How to Earn Double-Digit Returns While Avoiding Major Down Markets - PowerPoint PPT Presentation

One California Street, Suite 2800 San Francisco, CA 94111 (415) 249-6337 www.deltaim.com How to Earn Double-Digit Returns While Avoiding Major Down Markets in a Safety-First Approach AAII Chapter Meeting March, 2014

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The Bond and Interest Rate Investment Challenge

The 30 Year Bond Bull Market… Nominal and Real 10-year Treasury Yields 20% Yields Decline 90% Sep. 30, 1981: 1981 - 2012 15.84% Average 12/31/13 30-yr. Bond Bull 15% Nominal Yields 6.36% 3.04% Market Real Yields 2.53% 1.32% 10% Nominal 10-year Treasury Yield Dec. 31, 2013: 3.04% 5% Real 10-year Treasury Yield 0% Falling Rate Corp. Bonds S&P 500 Rising Rate Corp. Bonds S&P 500 Dec. 31, 2013: 1.32% 1982-2012 10.1% 11.0% 1958-1981 3.0% 8.6% Ann. Inflation 3.1% 3.1% Ann. Inflation 5.0% 5.0% Ann. Real Return 6.8% 7.7% Ann. Real Return -2.0% 3.5% -5% '60 '65 '70 '75 '80 '85 '90 '95 '00 '05 '10 Source: Federal Reserve, BLS, J.P. Morgan Asset Management.

Warren Buffett – May 6, 2013, USA Today  Doesn’t like owning bonds right now, and he doesn’t think average investors should either.  “Bonds are a terrible investment at the moment” and “owners of long-term bonds may see big losses.” iShares 20+ Year Treasury Bond Fund (TLT) May - Dec. 31, 2013 - 18%

Interest Rates Bernanke Speech – March 1, 2013

The Stock Investment Challenge

Volatility without Overall Market Appreciation Sustainable S&P 500 Index Characteristic Mar-2000 Oct-2007 Dec-2013 Dec. 31, 2013 Breakout? P/E (fwd.) = 15.4x Index level 1,527 1,565 1,848 1,848 P/E ratio (fwd.) 25.6x 15.2x 15.4x 1,800 Dividend yield 1.1% 1.8% 1.9% 10-yr. Treasury 6.2% 4.7% 3.0% Mar. 24, 2000 Oct. 9, 2007 1,600 P/E (fwd.) = 25.6x P/E (fwd.) = 15.2x 1,527 1,565 1,400 +101% +106% +173% 1,200 -57% -49% 1,000 Flat Trend Line 800 Dec. 31, 1996 Oct. 9, 2002 Mar. 9, 2009 P/E (fwd.) = 16.0x P/E (fwd.) = 14.1x P/E (fwd.) = 10.3x 741 777 677 600 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 Source: Standard & Poor’s, First Call, Compustat, FactSet, J.P. Morgan Asset Management. Problem 1: Stock Investment Not Growing As Expected

Uncertain Future S&P 500 Index Characteristic Mar-2000 Oct-2007 Dec-2013 Dec. 31, 2013 P/E (fwd.) = 15.4x Index level 1,527 1,565 1,848 1,848 P/E ratio (fwd.) 25.6x 15.2x 15.4x 1,800 Dividend yield 1.1% 1.8% 1.9% New Bull 10-yr. Treasury 6.2% 4.7% 3.0% Market? Mar. 24, 2000 Oct. 9, 2007 1,600 P/E (fwd.) = 25.6x P/E (fwd.) = 15.2x 1,527 1,565 1,400 +101% +106% +173% 1,200 -57% -49% 1,000 History Repeats? 800 Dec. 31, 1996 Oct. 9, 2002 Mar. 9, 2009 P/E (fwd.) = 16.0x P/E (fwd.) = 14.1x P/E (fwd.) = 10.3x 741 777 677 600 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13 Source: Standard & Poor’s, First Call, Compustat, FactSet, J.P. Morgan Asset Management. Problem 2: Protecting Investment From Major Loss

115 Year History of the Market: 1896 – 2011  The market typically moves in cycles. 11 years  There have been four bull markets (shown in green ) and four bear markets (shown in red). 18 years  Investment strategies that work in bull markets may not be effective in flat or bear markets.  72 years are red – 63% 16 years  43 years are green – 37% 12 years 25 years 5 years 18 years 9 years 1896 1906 1924 1929 1954 1966 1982 2000 2011 Dow Jones Industrial Average from December 1896 through December 2011 Graph created by Guggenheim Investments using data from www.dowjones.com

