Economic Cycle Page 2. Market Tops and Bottoms Page 7. Secular Cycle Page 9. Market Cycle Page 10. Short-Term Market Timing and Corrections Page 11

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1 Index Economic Cycle Page 2 Market Tops and Bottoms Page 7 Secular Cycle Page 9 Market Cycle Page 10 Short-Term Market Timing and Corrections Page 11 Market Forecasting July 2018 Investor Education Investor Education is Critical to reach your Financial Goals Wealth gives you Freedom and Control of your Life Setup an Auto-Investment Plan to Invest on a Regular Basis in Bull and Bear Markets Create a Diversified Portfolio with the Proper Asset Allocation Purchase Quality Investments Manage your Portfolio Properly PDM Investment Services, LLC A Registered Investment Advisor Corrections and Bear Markets Page 13 Our Market Timing Indicators Page 22 Annual Market Returns Page 26 Rolling Returns Page 27 Expected Returns Page 28 Bubbles and Growth Trends Page 31 Sell in May and Go Away Page 34 Developed World and Slower Growth Page 35 Demographics Total Debt Page 37 Inflation Predictions Page Standish Drive, Troy, Michigan * * info@fginvestor.com For complete disclosure see our website 1

2 The Economic Cycle The economy and stock market go thru repeatable cycles. The cycles consist of recession, recovery, transition, correction and a capital goods phase. Recession Bear Market Recessions come when excess is built in the economy, from commodity spikes, aggressive Fed tightening or extreme valuations. A downturn in economic activity, broadly defined by many economists as at least two consecutive quarters of decline in the nation s gross domestic product. Stocks fall the sharpest in the recession stage. Some of the past recession years were 1980, 1990, 2001, 2002 and In bear markets stocks fall slowly to a 20% or more loss over a 12 to 15 month period. Bear markers come with a contraction in economic growth, and a recession. They are more about changes likely to have lasting impact on corporate earnings and produce recessions. The average market top before a bear market typically lasted six months, giving time for long-term indicators to signal a bear market is coming. Recovery The period in the business cycle after a recession when economic activity picks up. Stocks rise the sharpest in the recovery stage. Some of the past recovery years were 1982, 1991, 2003 and Transition The period in the business cycle after a recovery when the stock market takes a breather and waits for earnings to catch up with stocks. Some of the past transition years were 1984, 1992, 2004 and Correction The period in the business cycle where stocks correct from overvalued. Some of the bear market correction years were 1987, 1998, A correction typically sees a 10% to 20% drop in the S&P 500 and lasts 1 to 3 months. During corrections economic growth is still positive. So long as the global economy does not weaken further and the stock market does not fall to new lows, it is likely just a correction in a bull market. In corrections, stocks typically fall fast and recover faster. If this correction-like behavior of fear and widespread selling activity follows the pattern of previous short-term panics, it s unlikely to lead to a bear market. Past rapid 10% declines saw an average gain of 5% after 10 weeks and 20% after 12 months. October is the start of the strong seasonal period. Capital Goods The final period in the business cycle is where the economy is growing the strongest and inflation is rising. This is the second strongest period in the business cycle for stocks. Some of the past capital goods years were 1985, 1986, 1988, 1989, 1993, 1995, 1997, 1999, 2005, 2006, 2007, Bull and Bear Markets Bull markets are a time period when the stock market is rising, lasting an average of 4.5 years. Bear markets are a time period when stocks fall at least 20%, lasting an average of 1.5 years. The average Bull Market period lasted 8.5 years with an average cumulative total return of 458%. The average Bear Market period lasted 1.3 years with an average cumulative loss of -41%. (First Trust 1926 thru 2015) The 1930 s, 1970 s and 2000 s were secular bear periods. Secular Bull Market A secular bull market is a long upward trend in the stock market lasting around 20 years. Within a secular bull, there are short cyclical bear markets. The last secular bull was from 1983 to Past secular bull markets were from 1922 to 1929, 1943 to 1965, 1983 to 1999 and 2009 to We measure secular bulls starting from the bottom just before the rise that surpasses the previous peak to the new peak before the secular bull ends. Secular bulls typically start when market valuations are at 100 year lows. New secular bulls are not verified until the market surpasses the previous bull market high. 2

3 Secular Bear Market A secular bear market is a long downward trend in the stock market lasting about 15 years. Within a secular bear, there are short cyclical bull markets. The secular bear market that started in 2000 ended in 2009, after 10 years. Cyclical bull markets typically produce returns of 60% to 100% over two to four years. Past secular bear markets were from 1906 to 1921, 1930 to 1942, 1966 to 1982, 2000 to We measure secular bears starting from the peak and ending at the bottom just before the rise. Secular bears typically start when market valuations are at 100 year highs. New secular bear markets are not verified until the new high attempt has failed. The secular bear market in the 1970s had 3 recessions and we have seen 2 recessions so far. Until we break out to new highs, the U.S. and other western developed markets are in a cyclical bull market within a secular bear market. The emerging markets are in secular bull markets. Economic Cycle & Market Indicators The question I am asked most often is, are we still in a bull market? My answer starts with the fact that it is impossible to time every bear market consistently due to unforeseeable shocks to the world markets like 9-11 in 2001 and the Japan Tsunami in Aside from world shocks, stocks are still in a bull market based on our long-term indicator and the current market dynamics. These indicators cannot time market corrections. There are no indicators that can time corrections consistently. Market Top Market Bottom Now December 2007 June (Dec) Inflation + + Monetary + + Economy + Earnings + Market Valuations + -- Cycles & Seasonality Market Sentiment Global Crisis Indicator 0 + Stock Prices 2008 = -38% 2009 = +26% 2017 = +17% (SPY 11/9/2017) Listed below are the elements that make up our Long-Term and Short-Term Indicators. The colors represent how the elements contribute to the Indicators and the future stock market. Green represents favorable, yellow represents neutral and red represents unfavorable conditions. Our Fundamental Indicator consists of economic, inflation and interest rate data. The Global Crisis Indicator considers political, financial, currency, speculation, energy crisis, gold spikes and volatility spikes. Fundamental Technical Valuation Market Sentiment Cycles & Seasonality Global Crisis Indicator Market Cycle Indicator Our Long Term Market Indicator Our Top Market Timers Our Short Term Market Indicator Indicator revised November JAN FEB MAR APR MAY JUN JUL AUG SEPT OCT NOV DEC S&P 500 (+/- 1.0%) 3

