2

Preparing for the Final Phase of the Bull MarketA) 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

Is the Stock Market Over Valued?

3

A) A Look at Valuations and the Fed Cycle

• High 29.9 - 6/1999

• Low 7.0 - 4/1980

• Medial 16.7

• Average 16.4

• Today 18.4/16.1

Source: Bloomberg

You Can Still Find Value4

• Valuations can improve with earnings

• Interest rates still favor equities

• Few alternatives

• Dividend yields higher than bonds

Should We Be Worried About the Fed?5

1. Interest rates impact stock prices 2. Direction of interest rates important

3. Early phase still favors stocks

Source: BCA Research

Stock Returns During Rate Cycles6

• Stocks do well early phase

• Economy/earnings still growing

• M&A activity strong drivers

• Stock buybacks - corporations

flush with case

Drivers of This Bull Market7

• Fed created liquidity

• Stock buybacks • M&A activity

• Central Bank purchases

Source: Bloomberg

Bull Markets Don’t Die of Old Age 8

collapse

Source: Bloomberg

(Fed usually kills the bull)

Market Rotations During Final Phase 9

๏ Sector rotation changes

๏ Sectors perform differently during final phase

๏ Markets become sector specific

๏ Fewer companies participate

The Impact of Fed Cycles on Sector Returns10

• As economic cycle matures sectors become more important

• Returns begin to concentrate

• Key is to be in right sectors

Source: Fidelity Capital Markets

Sector Specifics: Energy11

• Energy best sector

after fed tightens

• Cheapest sector

based on valuations

• Selling at recession

levels

Source: Fidelity Capital Markets

Sector Specifics: Technology12

• 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

13

• 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

14The Impact on the Business Cycle on Sector & Asset Class Returns

Source: Fidelity Capital Markets

• End of cycle consumer spending

• Staples more predictable

• Investors shift toward predictability

• Managers become more conservative

15

• 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 widenSource: Fidelity Capital Markets

Late-Cycle Asset Class Performance, 1950-2010

What Does Well During Final Phase?

Why Business Cycles Matter16

History of Bear Markets - For StocksBear Market Loss (in %) Lasted (in months) Start Date End Date

1876 -34.09 15 3/31/1876 6/30/1877

1893 -25.17 7 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 3 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

• Don’t have to be perfect market

timer to avoid pain

The Case for Active Management & Why Cycles Matter

17

• Nearly every recession has led to a

bear market

• Very few exceptions last 100 years

• Recessions are easy to spot

• LEI’s give advance warning

Source: Bloomberg

18The Case for Active Management & Why Cycles Matter

• 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

outside of cashSource: Bloomberg

20

The Case for Active Management & Why Cycles Matter

• 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?

Source: Advisor Perspectives

21The Case for Active Management & Why Cycles Matter

• Most perceive the bond market as safe

• During 1970s, bond funds lost half of their value

• Even popular UST bond ETFs can suffer sharp declines

over short periods as 2013’s “Taper Tatrum”

Source: Bloomberg Source: Bloomberg

The Case for Active Management & Why Cycles Matter

22

• During recessions and bear markets,

cash/bonds out perform

• Stock allocation becomes more defensive

• Don’t want to be completely out of stocks

• Quality companies raise their dividends

Why Risk Management Is Important23

• Minimize drawdowns

• Being defensive preserves

capital

• Allows you take advantage

of opportunities

Risk Management and Diversification 2007- 2009 Bear Market

24

Market Top 10/1/2007 Market Bottom 3/9/2009Asset 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 Don’t Want to Be Out of Stocks25

Source: Fidelity Capital Markets

Active Management vs. Market Timing26

Source: Fidelity Capital Markets

The Case for Blue Chips Long-Term Coca Cola27

2007

2008

2009

2015

$0.68

$0.76

$0.82

$1.42

{ }+129%+32.3%

Dividends per shareSource: Bloomberg

Preparing for the Top28

• 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

”Clear the Mechanism”31

Monitoring Recession Risk - LEI’s Less Volatile Than Market

32

• LEI’s great noise filter

• Consistently peaked

well before stock

market / recession

• Filters facts from fictionSource: Bloomberg

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

Bull Markets Are Born on Pessimism34

August 1979

Source: Bloomberg Source: Bloomberg

In the 2000s banks were encouraging homeowners to use their homes as ATMs with “NIJA” loans

