2

Preparing for the Final Phase of the Bull Market

A) A Look at Valuations & Fed Rate Cycles
B) Investing for the Final Phase of the Expansion & Bull Market
C) The Case for Active Management
D) Preparing for the Top: What Are the Signs?
E) Strategies to Mitigate Risks in a Mature Bull Market

A) A Look at Valuations and the Fed Cycle

Is the Stock Market Over Valued?

Source: Bloomberg

High 29.9 - 6/1999

Low 7.0 - 4/1980

Medial 16.7

Average 16.4

Today 18.4/16.1

You Can Still Find Value

Valuations can improve with earnings
Interest rates still favor equities
Few alternatives
Dividend yields higher than bonds

Should We Be Worried About the Fed?

Source: BCA Research

1. Interest rates impact stock prices

2. Direction of interest rates important
3. Early phase still favors stocks

Stock Returns During Rate Cycles

Stocks do well early phase
Economy/earnings still growing
M&A activity strong drivers
Stock buybacks - corporations
flush with case

Drivers of This Bull Market

Fed created liquidity
Stock buybacks

M&A activity
Central Bank purchases

Source: Bloomberg

Bull Markets Dont Die of Old Age

(Fed usually kills the bull)

collapse

Source: Bloomberg

Market Rotations During Final Phase

Sector rotation changes

Sectors perform differently during final phase
Markets become sector specific
Fewer companies participate

The Impact of Fed Cycles on Sector Returns

As economic cycle matures sectors become more important

Returns begin to concentrate
Key is to be in right sectors

Source: Fidelity Capital Markets

10

Sector Specifics: Energy

Energy best sector
after fed tightens

Cheapest sector
based on valuations

Selling at recession
levels

Source: Fidelity Capital Markets

11

Sector Specifics: Technology

12

Technology second best sector

Sector flush with cash
Strong balance sheet
More M&A activity

Source: Fidelity Capital Markets

The Impact on the Business Cycle on

Sector & Asset Class Returns
Late stage cycle commodity prices rise
Materials/energy do well
Consumer discretionary does poorly
Gradual shift to defensive sectors as
business cycle ages

Source: Fidelity Capital Markets

13

The Impact on the Business Cycle on

Sector & Asset Class Returns
End of cycle consumer spending
Staples more predictable
Investors shift toward predictability
Managers become more conservative

Source: Fidelity Capital Markets

14

What Does Well During Final Phase?

Late-Cycle Asset Class Performance, 1950-2010

Stocks still best performing asset

class early & late stages

As Fed cycle expands, stocks

begin to lose advantage

Cash/bonds become attractive

final innings

Mixed Asset Class Performance

Monetary policy becomes restrictive

Earnings under pressure
Credit spreads widen
Source: Fidelity Capital Markets

15

Why Business Cycles Matter

16

History of Bear Markets - For Stocks

Bear Market

Loss (in %)

Lasted (in months)

Start Date

End Date

1876

-34.09

15

3/31/1876

6/30/1877

1893

-25.17

1/31/1893

8/31/1893

1903

-25.96

13

9/30/1902

10/31/1903

1907

-34.06

14

9/30/1906

11/30/1907

1913

-25.25

24

10/31/1912

10/31/1914

1917

-27.90

13

11/30/1916

12/31/1917

1920

-26.37

20

10/31/1919

6/30/1921

1931

-83.66

34

8/31/1929

6/30/1932

1937

-49.82

13

2/28/1937

3/31/1938

1969

-29.18

19

11/30/1968

6/30/1970

1973

-42.72

21

12/31/1972

9/30/1974

1987

-29.59

8/31/1987

11/30/1987

2001

-44.73

25

8/31/2000

9/30/2002

2008

-50.95

16

10/31/2007

2/28/2009

Median bear market

-31.83

16

Avg. bear market

-37.82

17

Source: United Capital

Bear markets can be hazardous

Recessions/bear markets can

disrupt long-term plans

Dont have to be perfect market

timer to avoid pain

17

The Case for Active Management

& Why Cycles Matter

Nearly every recession has led to a

bear market

Source: Bloomberg

Very few exceptions last 100 years

Recessions are easy to spot

LEIs give advance warning

The Case for Active Management

& Why Cycles Matter

18

The last two bear

markets have been
devastating, wiping
out half of the
market capitalization
of the S&P 500

