MOMENTUM (IS NOT ENOUGH)

MOMENTUM (IS NOT ENOUGH)

IN PRACTICE IT WORKS. IN THEORY IT DOESN T

OBJECTIVES: (building blocks) MARKET REGIME STOCK BASKETS MOMENTUM (selection & management) DIVERSIFICATION LIMITED TRADING FOR TAX EFFICIENCY

MARKET REGIMES

59% Over the past 85 years this is the percent of time that the market (S&P 500) has been in a bear market or recovering from a bear market to a previous high for new growth. This FACT alone is WHY we are always diligent in our efforts to avoid significant portions of bearish regimes. Ned Davis research: 74% time recovering from cyclical downturns since 1900.

1 10 100 1000 1/2/1930 1/2/1932 1/2/1934 1/2/1936 1/2/1938 1/2/1940 1/2/1942 1/2/1944 1/2/1946 1/2/1948 1/2/1950 1/2/1952 1/2/1954 1/2/1956 1/2/1958 1/2/1960 1/2/1962 1/2/1964 1/2/1966 1/2/1968 1/2/1970 1/2/1972 1/2/1974 1/2/1976 1/2/1978 1/2/1980 1/2/1982 1/2/1984 1/2/1986 1/2/1988 1/2/1990 1/2/1992 1/2/1994 1/2/1996 1/2/1998 1/2/2000 1/2/2002 1/2/2004 1/2/2006 1/2/2008 1/2/2010 1/2/2012 1/2/2014 S&P 500 New Growth Bear Recovery

50 500 5000 1/1/1916 8/1/1917 3/1/1919 10/1/1920 5/1/1922 12/1/1923 7/1/1925 2/1/1927 9/1/1928 4/1/1930 11/1/1931 6/1/1933 1/1/1935 8/1/1936 3/1/1938 10/1/1939 5/1/1941 12/1/1942 7/1/1944 2/1/1946 9/1/1947 4/1/1949 11/1/1950 6/1/1952 1/1/1954 8/1/1955 3/1/1957 10/1/1958 5/1/1960 12/1/1961 7/1/1963 2/1/1965 9/1/1966 4/1/1968 11/1/1969 6/1/1971 1/1/1973 8/1/1974 3/1/1976 10/1/1977 5/1/1979 12/1/1980 7/1/1982 2/1/1984 9/1/1985 4/1/1987 11/1/1988 6/1/1990 1/1/1992 8/1/1993 3/1/1995 10/1/1996 5/1/1998 12/1/1999 7/1/2001 2/1/2003 9/1/2004 4/1/2006 11/1/2007 6/1/2009 1/1/2011 8/1/2012 3/1/2014 10/1/2015 100 YEARS DJIA New Growth Bear Market Recovery New Growth 37.4% Bear 15.2% Recovery 47.4%

50 500 12/1/1969 9/1/1970 6/1/1971 3/1/1972 12/1/1972 9/1/1973 6/1/1974 3/1/1975 12/1/1975 9/1/1976 6/1/1977 3/1/1978 12/1/1978 9/1/1979 6/1/1980 3/1/1981 12/1/1981 9/1/1982 6/1/1983 3/1/1984 12/1/1984 9/1/1985 6/1/1986 3/1/1987 12/1/1987 9/1/1988 6/1/1989 3/1/1990 12/1/1990 9/1/1991 6/1/1992 3/1/1993 12/1/1993 9/1/1994 6/1/1995 3/1/1996 12/1/1996 9/1/1997 6/1/1998 3/1/1999 12/1/1999 9/1/2000 6/1/2001 3/1/2002 12/1/2002 9/1/2003 6/1/2004 3/1/2005 12/1/2005 9/1/2006 6/1/2007 3/1/2008 12/1/2008 9/1/2009 6/1/2010 3/1/2011 12/1/2011 9/1/2012 6/1/2013 3/1/2014 12/1/2014 9/1/2015 EAFE 1970-2015 New Growth Bear Recovery New Growth 42.3% Bear 19.0% Recovery 38.7% EAFE

The simple math of losses and recovery

Impact of MARKET REGIME CHANGE INDICATOR

Many ways to measure regime change 200 day moving average most popular MACD 2 average cross Simple in design Not optimized Whipsaws can occur Must be a bold portfolio action Out of a tough corrective action will come the next bear Bearish regime lows are the great MISPRICING event (cash)

STOCK BASKETS

Why can t 95% of mutual funds beat the S&P 500? Why can t ETF s beat the S&P 500? What common characteristics do these under performers possess? Why stock baskets?

