American Investment Services, Inc.

Disciplined, Diversified, & Cost Effective

June 2008 – Big Bank Fears

On June 26 the share prices for Citigroup and Bank of America, both of which were already testing multi-year lows, tumbled by more than 4 percent. Our high-yield Dow (HYD) model, which holds both stocks and declined sharply as a result, will buy more of these shares if they continue to provide a high relative yield. It is instructive to understand the nature of this episode as it serves to clearly distinguish between rational investing and the speculation in which much of Wall Street seems hopelessly engaged.

The media instantly pointed to the recommendations of a single analyst as the cause of the sell-off. A Goldman Sachs stock analyst recommended that investors sell Citigroup short, and predicted that Citi would write down an additional $8.9 billion, largely in collateralized debt obligations, and also surmised that the bank would cut its dividend for the second time in a year.

It is nearly impossible to track the success of analysts’ recommendations, because they are rarely defined clearly (“neutral”, “outperform” and other mysterious labels are common), so it is nearly impossible to discern established times to buy or sell. In the case at hand the analyst saw fit to move Citigroup to his “Americas conviction sell” list (we’re not sure what that means but apparently this time they really mean it). For an individual investor this sort of “drive-by” commentary is useless in gauging how much of a particular security to hold in the context of a comprehensive portfolio strategy.

Our HYD approach, on the other hand, is unequivocal. Each month the model provides explicit orders to buy, sell, or hold securities, in proportions that individual investors can easily apply to their portfolios. Most importantly, the model relies on data that is not subject to interpretation: a market price and a cash dividend (rather than projections), in order to gauge a stock’s relative risk (and hence its potential return).

Bank of America and Citigroup comprise roughly 24 percent of the HYD model. But for many of our PAM clients’ portfolios, our broader asset allocation strategy leaves many with roughly four percent of their total holdings allocated to these two stocks. Our target allocations for U.S. large cap value stocks generally range between 15 percent (for conservative investors) and 30 percent (for aggressive investors), and we fulfi ll this allocation with both the HYD model and large cap value index-type products.

The model’s discipline has trumped the analysts’ predictions on numerous occasions. To cite the case of another bank stock, in the summer of 2002, J.P. Morgan’s share price fell to $20 as analysts fretted over shareholder lawsuits and investigations regarding the bank’s role in the Enron debacle. The model nevertheless continued buying methodically as the share price subsequently bottomed out around $15.50 per share in October of that year.

Over time the price rebounded and the model began selling JPM and was completely sold out in April 2007, with shares trading as high as $50 per share. No one knows whether Citigroup will follow the same course, but we are confident that it can. The HYD model has held both winners and losers but the winners have far outgained the losers.

Also in This Issue:

A Reader Inquires
Portfolio Rebalancing: Keep Your Hands on the Wheel
The Cost of Caring for Elderly Parents
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield
Asset Class Investment Vehicles