here http://profitscore.com/clientgroup.aspx and submitting your contact information. (This is the most preferred method.)
• Call us directly at (800) 731-5690.
• Simply send us an email to info @ profitscore.com.

Someone will contact you within 24 hours of receiving your information.