Market Timing Important Again 9 -3 -2009 Porter

Market Timing: Important Again 9 -3 -2009, Porter Library, Westlake, Oh Dr. Gary J. Harloff, Ph. D. Harloff Capital Management (HCM) Registered Investment Advisory Firm, 1994 Monthly newsletter: The Intelligent Fund Investor, 1993 795 Sharon Dr. , St. 226, Westlake, Oh 44145 Meetings by appointment 440 -871 -7278, www. harloffcapital. com

Disclaimers z. Educational, not investment advice znot actual performance zpast performance does not insure future performance zthought to be accurate and not guaranteed

Educational talk outline z. Harloff background & what he does z. Why market timing z. Market timing overview z. Business cycle and market timing z. Technical Analysis indicators: Pro & Con z. Example of HCM’s advanced technology z. Current market conditions z. Summary and conclusions

Harloff background z Specialist in tactical portfolio management: significant original investment research, 1970 -2009 z regional and national contests in 1980 s, 1990 s z authored “Dynamic Asset Allocation: Beyond Buy and Hold”, 1 -1998 Stocks & Commodities (on web site) z author book : Active Investing Wealth-Management for High Net Worth Individuals, 2007, 2008 z Ph. D. Aero. Space Engineer, 27 years, 100+ papers/ reports; 2 international papers, . . rocket science z 1970 jet engine coworker in S. Florida said “nobody can model the stock market”- personal challenge

Harloff does z Tactical portfolio management, fee-based z Time markets, countries, sectors, funds, ETF’s z Alternate investment for accredited investors z Monthly timing newsletter for self managers: “The Intelligent Fund Investor”: time funds, S&P 500, bond, & gold, examples z Investment speaker at AAII chapters: Louisville Ky, St. Louis, Mo, and Fl West Coast, Fl Central, and Fl South. West: Sept. 2009 z Post Modern Quantitative Analysis: not TA

Average investor compound return is 9. 24%/year LESS THAN S&P 500 compound return %/year* BEFORE COMMISSIONS & FEES 19841997 Avg. investor, % S&P 500, % Avg. -S&P 500 19841998 19842000 19842002 19872007 6. 7 7. 25 5. 32 2. 57 4. 5 1. 87 17. 1 17. 90 16. 29 12. 22 11. 8 8. 35 -10. 4 -10. 65 -10. 97 -7. 3 -6. 48 -9. 65 1988 2008 *source: Dalbar Inc. Financial Services of Boston, Ma. , Quantitative Analysis of Investor Behavior Study 1997, 1998, 2000, 2003, 2008, 2009 updates

Professional Money Managers z 5 to 10% beat S&P 500 in any given year z. Question- who do you want managing your portfolio?

Investing is hard because: z Markets change z change inconsistent with buy-and-hold z companies fail over time (GM stock => zero) z capital leadership shifting from US to Asia z manufacturing already exported from US z service jobs being exported from US z new industries born/die every 3 years z Who makes ongoing asset allocation changes for you?

Why market timing? z. Bear markets: investor losses $ and faith in buy-and-hold strategy/advisor z. When buy-and-hold performs there is less interest in market timing z. Bull market asset allocation different than bear market asset allocation z. Need for ongoing asset allocation z. Business cycle aspect important

Market timing overview z Old as Dow theory: buy (sell) when transportation and industrials are both going up (down) z Buy/sell = timing; opposite of buy-and-hold z Big question is what to buy/sell and when z Most planners/brokers: timing is a waste of time z Most mutual funds have trading constraints z ETF’s- no limitations: will overtake mutual funds

Market timing, cont’d z Form of risk management (not insurance) z No single method or product; many approaches z Time consuming, sometimes works/doesn’t z Not taught in MBA programs at university z Not taught to CFP/CFA pass-exam designees z Planners/brokers are generalists and not portfolio managers; mostly buy-and-hold diversified portfolios for long term. No market timing. Product sales may lead to conflict of interest.