4 Economic Cycle Inner Workings The section below shows the inner workings of the economy and how they affect the stock market. Low inflation is allowing the Federal Reserve to keep interest rates low. Low interest rates are making money easier to borrow driving economic growth, which in turn fuel earnings. Earnings growth is driving stock prices higher since valuations are still reasonable. Cycles & Seasonality are positive at this time of the year. Investor Psychology turned negative after the big run-up in stocks, which should slow the stock market some. Global crisis have subsided some allowing investors to focus on investing. We are in the Capital Goods stage of the economic cycle. Inflation, Monetary, the Economy, Cycles & Seasonality, and Investor Psychology set the direction of the market. Earnings and Valuations set the magnitude of the stock market change. Investor Psychology & Sentiment help identify major tops and bottoms. Sentiment Short Term Indicator (< 6 months) Technical Short and Intermediate Term Indicators Monetary (GDP, Interest rates, Inflation) Intermediate Term Indicator (6 to 12 months) Valuations Long Term Indicator (> 12 months) Market Valuations Shiller CAPE Valuation Index This index is cyclically adjusted and worked well from 1900 thru 2000 spotting over and under valuation periods. The following factors have made this indicator less effective since Since 2000, GDP has been low averaging around 2% and the S&P 500 returned only 5.6% from 2001 thru Lower interest rates and accommodative monetary policy Increased globalization and US dominance in technology, bio-pharma, social media and e-commerce. Many disruptor corporate giants possess near monopoly power like Amazon and Google. With low economic growth, these companies defy the mainstream and get rewarded. The surge to ETF s has pushed these giants stock prices higher. Surge in corporate profits and profit margins Higher corporate leverage Interest Rate Cycle This stock market has been volatile every time strong economic data or higher inflation reports come out for fear of rising interest rates. As the Fed continues to taper QE, the closer we are to rising short-term interest rates. Fed chair Janet Yellen has mentioned that rate hikes could begin as soon as six months following the end of tapering in October. This puts rising short-term interest rates in mid 2015 likely. The Fed s mandate on interest rates is based on employment and inflation. If the natural rate of unemployment is 5.4%, we have a while to go to bring down the current 6.1% unemployment rate. The Fed s target inflation rate (PCE) is 2.0% and the 2014 inflation rate is 1.8%. Phase 1 Low ST rates, rising 10% 2015 Phase 2 High ST rates, rising 3% Phase 3 High ST rates, falling -9% Phase 4 Low ST rates, falling 23% (2008 thru 2016) 4

5 It is common to experience some volatility and initial pullbacks when moving toward the initial rate hike. Average pullbacks have been less than 6%. Overall, the stock market fares well in the six months before and after the initial interest rate hike. On average, it was 16 months from the initial short-term rate hike before a bear market began. This would put the next bear market starting in August According to Bank Credit Analysis, the interest rate cycle has four phases. See the average annual returns below during each phase. We have been in phase 4 since 2008 and will likely be in phase 1 in Interest Rate Cycle The Yield Curve All recessions are preceded by an inverted yield curve, but not all inverted yield curves produce a recession. In 2018 the 10-year treasure is starting lower than normal due to QE and global rates near zero. Also, inflation is very low. Flat yield curve years like 1994 and 1998 did not see a recession in the next 2 years. Inverted yield curves like 1981, 1989, 2000 and 2006 saw recessions within 12 months. 5

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7 Market Bottoms Takes Courage to Buy (Best market opportunities) Correction bottoms tend to be sharp and recover faster unless they lead into a bear market. (NDR) Bottoms are formed by gloom and doom panic and fear. Fear is a stronger emotion than euphoria. Don t underestimate a bear markets depth due to overreaction by investors. How far the pendulum swings down and what will cause it to reverse are unpredictable. Bull markets start when there is extreme pessimism. Market bottom characteristics; Fear, risk-off, gloomy outlooks, uncertainty, skepticism, caution and undervalued prices. Buy once a solid bottom is formed over a period of months with 2 or 3 bottom tests. Bull markets start with a sharp rise to make up for the sharp drop at the end, so it is ok to get in early. Increase equity exposure as the bull market recovery starts. The best time to make money is the first year coming out of a bear market. Every recession ended and was followed by a recovery and bull market. Be an optimist and have faith in the future of the United States and the world. Based on history, the stock market rises over time. Expected returns are the highest at recession lows due to low valuations and earnings growth off the lows is easy. Market Tops Takes Brains to Sell Almost all market tops show extended topping action before a bear market. Some tops end in a parabolic rise. Tops are formed by euphoria, complacency, greed and confidence. Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria (John Templeton) Don t overestimate a bull markets strong rise just before the end as the dumb money finally comes in full force. How far the pendulum swings up and what will cause it to reverse are is unpredictable. Bull markets end in a whimper by rolling over slowly over about 6 months, giving you time to get out. Market top characteristics; Euphoria, risk-on, rosy outlooks, greed, optimism, confidence, easy loans and overvalued prices. Every bear market starts as a correction, so being right about the correction or the start of a bear market is important. A Short-Term Sell & Correction with a Long-Term Sell is often a warning of a bear market. Reduce equity exposure as the bull market matures. By the time a recession is identified the bottom is near making this a time to start thinking about buying. Economists and the Fed do a poor job of economic and stock market forecasting. Expected returns are the lowest at market tops since valuations are high and earnings have likely peaked. Benjamin Graham According to tradition the sound reason for increasing the percentage in common stocks would be the appearance of the bargain price levels created in a protracted bear market. Conversely, sound procedure would call for reducing the common-stock component below 50% when in the judgment of the investor the market level has become dangerously high. 7

8 Templeton s Law (Hays Advisory 2017) Sir John Templeton s famous statement. Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria Buying into Pessimism Easier to recognize fear when pessimism indicators all start hitting previous market extremes Difficult to buy in fear since you are feeling the effects of fear yourself Selling onto euphoria It is more difficult to recognize euphoria because it can go on for a very long time Over-confidence is instilled in investors making them fearless Investors think they are smart enough to get out before the other guy Euphoric environments produce a feeling that things can get even better than they already are Hard to sell in the absence of fear and bad news You need to doubt yourself when your confidence in your own abilities is at its peak Investors tend to lose patience and a desire to throw caution to the wind, pressure to generate returns late in a cycle becomes unbearable Euphoria as an Absence of Fear (2017) Stock prices near all-time highs Assets flowing into passive investments at a record pace Consumer confidence at 16 year highs Junk bond yields near record lows Market valuation metrics near all-time highs Value of household financial assets relative to income at all-time highs Crypto currencies like the bitcoin tracing out bubble patterns Volatility (VIX) close to all-time lows VIX short interest at all-time highs (bet against rising volatility) Assets flowing into leveraged funds near highest on record Fed raising interest rates Unemployment at lows, initial unemployment claims close to historic lows Longest benign credit cycle on record Average credit rating on bonds worse than it was in 2000 and 2007 Market Sentiment Indicators Smart Money Investment Newsletters, Money Managers Individual Investors & Dumb Money 8