The Capitalism Distribution Observations of individual common stock returns, 1983 2007 39% of stocks had a negative lifetime total return (2 out of every 5 stocks are a money losing investment) 18.5% of stocks lost at least 75% of their value (Nearly 1 out of every 5 stocks is a really bad investment) 64% of stocks underperformed the Russell 3000 during their lifetime (Most stocks can t keep up with a diversified index) A small minority of stocks significantly outperformed their peers (Capitalism yields a minority of big winners that all have something in common) The following slides make the case for the Capitalism Distribution, a non-normal distribution with very fat tails that reflects the observed realities of long-term individual common stock returns.

An investor s portfolio missed the 20% most profitable stocks between 1989 and 2015. Instead, he invested in only the other 80%. His total gain would have been 0%. Eric Crittenden of Longboard funds

23.7% of all dramatically underperformed the S&P 500 by 200%

60 day ROC of S&P 500 stocks (in bullish regimes) % Annual Return # of Trades 400 200 16.4% 16.2% 17.4% 17.7% 19.9% 0-200 178-400 373-600 534 697-800 855-1000 50 Stocks 40 Stocks 30 Stocks 20 Stocks 10 Stocks

30.0% 20.0% % Annual Return Max Drawdown 16.4% 16.2% 17.4% 17.7% 19.9% 10.0% 6.2% 0.0% -10.0% -20.0% -30.0% -40.0% -26.6% -26.6% -30.8% -31.4% -35.4% -50.0% -60.0% -70.0% 50 Stocks 40 Stocks 30 Stocks 20 Stocks 10 Stocks S&P 500-56.8%

Our database covers all common stocks traded on the NYSE, AMEX and NASDAQ since 1989, including delisted stocks. Its not what you own its what you don t own is most important The efficient approach is to strategically avoid the many underperformers

After 20-30 stocks the amount of risk that can be diversified away becomes significantly less and less and adding more stocks at this stage: Actually hinders returns more than mitigating risk.

Impact of a regime change indicator 21week ema <> 34week ema (INDEX AND STOCKS)

MOMENTUM

10 Stocks with 20 100 ROC

10 Stocks with 20 100 ROC (with market regime)

60day ROC owning 10 50 stocks

Impact of momentum enhanced algorithms

$SPX $NDX

(momentum) * (multiplier) / (smoothing agent) 1. Various ROC measures 2. Various multipliers (macd, another ROC, weighted ROC, relative strength) 3. Denominator for smoothing momentum: ulcer, ATR, Alpha Architect

DIVERSIFICATION

DIVERSIFICATION = Offsetting RETURNS DRAWDOWNS VOLATILITY

NDX SPY

SP100 = 40% $NDX = 40% IEF = 20% MDD = 11.41%

With algorithm enhancements and blended diversification you can determine investment outcomes by return, volatility and you can beat the S&P 500

SP100 = 40% $NDX = 40% XLU = 20% IEF = 100% in bearish regime CAR/MDD = 1.23

TRADING FREQUENCY (individual stock management) AND TAX EFFICIENCY

Example of improving the quality of returns with fewer trades

IF 2 STRATEGIES BOTH EARN 10% IN A YEAR: Strategy A is 100% taxed at short term rate (40%) Strategy B is 100% taxed at long term rate (20%) 1. Strategy A must earn 33% greater return for equal after tax returns 2. Strategy B can earn 25% less return and have equal after tax returns ***(A simple example)

1. Strategy A must earn 33% greater return for equal after tax returns 2. Strategy B can earn 25% less return and have equal after tax returns 100 X.10 110 10 dollars long term capital gains (20%) = $8 100 X.10 110 10 dollars short term capital gains (40%) = $6 Strategy A $13.33 X.6 = $8 Strategy B $7.5 X.8 = $6