35

Widespread Fear and Panic is Associated With Bottoms, Not Tops

36

“The End of the Financial World as We Know It” - New York Times (01.03.2009)

“US Bankrupt, Dow Jones Closes at 6 Year Low” - The Market Oracle (02.20.2009)

“Market Crisis ‘Will Happen Again’” - BBC News (02.20.2009)

“World Financial Crisis ‘Not Over’” - BBC News (10.08.2009)

“This Recession Just Became a Depression.” - The Telegraph (10.23.2009)

“Bernanke Has Thrown in Towel on Economy” - CNN Money (08.10.2011)

“The End of Europe” - TIME (08.11.2011)

“Market Turmoil Heralds More Global Gloom.”

“This Time, It Really Is Different” - New York Times (10.10.2011)

2009 2011

Current Market Sentiment is Certainly Not Euphoric37

“We’re 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)

The Nature of Bull Market Tops & Recessions38

• Fewer shares reaching new highs

• Before the top many stocks begin to roll over

• Begins usually small-mid cap stocks

Bull Market Top Day

% Stocks @ New Highs

09/03/1929 2.30%03/10/1937 6.05%05/29/1946 8.59%04/06/1956 5.32%01/05/1960 1.60%12/13/1961 3.56%02/09/1966 9.66%12/03/1968 9.43%01/11/1973 5.30%09/21/1976 10.97%04/27/1981 7.09%08/25/1987 6.23%07/16/1990 5.35%01/14/2000 3.54%10/09/2007 10.77%

Average 6.38%

Source: Lowry Research Co.

The Nature of Bull Market Tops & Recessions 39

• At the top more stocks decline • Latest correction still positive

Source: Bloomberg

Philadelphia Fed State Coincident Indexes40

Source: Philadelphia Fed

41

Philadelphia Fed State Coincident Indexes

Source: Philadelphia Fed

• September report showed 41 states with increasing economic activity over the past month with six showing decreasing activity and three were stable

Strategies to Mitigate Risks in a Mature Bull Market & Economic Expansion

42

…DIVERSIFICATION!

The number one strategy to improve returns in the later phase of a bull market in one word…

Portfolio Diversification - Mitigate Risk / Returns43

Source: StockCharts

NYSE - Advance-Decline Issues Index

• Indexes hitting new highs

• AD line - declining

• Fewer stocks participate

• Fewer sectors

• ETF’s work well towards market tops

Falling Behind44

• Track indices or

get left behind

• As of late October,

S&P 500 down 4%

• NASDAQ down

4%, average stock

down 31%

% Off 52 Week HighIndex 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 10/26/2015Source: Bloomberg

“Only when the tide goes out do you discover who’s been swimming naked.” - Warren Buffett

45

• Single stock portfolios are more

volatile in final phase

• Market volatility picks up when

monetary policy tightens

• Diversification reduces risk & volatility

Company Specific RiskMarket Risk

Source: Fidelity Capital Markets

Sector Allocation Can Also Help Mitigate Market Risk46

Materials 12

Consumer Discretionary 11

Industrials 11

Financials 11

Health Care 9

Energy 7

Telecommunications 7

Consumer Staples 5

Utilities 5

Overall Market 6

Number of Bear Markets, 1962-2010• Tilting portfolios to more defensive

sectors in the later innings of a bull market such as the utilities, consumer staples, and telecom 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

Summary and Conclusion47

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

Summary and Conclusion48

C) Case for Active Management & Risk Control • Bear markets dangerous investing health • Usually caused by recessions • Can’t 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 LEI’s & monitoring market breath

Summary and Conclusion49

E) Strategies to Mitigate Risks in a Mature Bull Market • Diversification • Sector positioning

50Dow Jones Industrials (1920 - Present)

51

Break