9 Secular Cycle Secular Bull Markets Secular bull markets have occurred about every 10 to 15 years with an average length of 14 years before the next secular bear market to years 1942 to years 1982 to years 2009 to years The new Secular Bull Market started in 2009, confirmed by the breakout of the S&P 500 chart in April This bull market has gained over 200% (2015) and is over six years old. Previous Cyclical Bull Markets within secular bull markets lasted between 5 and 9 years before a Cyclical Bear Market. We are over 6 years into this Cyclical Bull Market with over 200% gains and are in the Capital Goods stage of the economy with a 10% correction likely. Based on the earnings yield predictor, the stock market could return 7.0% going forward. This is based on a current PE of 20 and a 2% dividend yield. (1/20 PE = 5.0% + 2.0% dividend yield) Secular Bear Markets Secular bear markets have occurred about every 8 to 23 years with an average length of 13 years before the next secular bull market. Secular markets are based more on distance and less on time. Secular bear markets are caused by greed, speculation, excess, debt, excess regulation, bad public policy and high energy prices. Once the debt cleansing, policy changes and regulation changes are complete in the U.S. and Europe, a new secular bull will be born. Secular bear markets typically saw 2 to 3 recessions each to years 1930 to years 1966 to years 2000 to years 9

10 Market Cycle Economic cycles follow similar patterns. Like John Templeton once said: Bull markets are born from pessimism, grow on skepticism, mature on optimism and die on euphoria. Ignoring cycles and extrapolating trends is one of the most dangerous things an investor can do. The economy follows a cycle that repeats itself because of human nature. Nothing goes in one direction forever. It starts with a recovery, then goes through a transition phase digesting gains and waiting for earnings to catch up; next is the capital goods phase when the economy gains steam; and finally the cycle ends in recession. There are often corrections in the capital goods phase. The Market Cycle Indicator identifies the phase in the cycle. The charts below show the stock market action of the current and past two cyclical bull markets within a secular bull market. In secular bull markets, bull runs are longer and in secular bear markets, they are shorter. Recovery (NDR:Post Recession Bull) - Bull markets start with a sharp increase in stock prices off the oversold recession bottom. (2009) Transition The bull market consolidates 5% to 10%. (2010) Capital Goods 1 - The economy starts growing strong and stocks rise. ( ) Corrections The bull market consolidates 5% to 10%. (2011, 2012, 2015, 2016) Correction Bear Market (NDR:Echo Bear) The bull market consolidates 10% to 20%. (2011, 2016) Capital Goods 2 (NDR: Post Echo Bull) The economy continues growing again. ( ) Cyclical Recession A short economic contraction in a secular bull market. (Likely in the next few years) Secular Recession A long economic contraction in a secular bear market. (2008) 2009 Bull Market 1991 Bull Market 1983 Bull Market 290% rise in 9 years from 2009 to % rise in 9.5 years from 1991 to % rise in 7 years. Correction Bears in 2011, 2016 Correction bear in 1998 Correction bear in Recovery Transition Correction Capital Goods 1 Correction Capital Goods Sources of charts: Bigcharts.com (Modified by PDM Investment Services, LLC) 10

11 Short-Term Market Timing Our Short-Term Market Indicator is used to manage a portfolio s cash inflows and outflows and the purchase and sale of equities. The indicator is not used for market timing since consistent short term timing indicators do not exist. We have revised the indicator many times. The latest revision was in November The Indicator is based on Correction Months, Valuation, Market Sentiment, Technical Strength, Support, Resistance and Turns in Relative Strength. The indicator looks for overbought and oversold market conditions. Positive Ok to invest cash. Correction Buy Oversold, a buying opportunities. Neutral Use caution when investing new cash. Negative Overbought, increased probability of a correction, ok to raise some cash. Our strategy is to invest cash waiting on the sidelines in buckets at market support levels during a bull market. The emotional market knows more than any analyst. It presents buying opportunities because investors overreact on the up and down side. The chart below is used to help determine the direction of the market from a short-term technical view. The support and resistance lines show the trend and channel in which the market will trade until broken Corrections in bull markets are very difficult to time because of their speed and short duration, making a positive trade difficult. Corrections come on the heels of a strong market that is overbought, they are unpredictable and typically don t have warning signs. It is not possible to consistently time the markets short-term due to unpredictable events and emotion driven stock market movements. Your best defense is a diversified portfolio with a bond and cash position appropriate for your risk level. Investors should stick to their long-term plan and not react to short-term corrections. Do not panic and sell after a big correction. Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves. Peter Lynch 1987 Bear Market Correction, no recession (Valuation), 1998 Bear Market Correction, no recession (Asia & Russia currency crisis) 2011 Bear Market Correction, no recession (Eurozone debt crisis, Japan tsunami) 2016 Bear Market Correction, no recession (Plummeting energy prices end in February) 11

12 Dangers of Market Timing Time in the market is better than market timing. It is important to be diversified and keep risk at suitable levels. Trying to time shallow corrections are not worth the time, performance risk, transaction cost and tax cost. The markets are positive around 70% of the years. The market moves up twice as often as it moves down, making it easy to miss strong up days. Short term timing and trend following are very difficult to do consistently. Very few people have the nervous mindset to sell at the top and battle-hardened opportunist mindset to jump in at the bottom. Computer models cannot model human emotions to predict crowd behavior. Most models get you out after a 10% correction and get you in after a 10% rally with little gains from the trade. Morningstar studies show investors typically earn less over time in a fund than the fund itself does, because they tend to buy after it has gone up and sell after it has gone down. Timer Digest and Hulbert Financial Digest monitor market timers. Their data shows little evidence that short term timing can provide a consistent advantage and improve a portfolio s performance over the long term. A well-diversified portfolio for your risk tolerance is the best way to achieve your long-term goals. Technical indicators take too long to turn over to catch the correction before the fall. After years of searching, we have not been able to find any short-term timers that have consistent results. Trying to time shallow corrections are not worth the time, transaction costs and tax costs. Short-term market tops are more difficult to time than bottoms of corrections. The market can rise for many months in an overbought mode, but typically remains in an oversold less time. Over the past 80 years we have seen 5%+ corrections every 7 months on average and 10%+ corrections every 2 years. Each year there are typically 1 to 2 corrections, some years may see 3 corrections. On average, 5% corrections occur 3 times per year, 10% corrections 1 time per year, 15% corrections once every 2 years and 20% corrections once every 4 years. Past Correction 5% to 10% losses: 1 to 2 months to bottom, 1 to 2 months to recover losses, no recession. Past Correction 10% to 20% losses: 2 to 3 months to bottom, 2 to 6 months to recover losses, no recession. Past Correction Bear >20% losses: 2 to 3 months to bottom, 4 to 8 months to recover losses, no recession. Stocks typically fall twice as fast in corrections than it takes for them to rise. Probability of timing corrections consistently is low. In the transition stage of an economic cycle, corrections are longer and easier to time. Buy corrections in bull markets and sell rallies in bear markets. A Short-Term Sell & Correction with a Long-Term Buy is often a buying opportunity. The market knows more than most, but it also presents opportunities because it overreacts on the up and down side. There will always be another buying opportunity. Correction bottoms are often V or W shaped giving you less time to buy. Volatility is not a loss if you do not sell. 12