Extreme Bull/Bear Weeks Bear (Red) Weeks: 63% Bull (Green) Weeks: 37%

Recent History of Bear Markets Over the past 30 years, the U.S. stock market has suffered a Bear Period (greater than 20% decline) about once every 6 years or 17% of the time. Duration Recovery Bear Market Decline New Market High (Months) (Months) Nov. 1980-Aug.1982 22 -28.0% Nov. 1982 3 Aug. 1987-Oct.1987 3 -35.9% Jul. 1989 21 Jul. 1990-Oct.1990 4 -20.3% Feb.1991 4 Jul 1998-Oct. 1998 4 -22.4% Nov. 1998 1 Mar. 2000-Oct. 2002 32 -50.5% Jul. 2007 57 Oct. 2007-Mar. 2009 17 -57.7% Apr. 2013 49

Making Back What Was Lost Takes Time Especially During Red Periods SECULAR BEAR MARKET 1965-1981

Difficulties with Diversification  Negative Market Events Happen More Frequently than a Normal Distribution Suggests  Correlations Migrate Towards 1 During a Crisis

Avoiding the Downs is More Important Than Catching the Ups

What Happens When Interest Rates Rise? Correlations Between Weekly Stock Returns and Interest Rate Movements Weekly S&P 500 returns, 10-year Treasury yield, rolling 2-year correlation, 1963-2013 0.8 When yields are below 5%, rising rates are 10-yr Treasury < 5% 0.6 generally Positive associated with Rising rates and rising stocks relationship rising stock between yield prices 0.4 movements Correlation Coefficient and stock Current 10-yr yield 1.75% returns 0.2 0 -0.2 Negative relationship -0.4 between yield movements and stock returns -0.6 -0.8 0% 2% 4% 6% 8% 10% 12% 14% 16% 10-Year Treasury Yield Source: Standard & Poor’s, US Treasury, FactSet, J.P. Morgan Asset Management. Returns are based on price index only and do not include dividends. Grey bars in the right chart represent the historic range in correlations for each sector. Data are as of 6/30/13.

How Do you Protect and Grow Your Portfolio?  Over the past 30 years, severe equity losses have occurred 17% of the time or about once every six years.  Diversification is not providing the portfolio protection it is expected to because correlations are not static.  Bonds may have entered a secular bear market.  Your personal investment horizon may not allow time for you to make back what was lost

Average Investor Returns – Past 20 Years 20-year Annualized Returns by Asset Class (1993 – 2012) 12% 11.2% 10% 8.4% 8.2% 8.1% 8% 6.5% 6.3% 6% 4% 2.7% 2.5% 2.3% 2% 0% REITs Gold S&P 500 Oil EAFE Bonds Homes Inflation Average Investor Source: J.P. Morgan Asset Management

BAD Timing Fund Flows AUM YTD 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 Billions, USD Domestic Equity 5,026 15 (156) (132) (81) (29) (149) (65) (0) 18 101 120 (26) 55 261 176 149 World Equity 1,763 91 3 4 58 28 (80) 139 149 106 71 24 (3) (22) 53 11 8 Taxable Bond 2,795 19 254 137 224 310 21 98 45 27 5 40 125 76 (36) 8 59 Tax-exempt Bond 515 (32) 50 (12) 11 69 8 11 15 5 (15) (7) 17 11 (14) (12) 15 Hybrid 1,126 59 46 29 29 12 (25) 41 18 37 48 38 8 9 (36) (14) 10 Money Market 2,633 (68) (0) (124) (525) (539) 637 654 245 62 (157) (263) (46) 375 159 194 235 Source: J.P. Morgan Asset Management • Steady Outflows from Domestic Equity Since Market Low – Peaking in 2012 • Steady Inflows into Taxable Bond Funds – Near Peak Inflow 2012 • Peak Equity Inflow 2000

Pie Based Emotions Based Investing Investing Frequent Strategy Changes Based on Bonds Second Guessing, Secular Bear? Stocks Reacting to Headline News, Downside Rear-view Mirror Approach, Volatility Etc.

Stock Buybacks

Solution: A Tactical Approach Tactical, Disciplined, Systematic Investing  Avoid major bearish moves  Participate in bullish equity moves

Tactical Investing  Adjusting investment exposure based on market risks Tactical investing is active management, not buy-and-hold  Avoid bearish markets and participate in bullish markets Delta’s allocation changes are based on non-emotional, systematic model driven investment methodologies.  Tactical investing is like having insurance Insurance policies are not perfect but they go a long way towards mitigating loss.

Delta Tactical Good Harbor 4 Delta Tactical Good Harbor 3.5 Participate in 3 Bullish Markets 2.5 S&P 500 Total Return 2 1.5 Avoid Major 1 Bearish Markets 0.5 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Important Disclosure: Past performance does not guarantee future results. Consider the investment objectives, risks, charges, expenses, and instruments used to implement a strategy before investing.. See full disclosures on website.

Delta Tactical Good Harbor Returns, May 2003 – Sep. 2013 Quintile Review Delta Good Harbor S&P 500