Timing is all about: z. Buy low and sell high zidentifying what to buy/sell when zinvest in up markets and not (or short) in down markets zinvest in good sectors, indexes, countries when they have profit potential and not when they don’t

Markets z. Don’t have laws of motion. . . not predictable z. Quantitative systems of HCM z. Many try to build “logical systems” z. Many look for patterns to repeat z. Technical analysis is used by many

Timing is advanced technology z Many planners/brokers: timing is irrelevant z Investors feel the pain of buy-and-hold during bear markets. z May lose faith in buy-and-hold stay-thecourse advice z Many investors wonder if advisor knows anything more than investor knows z Recent bear market losses, so timing is back in favor as an investment strategy

One approach: Technical Analysis (TA) indicators, pros & cons z Price higher/lower than 20 week ave (MA) z 21 day moving average, 30 week MA, etc. z What MA or EMA to use when? z momentum = price (t)/price (t-dt) z Relative strength index, RSI= [p(t) / P(t-dt)] /[ S&P 500(t) / S&P 500(t-dt)] z The Encyclopedia of Technical Market Indicators, Robert W. Colby, Mc. Graw-Hill, 2003, 820 pg. >100 technical indicators

TA indicators: Pros & Cons, cont’d z Qualitative: people read same chart differently z Many use TA, ubiquitous, on-line graphs z Sold in many cities through infomercials z Fun: lots of indicators to discuss and review z Graphics appealing and requires judgement; beauty in the eye of the beholder z Indicators may not work for different markets, sectors, indexes, (ex. gold or bonds)

TA indicators: Pros & Cons, cont’d z Usually relative, rarely absolute: may ride down when market goes down z Empirical: don’t know when TA will stop working z Gives hope. . . . that individual can compete with professions with much more sophisticated analyses and computer power z Individual up against Ph. D. ’s, banks, hedge funds z To win, need better tools or intuition than banks! z Doesn’t account for business cycle concepts

HCM gave up on TA as an investment system z In early 1990’s Harloff found computerized back-testing of TA indicators not profitable z Graphs different than back-testing indicators z Indicator overload: one says buy another sell z TA: may lead to false sense of capability z One index illustrative even if it lags

Vix index: 11 month delayed risk surrogate, recession started Dec. 2007

Other strategies z Buy-and-hold a diversified portfolio: usually cite MPT: 1952 method (Nobel prize) z MPT all in all for planners/brokers z Some count Morningstars: based on 3 year averages=> not profitable in bear market z 60/40, 40/60 equity/bond ratio (buy-hold) z Age dependent: older- buy more bonds z Endowment practices z Business cycle concepts

Buy-hold a diversified portfolio Nobel prize method- problems z 1952 technology called “modern”: pre computer z Markowitz in 1952 developed “MPT” z MPT (buy-hold)=> not useful in bear market z Non-correlated assets supposed to lower portfolio risk, but don’t, assets highly correlated today z Statistics input into computer programs are assumed constant. . . . but aren’t

Return vs. Risk is time dependent (HCM analysis)

60/40, 40/60. . . ratio z Many retail advisors: 60/40 equity/bond ratio w/o regard to market conditions z May be optimum ratio if correctly forecast: (1) market return vs. risk, & (2) risk tolerance z 60/40 not optimal in bear or bull market z Market return vs. risk always changes z Ivy league endowments use 86/14, see next slide

Ivy League endowment allocation 86/14 (source Barrons, 6 -29 -09)

Market timing & business cycle (BC) sector rotation (source: S. Stovall’s S&P’s Guide to Sector Rotation)

Sector rotation model

Does sector rotation outperform business cycle investing? Relative performance from 1948 -2006 (source: J. Stangl, B. Jacobsen, N. Visaltanachoti, Massey U. , Dept of Commerce) z Optimal sector rotation (20/20 hindsight) timing business-cycles stages earned 2. 01% alpha z Apparent out performance is quickly dissipated without hindsight and transaction fees z Alternate strategy switch to cash as business cycle enters a recession: superior returns to sector rotation z Market timing invests fully for all periods except the first period of a recession when only cash is held. z The terminal value for market timing is slightly higher than sector rotation at $1, 142 and $1, 094 respectively.