13 CORRECTION UPDATE (10%) PDM Investment Services (February 27, 2018) (For complete disclosure see our website at The S&P 500 finally saw its first 10% correction in two years. Most asset classes fell the same amount as the S&P 500 and are in correction territory. Financial and small cap value faired a little better. The stock market is fighting between reduced liquidity and strong fundamentals. The Trigger January saw extreme optimism, over valuation and a parabolic rise in stock prices. The correction was triggered by rising interest rates, a strong jobs report with rising wages and inflation fears. The Bitcoin crashed earlier and now the short volatility trade unwound. The 10-year Treasury yield hit a 4-year high of 2.85% last seen in March In 2018, the 10-year Treasury rose from 2.4% to 2.9% in 6 weeks. Most of the selling was from institutional traders. The speed of the correction can be attributed to momentum-based computer trading and the triggering of stop orders. The unwinding of the inverse leveraged volatility trade in ETF s like XIV and SVXY intensified selling. These funds lost 95% of their value in 6 days. The Damage 2018: December and January gains evaporated. The S&P 500 fell back to its November levels. The market went up too fast and too far and needed to take a breather. February was the first down month for the S&P 500 in 10 months. February 2018 Correction -10% (SPY) 6 Days to bottom 5 Days to bottom end February 2016 Correction -12% (SPY), -16% (VTI) 12 Days to bottom 30 days to bottom end Sept 2015 Correction -12% (SPY) 4 Days to bottom 45 Days to bottom end The Future The market is still supported by strong earnings growth. The S&P 500 forward PE over the past 12 months only rose 7% to (Jan 2018) Investors were exuberant, but not irrational like in 1999 and Corrections are normal in a bull market. Your best defense is a diversified portfolio with a bond and cash position appropriate for your risk level. Investors should stick to their long-term plan and not react to short-term corrections. Do not panic and sell after a big selloff. This one was well over due and is healthy to extend this old bull market. It is better to see a healthy correction now, than a larger crash later. Extreme volatility creates a desire to do something. To control your desire to act, buy a few high conviction stocks that are finally undervalued. If November was not a BIG buying opportunity, now is not either. The market is still high. Now is a good time to start picking up high conviction stocks on sale. Corrections are good times to make your IRA contributions. Age of the Bull Market This bull market is almost 10 years old. Most deep corrections come late in the bull market like 1987, 1998, 2016, We are in a secular bull market that could last another one to three years. Recession Bear markets come from excess built in the economy, commodity spikes, extreme valuations and aggressive fed tightening. The classic market top signals including an inverted yield curve and falling leading economic indicators are not present today like in other bull market tops. The market top warnings before the correction were over valuation, extreme market sentiment and speculation. Valuations Stock market valuations have moved from overvalued closer to fair valued. After the 10% correction the PE forward dropped from 19.9 to 18.9%. 13

14 Fundamentals There are no fundamental signs of a broad-based recession at this point. Inflation is low and just starting to rise, interest rates are low and just starting to rise, the economy and earnings are growing strong, and the tax reform and other fiscal stimulus should keep the economy going strong. Market Top Warning Signals Market Top Warnings are starting to build, but not extreme. (See the Focused Growth Investor Newsletter page 5) The current market top warnings are listed below. Advisor and individual optimism at all-time highs, high margin debt, relative strength indicator hit all-time highs. Stock market overvaluation. Asset bubbles and leverage: Inverse leveraged volatility trade and Bitcoin crashed. FANG stocks, housing prices and securities backed loans at record highs, investor cash levels nearing 1999 lows, 10-year market slopes; January 2018 final phase 3 melt-up. ETF Index Mania near end of bull markets 2000, 2007, Credit Spread is low at 2.3%. Technical Analysis (Support for a Correction Bottom) The stock market has reached a 10% correction for most asset classes. The S&P 500 touched its 200-day moving average (2550) on 2/9/2018, an 11% correction. The S&P 500 closed at 2620 on 2/9/2018 the bottom of its 2-year support channel, a 10% correction. It looks like the correction is over based on the breakout above the 1-week trading channel and 75% of loss was recovered. The market will likely rise with the 1-year trend line of the S&P 500 on the graph on page 16. We did not see a good double bottom formation to support a stronger bottom conclusion CB1. Our Long-Term Indicator Positive Our Short-Term Indicator Positive (02/18/2018) Correction Buy Indicator CB2 (02/27/2018), CB1 not issued no strong bottom or double bottom. Technical Indicators, Looking for a Bottom (From Stock Charts 10 Year Graph of S&P 500 for 1998, 2010 and Year Graph for 2015, 2016 and 2018) Once these signals hit bottom levels and start to turn up, it is likely the correction floor has been reached. RSI The Relative Strength Indicator at bottoms. Rose from 50 to =55, 2010=45, 2011=45: 2015=35, 2016=35, 2018=90 to 50. CMF The Chaikin Money Flow indicator at bottoms. Still at 0.45 bottom =?, 2010=0.10, 2011=0.10: 2015=0, 2016=0, 2018=0.50 to MACD A Moving Average Convergence Divergence. Sitting at -5 bottom =-10, 2010=+10, 2011= -10: 2015= -20, 2016= -18, 2018=20 to -5. STO The Stochastic score at bottoms. Rose from 55 to =65, 2010=70, 2011=55: 2015=20, 2016=20, 2018=100 to 55. Percent of S&P 500 stocks > 50 day moving average, >200 day moving average. 50-day up to 50, 200-day up to = 15%, 20%, 2018= 18%,55%. 14