An example of capturing long term gains for tax purposes can be found when using a momentum selection criterion in a bullish market regime ($SPX) with the ranking mechanism ROC60* MACD from 1995-2015. The average winning percentage was 72%. The average winning trade gained 104.7%. The average winning bars held was 399 days. Conversely, the average losing trade lost -12.3%. The average losing trade bars held was 153 days. There were 116 stock purchases (10 at start of each bullish regime). Of the stocks purchased, 50 were original buys (5 bullish legs), 18 were stock buy outs, and 48 were traded as they met sell criteria during the bullish regime. The appendix specifies the trade dates, holding periods and yearly tax treatment.

Quick Review and Take Aways The strategy is a long only strategy using highly liquid stocks from the major indexes The strategy is an active effort to exploit anomalies in a bullish regime through stock basket selection and management. Between 60 and 70% of time the markets are either in a bearish mode (falling) or recovering from one to a new high. One of the most rewarding aspects of negotiating a bearish regime is there is ample liquid assets available to take advantage of the significant mispricing event that presents itself as the new bullish regime initiates. (true value) A significant portion of basket momentum outperformance comes from the avoidance of negative momentum stocks. Indices and ETF s must hold positions while having no consideration for positive or negative performance. Index returns depend heavily on the relatively small set of winners. The top 10 stocks have usually accounted for between 40-60% of the market s total return. The few rule the many. All big winners have a common theme: They consistently exhibited powerful momentum in bullish regimes. There is ample evidence to exploit the momentum effect in bullish regimes with only a limited number of stocks. The more stocks held in each basket (more than 20-30 ) inhibits return rather than mitigating risk.

We have strong evidence of momentum profits increasing as the number of stocks in the portfolio decreases. Owning more than 30 stocks is an unnecessary expense item. Momentum is not enough. The proprietary Trademark algorithms used for momentum enhancement must either improve returns and/or reduce risk in a bullish regime. Simplicity and robustness go hand in hand. The algorithms are applicable for selecting stocks from any index, country, or sector. There is significant offsetting "characteristics when selecting stocks from multiple indices. This offsetting effect occurs both in returns and volatility. Simply, the indexes exhibit different characteristics. The liberal management scheme allows the extended holding periods for the high momentum stocks to achieve long term tax treatment and reduce trading costs. Trading more and using stop loss features usually have a negative effect on returns. The fewer the rules, the simpler the methods, the more likely it will keep working. Become agnostic about the future (IIWII). Follow your management rules.

HERE ARE USUAL QUESTIONS: Did you optimize for these returns? Will you be capable of capturing these type returns in the future? What kind of capacity does a portfolio of 20-30 stocks have? Does trading more give better returns? Rotation system? How sensitive is the start date in achieving these results? How is this strategy different than most stock basket strategies? How do you know when to sell a stock? What are the costs associated with buying individual stocks? Can you use this strategy in a bear market? What are the opportunities for an individual investor? What is the current status of the regime change indicator? Do you have personal money committed to this basket strategy? How long have you been practicing this strategy? Success?

THANKS Don Beasley Trademark Capital dbeasley@trademarkcapital.com Cell 706 247 9556

CONCLUSIONS This paper finds evidence of: 1. Using a market regime measure can enhance returns, reduce maximum drawdown, and increase Sharpe and Sortino ratios. 2. Momentum profits increase and risk adjusted measures rise as the number of stocks in the portfolio decreases with limited additional volatility. 3. Using algorithm multipliers can significantly add value to basic momentum measures by enhancing returns and/or reducing volatility. 4. Diversification among major indexes enhances returns and reduces volatility. 5. Long term management measures (not calendar rebalancing) enhance tax treatment of returns, minimizes trading costs, and increases capacity.

EVERY INDEX MUTUAL FUND SECTOR BOND ETF STOCK STOCK BASKET IS EITHER IN AN UP OR DOWN TREND AND IS IN EITHER A BULL OR BEAR MARKET

MORNINGSTAR STYLE BOXES

REDNECK STYLE BOXES Going UP Going DOWN