Does sector rotation outperform business cycle investing? Relative performance from 1948 -2006 (cont’d) z Overall, market timing (0. 18) also outperforms sector rotation (0. 15) from a Sharpe ratio perspective. z Market timing advantage: forecast 1 business-cycle stage rather than 5 stages & lower transaction fees z Market timing: better diversification than sector rotation. Even for an investor with the ability to correctly time business cycles, a simple market-timing strategy would be optimal to sector rotation. z Conclusion: contrary to conventional market wisdom, rotating sectors over business cycles is not an optimal investment strategy and question the widespread acceptance of sector rotation.

Business Cycle Timing: source: (J. Stangl, B. Jacobsen, N. Visaltanachoti, Massey U. , Dept of Commerce paper)

Harloff & Eacott business cycle study z “U. S. Business Cycle Math Quantification”, Harloff and Eacott z Need reliable real time analysis as to when recession starts, NBER often 12 months late z Analyzed 32 business cycles z Developed new equations for expansion and recession cycles

Used NBER dates and duration of 32 complete expansion and recession from 1854 to 2001 z. Home-work for later BC math modeling z Free paper on web site, www. harloffcapital. com/articles. html zand zwww. scribd. com/doc. . . /US-Business-Cycle -Math-Quantification

Harloff BC math model: system of 9 ODE’s, cycles about 5 years, preliminary

HCM math model of BC z. Looking for unpaid researcher to join me in math modeling b. c. (8 -16 system of stiff ODE’s). z. HCM has running computer program, call me! z. Need to be able to solve stiff system of ODE’s

HCM 3 new quantitative systems (not TA) z Significant resources expensed over many years by Ph. D. : HVI, trade, and vector. z Quantitative calculations and statistics to manage portfolios z Universal indexes, absolute momentum z Compute, rank, sort funds y 1) Harloff Value Index (HVI) system (>16 yrs) y 2) Vector system (> 16 years) y 3) Trade system (several years)

Current Market Conditions z. The Intelligent Fund Investor monthly newsletter, 8 -21 -09 issue zemploys Harloff Value Index (HVI) for all funds and indexes

The Intelligent Fund Investor Newsletter, employs HVI; Current Market Conditions z. Performance of portfolios and timing calls z. History of portfolios and trades z. Timing S&P 500, NDX, gold, bonds z. HVI used to select portfolios z. Example how to use newsletter analysis

The Intelligent Fund Investor, 8 -21 -09 Portfolio Performance_ ________YTD, % Ave of three portfolios (-11. 54% 2008). . . . 47. 18 Dynamic Frontier portf. ( -3. 20% 2008). . 26. 61 No-Load Agg Gr portf. ( -0. 45% 2008). . 56. 13 Rydex portfolio. . . . (-30. 97% 2008). . 58. 81 S&P 500 index. 2009. . . (-38. 49% 2008). . 13. 60 NDX 100 index. 2009. . . (-41. 89% 2008). . . 35. 17

The Intelligent Fund Investor timing signals, 8 -21 -09 Market Timing, long term gain, % S&P 500: 08/21/09 1026. 13 33. 51 last signal(e): buy 03/20/09 768. 54 NDX 100: 08/21/09 1637. 78 37. 96 last signal(e): buy 03/20/09 1187. 18 Gold, XAU: 08/21/09 147. 37 -1. 42 last signal(e): buy 07/24/09 149. 50 US 10 yr bnd yield %: 08/21/09 3. 56 0. 00 last yield signal(e): sell 08/21/09 3. 56