15 CORRECTION HISTORY On average, the market corrects 10% or more, once per year. There are four types of correction bear market combinations. Market (SPY) Legs Age of Bottom Market Top Market Days to Bottom Recession Correction Down Bull Market Formation Bottom End for Year to Bottom End 5% to 10% Loss Correction (2014 Oct) No -8% 1 5 years 3 days 1.0 months +13% % to 17% Loss Correction (2018 Feb) No -10% 1 10 years 1-week x.x months +xx% 6 2/9 x Correction (2016 Feb) No -16%* (VTI) 2 7 years 1.0 months 6.0 months +12% Correction (2015 Sept) No -12% 1 6 years 1.5 months 2.5 months +1% 4 30 Correction (2010 Aug) No -16% 1 1 year 3.0 months 4.0 months +15% % to 35% Loss Correction Bear Market (2011 Oct) No -19% 1 2 years 2.0 months 5.0 months +2% Correction Bear Market (1998 Sept) No -19% 2 8 years 1.5 months 3.0 months +29% Correction Bear Market (1987 Sept) No -34% 1 5 years 2.0 months 3.5 months +5% Cyclical Recession Bear (1990 Aug) Yes -20% 2 8 years 2.0 month 3.5 months -5% 35% to 50% Loss Secular Recession Bear ( ) Yes -48% 3 6 months 1.5 years -37% (2008) Secular Recession Bear ( ) Yes -47% 3 8 months 3 years -22% (2002) Data is from SPDR S&P 500 ETF (SPY), Vanguard Total Stock Market ETF (VTI) and Vanguard Total World Stock ETF (VT). *The 2016 correction uses the Vanguard Total Stock Market since most asset classes fell over 16%. The S&P 500 was artificially inflated due to a few large cap stocks holding it up. In order to participate in the bull market gains, we must also endure the corrections. Corrections and bear markets create opportunities for investors to invest cash at a good price. Corrections in bull markets are very difficult to time because of their speed and short duration, making a positive trade difficult. Corrections come on the heels of a strong market that is overbought, they are unpredictable and typically don t have warning signs. It is not possible to consistently time the markets short-term due to unpredictable events and emotion driven stock market movements. Your best defense is a diversified portfolio with a bond and cash position appropriate for your risk level. Investors should stick to their longterm plan and not react to short-term corrections. Do not panic and sell after a big selloff. In Corrections, stocks typically fall between 10% and 20%, they fall fast and recover faster. Often a good buying point once bottom forms. In Correction Bear Markets, stocks typically fall 20%, they fall fast and recover faster. Often a good buying point once bottom forms. In Recession Bear Markets, stocks fall slowly to a 20% or more loss over a 8 to 36 month period. Bear markets are more about changes likely to have lasting impact on corporate earnings and are accompanied by recessions. Recession Bear Markets come when excess is built in the economy, from commodity spikes, rising inflation, aggressive Fed tightening or extreme valuations. 15

16 Corrections No recession, 5% to 16% losses, 4 to 20 days to bottom, 0 to 3 mo. to bottom end, positive gains for year %, 6 days to bottom, 3 months to bottom end %vti,12 days to bottom, 1 month to bottom end Extreme optimism, overvaluation, rising inflation and rising interest rates. Commodity prices collapse, China economy, high yield bonds falling, Bitcoin, volatility trade crash, tariffs. Late in the economic cycle, (9 years) earnings recession. Broke below 2-yr trend line support. Did not break below 2-yr trend line. 3 correction bottom hits, strong support. After correction went to new highs. CB1 mid Feb, CB2 late Feb Inflation, interest rates, GDP, earnings, PE: (00++--) CB2 2/27, CB1 4/15, CB2 5/13 Inflation, interest rates, GDP, earnings, PE: (++0 0) %, 4 days to bottom, 1.5-month to bottom end Commodity prices collapse, China market crash, Greece, slow global growth, earnings recession. Broke below 2-yr trend line support. CB1 late Sept, CB2 early Oct After correction hit old top then went into 2016 correction. Inflation, interest rates, GDP, earnings, PE: (++0 0) 16

17 Corrections No recession, 5% to 16% losses, 4 to 20 days to bottom, 0 to 3 mo. to bottom end, positive gains for year %, 8 days to bottom, 3 days to bottom end, V recovery Weak Economic Growth, Fed Ends QE, Ukraine Instability. Did not break below 2-yr trend line. No CB1, CB2 end Oct After correction went to new highs. Inflation, interest rates, GDP, earnings, PE: (++++0) %, 20 days to bottom, 3 months to bottom end Consumer & Bank Deleveraging, European Debt Crisis. Broke below 2-yr trend line support. After correction went to new highs. Inflation, interest rates, GDP, earnings, PE: (++0++) 17

18 Correction Bear Markets No recession, 16% to 19% losses, 1.5 to 2.0 mo. bottom, 3.0 to 5.0 mo. market top to bottom end, positive gains for year. 2011, 19% correction, 2.0-month bottom formation Eurozone Debt Crisis Warnings: Massive government and bank deleveraging. After correction went to new highs. Inflation, interest rates, GDP, earnings, PE: (0+0++) 1998, 19% correction, 1.5 month bottom formation 1987, 34% correction, 2.0 month bottom formation Asia & Russia Currency Crisis Black Monday Warnings: Rising interest rates and high valuations. Late in the economic Warnings: Extreme Valuations and Speculation Stock Bubble. cycle. (Year 8) After correction went to new highs. In 1986 the price of oil fell 50% due to OPEC pricing concerns. Inflation, interest rates, GDP, earnings, PE: (+000-) Late in economic cycle (5 yrs.) After the correction went to new highs. Inflation, interest rates, GDP, earnings, PE: ( ) 18

19 Cyclical Recession Bear Markets Recession, 20% losses, 2.0 mo. bottom, 3.5 mo. market top to bottom end, negative gains for year. 1990, 20% correction, 2.0 month bottom Gulf War, Savings & Loan Bailout Warnings: Rising Inflation and Interest Rates, Sharp rise in oil prices from Gulf War. Inflation, interest rates, GDP, earnings, PE: ( ) 19

20 Secular Recession Bear Markets Recession, 48% losses, 6 to 8 mo. bottom, 1.5 to 3.0 year market top to bottom end, negative gains for year , 47% correction, 8 month bottom formation (4 month bottom #1, 14 month bottom #2, 8 month bottom #3) Technology Bubble Crash Warnings: PDM Long-Term Indicator Sell, Rising Interest Rates, Extreme Valuations, Internet Bubble Crash and Recession. Inflation, interest rates, GDP, earnings, PE: ( ) , 48% correction, 6 month bottom formation (8 month bottom #1, 6 month bottom #2) Housing, Mortgage & Credit Crisis Warnings: PDM Long-Term Indicator Sell, Rising Inflation and Interest Rates and Housing Credit Bubble Crash and Recession. Inflation, interest rates, GDP, earnings, PE: ( ) 20