Source: Bloomberg

The Case for Active Management

& Why Cycles Matter

19

2000-2002 bear market

offset by real estate

2007-2009 bear market

hit every asset class

Very few places to hide

Source: Bloomberg

outside of cash

The Case for Active Management

& Why Cycles Matter

20

Source: Advisor Perspectives

Most wealth managers preach

buy and hold as stocks come
back after a bear market

What if your investment horizon

is 10 years, or 5 years?

The Case for Active Management

& Why Cycles Matter

Source: Bloomberg

Most perceive the bond market as safe

During 1970s, bond funds lost half of their value

21

Source: Bloomberg

Even popular UST bond ETFs can suffer sharp declines

over short periods as 2013s Taper Tatrum

22

The Case for Active Management

& Why Cycles Matter
During recessions and bear markets,
cash/bonds out perform

Stock allocation becomes more defensive

Dont want to be completely out of stocks
Quality companies raise their dividends

Why Risk Management Is Important

Minimize drawdowns
Being defensive preserves
capital

Allows you take advantage

of opportunities

23

24

Risk Management and Diversification

2007- 2009 Bear Market
Market Top 10/1/2007

Market Bottom 3/9/2009

Asset Class

Weight

Market Value

Asset Class

Gain/Loss

Market Value

Bonds

50%

$500,000

Bonds

24%

$619,650

Stocks

40%

$400,000

Stocks

55%

$181,320

Cash

10%

$100,000

Cash

2%

$102,150

Total

100%

$1,000,000

Total

-9.69%

$903,120

Note: Bonds represented by Merrill Lynch UST Long-Term Total Return Index. Stocks
represented by S&P 500. Cash represented by Fidelity UST Money Market.

Why You Dont Want to Be Out of Stocks

Source: Fidelity Capital Markets

25

Active Management vs. Market Timing

Source: Fidelity Capital Markets

26

27

The Case for Blue Chips Long-Term Coca Cola

+32.3%

Source: Bloomberg

2007

$0.68

2008

$0.76

2009

$0.82

2015

$1.42

Dividends per share

+129%

28

Preparing for the Top

What are the signposts

Strategies to mitigate risk

Source: Bloomberg

Remaining Objective in Big Picture Macro Assessment

- Tune Out the News!

29

Remaining Objective in Big Picture Macro Assessment

- Tune Out the News!

30

31

Clear the Mechanism

Monitoring Recession Risk LEIs Less Volatile Than Market

32

LEIs great noise filter

Consistently peaked
well before stock
market / recession
Source: Bloomberg

Filters facts from fiction

Monitoring Recession Risk Labor Market Deterioration

33

Labor market deteriorates

with recession

Before a recession begins

Unemployment rate >
7.5% y.o.y.
Weekly jobless claims >
15% y.o.y.
Source: Bloomberg

34

Bull Markets Are Born on Pessimism

August 1979

Source: Bloomberg

Source: Bloomberg

35

In the 2000s banks were encouraging homeowners to use

their homes as ATMs with NIJA loans

Widespread Fear and Panic is Associated

With Bottoms, Not Tops

2009

2011

The End of the Financial World as We Know It

Bernanke Has Thrown in Towel on Economy

- New York Times (01.03.2009)

- CNN Money (08.10.2011)

US Bankrupt, Dow Jones Closes at 6 Year Low

The End of Europe

- The Market Oracle (02.20.2009)

- TIME (08.11.2011)

Market Crisis Will Happen Again

Market Turmoil Heralds More Global Gloom.

- BBC News (02.20.2009)

This Time, It Really Is Different

World Financial Crisis Not Over

- New York Times (10.10.2011)

- BBC News (10.08.2009)

This Recession Just Became a Depression.

- The Telegraph (10.23.2009)

36

37

Current Market Sentiment is Certainly Not Euphoric

Were in a Bear Market: Carter Worth
- CNBC (09.29.2015)

Are You Ready for the Next Bear Market?