The Intelligent Fund Investor absolute momentum, 8 -21 -09 Table 3, HVI, change, nav, 4 wk % change, 13 wk % change, risk adjusted, HVI/risk, 13 wk/risk, risk level (high, medium, low), and buy/sell 8 -21 -09 R-F obj HVI %ch nav g sr sf i i g i i i g sf 544. 464. 411. 309. 306. 293. 282. 269. 260. 258. 256. 252. 248. 243. 0. -9. -4. -10. -5. -8. -9. -13. -9. -7. -9. -8. -11. -9. -5. 6. 94 12. 86 6. 83 22. 68 64. 30 11. 48 24. 51 29. 20 19. 81 18. 77 14. 57 18. 70 27. 63 23. 88 22. 25 45. 99 4 wk 13 w rsk adj HVI rsk 13 w rsk 36. 9 23. 8 23. 5 12. 3 15. 6 12. 2 14. 6 10. 9 14. 6 10. 5 9. 6 9. 5 9. 7 11. 7 10. 9 15. 2 43. 1 42. 6 37. 1 41. 7 28. 7 45. 3 45. 7 27. 3 34. 6 32. 2 31. 4 32. 5 30. 8 26. 6 19. 9 7. 7 7. 9 4. 7 2. 9 3. 2 2. 9 2. 1 3. 3 4. 6 1. 9 2. 2 2. 0 2. 4 2. 2 3. 8 4. 6 1. 8 3. 9 -0. 1 2. 6 -0. 7 1. 6 -0. 6 1. 6 0. 5 -0. 1 0. 0 0. 9 0. 8 2. 8 1. 4 1. 1 1. 7 2. 1 1. 9 2. 1 2. 8 1. 7 1. 2 2. 7 2. 3 2. 4 2. 0 2. 2 1. 2 5. 6 5. 4 7. 9 14. 4 8. 9 15. 8 21. 4 8. 5 6. 0 17. 9 14. 5 15. 9 12. 8 12. 3 5. 2 rsk b/ lvl s INDEX FUNDS 1 2 3 7 8 9 10 11 13 14 15 16 17 18 19 20 Pro. Funds INV: Banks Ultra Pro. Funds INV: Ultra. Sector Pro. Funds INV: Ultra Mid. Ca Rydex Large. Cap Value-H Pro. Funds INV: Ultra Small Rydex Small. Cap Value Pro. Funds INV: Basic Mater Rydex Real Estate-H Rydex Titan 500 -H Rydex Long Dynamic Dow 3 Pro. Funds INV: Ultra Bull/ Rydex Mid. Cap Value-H Pro. Funds INV: Ultra Secto Rydex INV: Banking/242 BKPIX REPIX FNPIX UMPIX RYZAX UAPIX RYAZX BMPIX RYHRX RYTNX RYCVX UDPIX ULPIX RYAVX IDPIX RYKIX h h h h b b b b

Current market conditions, cont’d, S&P 500 buy signal

The Intelligent Fund Investor Monthly Newsletter: 3 Portfolios, 8 -21 -09 may differ from managed account portfolios Dynamic Frontier , Ticker % Direx Latin Am, DXZLX 34 Rydex Sm. Cp Vlu, RYAZX 33 Rydex Titan, RYTNX 33 No-load, Aggressive, Ticker % Pro. Fnds U Bank, BKPIX 34 Pro. Fnds U Real Est, RYPIX 33 Pro. Fnds U Md. Cp, UMPIX 33 Rydex Portfolio, Ticker Rydex Lg. Cp Vl, RYZAX Rydex Sm Cp Vl, RYAZX Rydex Real Est, RYHRX % 34 33 33

Optimal timing with HCM’s “trade” system z. Trade: single system that times S&P 500, oil, bonds, . . All funds z. Trade computes optimal timing for each fund and index z. Trade system: different signals for each

HCM S&P 500 optimal timing: 167%

HCM Oil optimal timing: 123%

HCM 30 -year yield (inverse bond) optimal timing: 211. %

Summary and conclusions z average individual under-performs S&P 500 by 9. 24% before commissions and fees; may need professional help beyond planner/broker z Market timing needed over full investment cycle z Asset allocation should change with market condition z Business cycle awareness important z MPT isn’t modern or useful in bear market

Summary and conclusions, cont’d z Timing is difficult and opposite of buy-and-hold z TA doesn’t add value when put to computerized back testing test. Graphics are deceptive z “Intelligent Fund Investor” monthly timer newsletter: good performance z Timing illustrated for S&P 500, gold, bonds, funds z Current market conditions: new bull market March 2009. Good areas now are emerging markets, value, commodities, real estate, and banks

Any questions? z Contact me to request an investment talk for your group of 20 or more z Call me if I can help you

Market Timing: Important Again 9 -3 -2009, Porter Library, Westlake, Oh Dr. Gary J. Harloff, Ph. D. Harloff Capital Management (HCM) Registered Investment Advisory Firm, 1994 Monthly newsletter: The Intelligent Fund Investor, 1993 795 Sharon Dr. , St. 226, Westlake, Oh 44145 Meetings by appointment 440 -871 -7278, www. harloffcapital. com