21 S&P 500 Price Declines (1946 to 2016) AAII CORRECTION HISTORY Decline Occurrence Number Average Drop % Duration Time to Recovery Every x Years of Declines from Peak (Months) (Months) Pullback 5.0% to 9.9% % 1 2 Correction 10.0% to 19.9% % 5 4 Bear Market >20% % Normal Bear 20% to 40% 9-26% Mega-Bear >40% 3-51% CORRECTION OCCURANCE RATES (NDR) 21

22 Our Short-Term Market Indicator Our Short-Term Market Indicator is used to manage a portfolio s cash inflows and outflows and the purchase and sale of equities. The indicator is not used for market timing since consistent short-term timing indicators do not exist. We have revised the indicator many times. The latest revision was in November The Indicator is based on Correction Months, Valuation, Market Sentiment, Technical Strength, Support, Resistance and Turns in Relative Strength. The indicator looks for overbought and oversold market conditions. Positive Ok to invest cash. Correction Buy Oversold, a buying opportunity. Neutral Use caution when investing new cash. Negative Overbought, increased probability of a correction, ok to raise some cash. Our strategy is to invest cash waiting on the sidelines in buckets at market support levels during a bull market. The emotional market knows more than any analyst. It presents buying opportunities because investors overreact on the up and down side. The chart below is used to help determine the direction of the market from a short-term technical view. The support and resistance lines show the trend and channel in which the market will trade until broken Market Tops: Almost all market tops show extended topping action before a bear market. Some tops end in a parabolic rise. Tops are formed by euphoria, complacency, greed and confidence. (NDR) Market Bottoms: Correction bottoms tend to be sharp and recover faster unless they lead into a bear market. Bottoms are formed by gloom and doom panic and fear. Fear is a stronger emotion than euphoria. Corrections in bull markets are very difficult to time because of their speed and short duration, making a positive trade difficult. Corrections come on the heels of a strong market that is overbought, they are unpredictable and typically don t have warning signs. It is not possible to consistently time the markets short-term due to unpredictable events and emotion driven stock market movements. Your best defense is a diversified portfolio with a bond and cash position appropriate for your risk level. Investors should stick to their long-term plan and not react to short-term corrections. Do not panic and sell after a big correction. Graph below is from bigcharts.com. 22

23 Volatility Spikes Volatility spikes often can predict the worst is over in a correction. Peaks occur at 20, 30 or 40 Market Positive VIX falling from peak of 20, 30 or 40 Market Neutral VIX else Market Negative VIX rising from bottom (12 to 15) past 16 VIX 30 Spike 1 mo. later 0% return 1 year later 8% return (Positive 13/21 60% of time), (Positive 100% of time if no secular bear) VIX 30 Spike 1 mo. later 1% return 1 year later 14% return (Positive 6/8 75% of time), (Positive 100% of time if no secular bear) 23

24 Long Term Market Timing (Tactical Asset Allocation & Risk Management) This indicator is based on Fundamental, Technical, Valuation, Market Sentiment, Cycles & Seasonality, Top Long-Term Market Timers and our Global Crisis Indicator. The indicator is used to signal risks of a Recession Bear Market (> 20% prolonged losses, 2000, 2008), not Correction Bear Markets (>20% loss, 1987, 1998, 2011) or Corrections (10% to 20% loss). A positive reading means an increased probability of positive stock market returns. Equity allocation for portfolio asset allocation is derived from this Indicator. This Secular Bull Market started in Previous Cyclical Bull Markets within secular bull markets lasted between 5 and 9 years before a Cyclical Bear Market. We are over 7 years into this Cyclical Bull Market with over 200% gains and are in the Capital Goods stage of the economy. A sharp correction is always likely. The classic market top signals including an inverted yield curve, extreme sentiment, falling leading economic indicators and overvaluation are not present today like in other bull market tops. The market top warnings now are a weakening advance-decline, divergence asset classes and 6 months rolling over. Bear markets come from excess built in the economy, commodity spikes, extreme valuations aggressive or Fed tightening. The greatest buying opportunities exist off bear market bottoms when others are forced to sell fundamentally good stocks. These opportunities come around about every 10 years. Exact bottoms are not predictable due to investor emotion and irrational behavior. It is best to buy after the second bounce off an extreme pessimism bottom when valuations are attractive. Tactical asset allocation actively varies your allocation in equities relative to bonds and cash depending on forward-looking market predictions. We define TAA as making small longer-term changes to allocation and consider market timing as all-in or all-out shorter term market allocation changes. Being in the market at the right time helps avoid bear markets and controls risk. TAA has increased in popularity after two big bear markets and low equity returns in the past twelve years. TAA works best in bear markets and in times of high volatility. Buy and Hold works best in strong bull markets when volatility is low. Do not make the mistake of switching to a buy and hold at the top of the market and market timing model after a market bottom. These strategies are often used as risk reduction techniques and can improve risk adjusted return, but only improve performance in some periods. Market timers typically underperform the market during more periods than buy and hold investors. Below is a list of concerns about TAA. We do not try to time corrections because they are impossible to time consistently. Short-term timing can be costly due to transaction fees and taxes. The S&P 500 Total Return (PREIX) has been negative for the year 27% of the years from 2000 thru We only focus on timing major bear and bull markets, not corrections. We have seen 1 or 2 bear markets (20% or greater decline) each decade since the 1970 s. The elements of our tactical asset allocation model include inflation, interest rates, economic growth, corporate earnings, stock prices, market valuations, cycles & seasonality, market sentiment, global crisis, fiscal policy and geopolitical risks. The primary risk to portfolio performance with tactical allocation is you have to be correct at when to reduce equity exposure and correct when to increase equity exposure to see its benefit after transaction costs. It takes one type of brain to sell at the top and another type of brain to buy at the bottom, making this difficult to execute. Timing models that worked in the past, often do not work in the future. Very few mutual funds and investment newsletters rated by Morningstar and Timer Digest outperform the market using timing. We have not found any Tactical Allocation funds that perform well. (GTAA, IASRX, PASDX, HTUS, HAZIX not well) 04/14/2017: 3YR 5YR 10YR AVE Morningstar TAC Category 2.2% 4.0% 3.2% 3.1% Alpha to Moderate -2.6% Morningstar Moderate Alllocation 4.8% 7.0% 5.3% 5.7% Leuthold Core Investment Fund (LCORX) 4.5% 7.0% 4.4% 5.3% Alpha to Moderate -0.4% 24