- Informed Broker (09.30.2015)

Are Stocks Headed for a Bear Market?

- Forbes (09.30.2015)

Bear Claw Will Strike the Market Again: Louise Yamada

- CNBC (10.16.2015)

38

The Nature of Bull Market Tops & Recessions

Bull Market
Top Day

% Stocks @
New Highs

09/03/1929
03/10/1937
05/29/1946
04/06/1956
01/05/1960
12/13/1961
02/09/1966
12/03/1968
01/11/1973
09/21/1976
04/27/1981
08/25/1987
07/16/1990
01/14/2000
10/09/2007
Average

2.30%
6.05%
8.59%
5.32%
1.60%
3.56%
9.66%
9.43%
5.30%
10.97%
7.09%
6.23%
5.35%
3.54%
10.77%
6.38%

Source: Lowry Research Co.

Fewer shares reaching new highs

Before the top many stocks begin to roll over
Begins usually small-mid cap stocks

The Nature of Bull Market Tops & Recessions

At the top more stocks decline

Latest correction still positive

Source: Bloomberg

39

40

Philadelphia Fed State Coincident Indexes

Source: Philadelphia Fed

41

Philadelphia Fed State Coincident Indexes

September report showed 41 states

with increasing economic activity
over the past month with six
showing decreasing activity and
three were stable

Source: Philadelphia Fed

42

Strategies to Mitigate Risks in a Mature

Bull Market & Economic Expansion
The number one strategy to improve returns in the later phase of a bull market in one word

DIVERSIFICATION!

43

Portfolio Diversification - Mitigate Risk / Returns

NYSE - Advance-Decline Issues Index

Source: StockCharts

Indexes hitting new highs

AD line - declining
Fewer stocks participate
Fewer sectors
ETFs work well towards market tops

44

Falling Behind
% Off 52 Week High
Index

Average

Median

Index

S&P 1500

(19.32)

(15.29)

(3.34)

S&P 500

(16.09)

(12.75)

(2.98)

S&P 400

(18.53)

(15.12)

(7.36)

S&P 600

(22.63)

(18.39)

(6.94)

Dow

(11.50)

(8.73)

(3.97)

NASDAQ

(30.85)

(26.84)

(3.77)

Russell 2000

(27.02)

(22.47)

(10.53)

Russell 3000

(24.02)

(19.09)

(4.02)

As of 10/26/2015
Source: Bloomberg

Track indices or
get left behind

As of late October,
S&P 500 down 4%

NASDAQ down
4%, average stock
down 31%

Only when the tide goes out do you discover whos

been swimming naked. - Warren Buffett
Market Risk

Company Specific Risk

Source: Fidelity Capital Markets

45

Single stock portfolios are more

volatile in final phase

Market volatility picks up when

monetary policy tightens

Diversification reduces risk & volatility

46

Sector Allocation Can Also Help Mitigate Market Risk

Number of Bear Markets, 1962-2010

Tilting portfolios to more defensive

Materials

12

sectors in the later innings of a bull

Consumer Discretionary

11

market such as the utilities,

Industrials

11

consumer staples, and telecom

Financials

11

Health Care

Energy

Telecommunications

Consumer Staples

Utilities

Overall Market

sectors can help reduce overall risk

One other added benefit of allocating

more resources to these sectors is
the pickup in income as they often
pay higher market dividend yields

Source: Fidelity Capital Markets

47

Summary and Conclusion

A) Valuations & Fed Cycles
Valuations not cheap
Earnings growth picks up as cycle ages

B) Investing During Final Phase

Top sectors energy & technology
Late stage commodities & staples
Cash & bonds - help to mitigate risk

48

Summary and Conclusion

C) Case for Active Management & Risk Control

Bear markets dangerous investing health

Usually caused by recessions
Cant perfectly time market
But can mitigate risk
D) Preparing for the Top - Signposts & Strategies

Clear the mechanism - assessing recession risk

Monitoring sentiment for euphoria
Watching LEIs & monitoring market breath

49

Summary and Conclusion

E) Strategies to Mitigate Risks in a Mature Bull Market

Diversification
Sector positioning

Dow Jones Industrials (1920 - Present)

50

51

Break