25 Tactical asset allocation is rarely successful because it takes a different mindset to buy at the bottom then it does to sell at the top. The strategy typically underperforms during bull markets and outperforms during bear markets. Thru our experience, we believe very few indicators have predictive powers. Market timing systems have a way of breaking down if not constantly evaluated and adjusted for changing world economic and investment conditions. The world continues to evolve and flatten and new investment methods and systems are added. A better strategy for most is to build a portfolio that you can live with through the market s ups and downs. Even if you had the holy grail of a timing system, you may not act properly on the sell and buy signals due to your emotions. Market timing works best in higher volatility markets like stocks especially during bear markets. It does not work well in low volatility markets like in bonds. From 2004 to 2014 only 20% of market timers covered by the Hulbert Financial Digest beat the buy and hold strategy. Bond timers beat buy and hold 0% of the time. Using good stock picking and market buy-and-hold is likely to produce better results than market timing based on investment newsletter performance. Technical charting systems tend to deliver disappointing results because of human emotion override. Trying to buy low and sell high based on personal judgment alone is even tougher, because it requires a nervous pessimist to get out near the top and a battlehardened opportunist to buy back in at the bottom. Those who move to the sideline rarely manage to get back in at a lower price. TAA portfolios have higher management fees, transaction fees and higher taxes, hurting returns. Tactical strategies can reduce losses in secular bear markets, but often reduce gains during secular bull markets. TAA models helped in the secular bear markets of the 1930 s, 1970 s and 2000 s, but hurt in the bull markets of the 1940 s, 1950 s, 1980 s and 1990 s. The most difficult task with TAA is identifying the difference between a correction and a bear market. Technical TAA models start reducing equity exposure as the correction worsens, preparing for a potential bear market. If it turns out to be a correction in a bull market, having a lower equity exposure at the market bottom, hurts performance. As it becomes clear it was a correction, they raise equity exposure too late. Timing the correction rarely produces any extra return. Sharp corrections like 1998 and 2011 triggered sell signals that hurt timers. New mutual funds and ETF s employing tactical methods are being launched. Very few of the tactical mutual funds or ETF s have lived up to expectations. Over any ten-year period, TAA has beat the S&P 500 buy and hold strategy less than 10% of the time. In 2008 bear market, 10% of the timers were correct, 55% missed the timing opportunity and 35% were hurt by their timing activities. From 1973 to 2008, good timing models have only improved performance by a few percent annually. Portfolio volatility was reduced improving risk adjusted returns. Timers outperformed the buy and hold strategy about 50% of the time. A 2013 Hulbert Financial Digest study showed only 4% of timing newsletters outperformed on the up and the downside from 2000 to Since 1987, the average tactical portfolio would have delivered little incremental diversification over a balanced fund. A market that exhibits little volatility presents little opportunity to add value by trading in and out. Timing works better on more volatile asset classes such as the NASDAQ, Asia and emerging markets. 25

26 Our Long-Term Market Indicator Our Long-Term Market Indicator sets up the stock market exposure for our portfolios around the define base risk level. We attempt to reduce stock market exposure during periods of high risk and recessions and raise exposure during periods of low risk. We also use other top timing models to confirm our model signals. The model is based on inflation, interest rates, economic growth, earnings, technical, relative strength, sentiment, valuations, cycles & seasonality and global crisis. The indicator is used to signal the risk of a Recession Bear Market (> 20% prolonged losses, 2000, 2008), not Correction Bear Markets (>20% loss, 1987, 1998, 2011) and not Corrections (10% to 20% loss). A positive reading indicates an increased probability of positive stock market returns. A negative reading, decreased probability of positive stock market returns. These indicators are not a forecast, but more a probability of future returns. Equity allocation for our portfolio asset allocation is derived by this Indicator. The Long-Term Indicator may not work in this post debt bubble environment. The chart below is used to help determine the direction of the market from a long-term technical view. The support and resistance lines show the trend and channel in which the market will trade until broken. The indicator ratings are displayed on the bottom of the graph as Positive, Neutral and Negative. Previous Cyclical Bull Markets within secular bull markets lasted between 5 and 9 years before a Cyclical Bear Market. We are over 7 years into this Cyclical Bull Market with over 150% gains. We are in the final stage of a bull market, the Capital Goods stage. Correction Bear Markets are common in late stages of bull markets like in 1987, 1998 and Sir John Templeton said, Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria. The next bear market will have to deal with the ETF boom (flash crashes and easy liquidity), a market dominated by machine trading and the rise in interest rates from record low levels. Graphs below is from bigcharts.com. 26

27 Bear Market Causes Recession X X X X X X X X Commodity Spike X X X X Aggressive Fed Tightening X X X X Extreme Valuations X X X X X X Bear Return -86% -60% -30% -28% -36% -48% -27% -34% -49% -57% Duration 33mo 63mo 37mo 7mo 18mo 21mo 21mo 3mo 31mo 17mo Source:JPMorgan Buy and Hold Strategy Buy and hold strategies outperform most timing models over the long term. By maintaining steady stock exposure, fear and greed are forced to operate at the same level in your portfolio. Buy and Hold works best in strong bull markets when volatility is low. Annual Market Returns Annual market returns vary widely. You must understand that in a bear market most equity investments will lose 20% or more. Are you willing to take on more risk for the potential of higher returns? Higher risk portfolios often produce higher returns over time, but are more volatile. Lower risk portfolios often produce lower returns over time, but are less volatile. The list below shows the annual stock market returns since 1941 and how often they occurred. Source: Manifest.com 27

28 Annual Market Returns Source: Schwab.com 28

29 Rolling Returns The numbers below are based on returns from 1900 to The worst period in the past 100 years saw a 1% annual return from 2000 to This was a secular bear market. A bubble at the beginning of the period and two devastating bear markets created these poor results. The second worst period saw a 2% annual return from 1930 to This was a secular bear market and the Great Depression. The third worst period saw a 3% annual return from 1966 to This was a secular bear market. The stock market saw an annual return of less than 8% for 43% of the past 10-year rolling periods. The stock market saw an annual return between 8% and 12% for 22% of the past 10-year rolling periods. The stock market saw an annual return of greater than 12% for 35% of the past 10-year rolling periods. Based on history, the stock market will start producing higher annual returns after these bottom lows as a new secular bull market emerges. The secular bull markets of the past produced 18% annual returns over 10-year rolling periods. Mean Revision Theory The Mean Reversion S&P 500 forecasting model is predicting a 14% annual total return over the next 20 years based on a mean reversion to a 10% total return, low valuations and low interest rates. The past 20 years saw a 6% annual total return, below the 10% mean. The next secular bull market should start by 2013, driving higher returns for about fifteen years. 29

30 Stock Market Return Expectations (2017) Annual return predictions should be calculated for a period of five to ten years. Expected returns are much higher after a bear market when valuations are low, than in a mature bull market when valuations are high. Stock appreciation is based on fundamental return (earnings growth and dividend yield) and speculative return (valuation expansion). Speculative return is difficult to predict. Global growth has slowed to the 3.0% to 4.0% range and this will likely be the norm going forward. The developed countries like the United States, Europe and Japan continue to see slower growth. Emerging market growth is higher, but is also slowing. Slowing productivity is also hurting growth. Expected returns are going to be low going forward. Bond yields are at record lows, so bond returns are likely to be low or negative as interest rates rise. Bonds will not contribute much to the typical 70% stock & 30% bond portfolios like they have in the past 30 years. Stocks are fair valued so their contribution to portfolio returns will also be low. Dividend yields in the past 100 years were around 4.0% but have slowed to around 2.5%. The PE ratio of the S&P 500 (SPY) at the end of 2015 was 19.1 past/18.7 forward. The PE ratio is close to the average PE of 18, leaving 0% return for long-term expansion. Since the 1980 s stocks and bonds moved together benefiting from falling interest rates, falling inflation and rising productivity. Stocks and bonds will likely be negatively correlated going forward as interest rates rise and bond funds produce lower returns. This is sparking an interest in alternatives. If you add earnings growth (includes buyback yield: 3% from 2011 thru 2015), dividends and PE expansion, you get a 6.0% annual return for the next ten years. Based on the earnings yield predictor, the stock market could return 7.3% going forward. This is based on a current PE of 19 and a 2% dividend yield. (1/19 PE = 5.3% + 2.0% dividend yield) The Forward PE and subsequent 5-yr annualized returns of the S&P 500 shows an average of 5% return over the next five years. Expected Returns are based on past performance, a secular bull market and future expectations from various sources. Returns in the table reflect average annual S&P 500 total returns going forward, but are not guaranteed. For real return, subtract 2.5% for inflation. The Global Stock Market, Asset Allocation and Equity Selection contribute to portfolio performance. Earning Dividends PE Total Return Expectations Growth Yield Expansion Next 5 Years (Annualized) Past Stock Market 4.0% 4.0% 1.0% 9.0% Future Stock Market 3.5% 2.5% 0.0% 6.0% High volatility, higher risk of loss Moderate Allocation Portfolio (75% stocks / 20% bonds / 5% cash) 5.2% Moderate volatility, less risk of loss Future Bond Mix 3.0% Money Market, CD or Short Term Bond Fund 2.0% Low volatility and limited risk of loss 30

31 Bubbles and Growth Trends A bubble is an unsustainable price increase. A period of enthusiastic bidding of prices by a growing group enthusiastic investors that goes on too long and is carried away by its own momentum. People are motivated by envy of those who made money investing in it. Stories develop that justify the bubble, they become current and then people think they re right because everyone s confirming the stories. Eventually prices get too high and the bubble bursts. Four of the past nine bull-market peaks ended in bubbles. (1974, 1987, 2000, 2007) Bubble Warning Signs A Parabolic rise in stocks is the best way to spot a bubble. Bubbles are easy to spot from graphs like below. (3 slopes higher) A greater than 100% gain in an industry over 2 years followed by a 40% loss over 2 years. S&P 500: 1929, Housing Harvard Study: 53% accurate. The market could continue to rise in a newer bull market or could end in recession. Irrational Exuberance. New Paradigm Talk, Earnings Become Irrelevant, Equity Risk Premium Talk, Retail Investor Dominate Buying, Mergers & Acquisitions surge, Earnings Slump and Stocks rise, Companies Overinvest in Capital then Market Breath Collapses. Technology saw a bubble from 1997 to 2000, housing 2001 to 2006, emerging markets 2003 to 2007, natural resources 2003 to 2008 and the Consumer Debt Bubble was from 2003 to Massive stimulus has led to bubbles in the past. Post-1987 the commercial real estate and junk bond bubble was formed. Year 2K stimulus helped fuel the dot-com technology bubble. The post dot-com burst stimulus caused the housing and credit bubble to form. What bubble will the massive post-credit crisis stimulus form? Will it be a Green Energy Bubble or Natural Resources? The internet bubble was one of the largest bubbles and growth trends in our times. You can see from the graph below how it started off slowly in phase 1, then rose sharply in phase 2, causing a bubble. After the bubble burst, then the slower growth phase 3 started. Our technical indicator signaled a buy in phase 1 and a sell at $65/share just before the internet bubble burst. By getting in and out of this growth trend correctly, you would have produced a 550% return in 3 years. Then came the Financial crisis of 2007 which was even worse. Crises are more severe when accompanied by a leading boom and high leverage of market players and when financial institutions themselves are participating in the buying frenzy. 31

32 Bubbles (Charles Schwab) Market bubbles have occurred across the globe and throughout history. An asset bubble is characterized by a wave of optimism that lifts prices beyond levels warranted by fundamentals and ends in a crash. Behavioral finance theory attributes bubbles to irrational investing behaviors characterized by groupthink and herd mentality. All it takes is a rising price on an overly optimistic outlook that gathers more followers as the trend is extrapolated into the future. The bubble bursts when the outlook is proven to be too optimistic, often after becoming the mainstream consensus. When a small sub-industry bubble crashes, it causes a correction in the general market but not a wide based economic recession. Wide based bubbles typically bring risks for all investors, even those that don't own the inflating asset, because they represent a broader market and economy that has become out of balance and dependent upon a flawed outlook. While sometimes only seen in hindsight, bubbles with potentially damaging impact on the broader markets and economy seem to have some similar characteristics which may enable us to spot them before they burst. Past bubbles inflated 1,000% over 10 years before bursting, cutting prices by more than half in the following two years. Bubbles that are into the economy and impact the economy are the dangerous ones that typically see assets rise 1000% over 10 years. Technology, telecommunications and media stocks of the NASDAQ Composite Index (2000 peak) Crude oil (2008 peak) Precious metals (2011 peak) Homebuilder stocks in the S&P 500 Homebuilding Index (2005 peak) Low volatility strategies, overvalued consumer staples stocks (2017 peak? at 10 years 1000%) On-Line Retail (+1700% in 8 years as of 2017) Structure shift offset by the death of other retailers.. 32