Dr. Gary J. Harloff, Ph.D. Harloff Capital Management (HCM)

Dr. Gary J. Harloff, Ph.D.

Harloff Capital Management (HCM)

Registered Investment Advisory Firm, 1994

Monthly newsletter: The Intelligent Fund Investor, 1993

795 Sharon Dr., St. 226, Westlake, Oh 44145

Meetings by appointment

440-871-7278, www.harloffcapital.com

Market Timing: Important Again 9-3-2009, Porter Library, Westlake, Oh

Disclaimers

Educational, not investment advicenot actual performancepast performance does not insure

future performancethought to be accurate and not

guaranteed

Educational talk outline

Harloff background & what he doesWhy market timingMarket timing overviewBusiness cycle and market timingTechnical Analysis indicators: Pro & ConExample of HCM’s advanced technologyCurrent market conditionsSummary and conclusions

Harloff background

Specialist in tactical portfolio management: significant original investment research, 1970-2009

regional and national contests in 1980s,1990s authored “Dynamic Asset Allocation: Beyond Buy and

Hold”, 1-1998 Stocks & Commodities (on web site) author book : Active Investing Wealth-Management for

High Net Worth Individuals, 2007, 2008 Ph.D. AeroSpace Engineer, 27 years, 100+ papers/

reports; 2 international papers, ....rocket science 1970 jet engine coworker in S. Florida said “nobody can

model the stock market”- personal challenge

Harloff does

Tactical portfolio management, fee-based Time markets, countries, sectors, funds, ETF’sAlternate investment for accredited investorsMonthly timing newsletter for self managers:

“The Intelligent Fund Investor”: time funds, S&P500, bond, & gold, examples

Investment speaker at AAII chapters: Louisville Ky, St. Louis, Mo, and Fl West Coast, Fl Central, and Fl SouthWest: Sept. 2009

Post Modern Quantitative Analysis: not TA

Average investor compound return is 9.24%/year LESS THAN

S&P500 compound return %/year* BEFORE COMMISSIONS & FEES

1984- 1984- 1984- 1984- 1987- 1988 1997 1998 2000 2002 2007 2008

Avg. investor,% 6.7 7.25 5.32 2.57 4.5 1.87

S&P500,% 17.1 17.90 16.29 12.22 11.8 8.35

Avg. -S&P500 -10.4 -10.65 -10.97 -9.65 -7.3 -6.48

*source: Dalbar Inc. Financial Services of Boston, Ma., Quantitative Analysis of Investor Behavior Study 1997, 1998, 2000, 2003, 2008, 2009 updates

Professional Money Managers

5 to 10% beat S&P500 in any given year

Question- who do you want managing your portfolio?

Investing is hard because:Markets changechange inconsistent with buy-and-holdcompanies fail over time (GM stock =>

zero)capital leadership shifting from US to Asiamanufacturing already exported from USservice jobs being exported from USnew industries born/die every 3 yearsWho makes ongoing asset allocation

changes for you?

Why market timing?

Bear markets: investor losses $ and faith in buy-and-hold strategy/advisor

When buy-and-hold performs there is less interest in market timing

Bull market asset allocation different than bear market asset allocation

Need for ongoing asset allocationBusiness cycle aspect important

Market timing overview

Old as Dow theory: buy (sell) when transportation and industrials are both going up (down)

Buy/sell = timing; opposite of buy-and-hold Big question is what to buy/sell and when Most planners/brokers: timing is a waste of time Most mutual funds have trading constraints ETF’s- no limitations: will overtake mutual funds

Market timing, cont’d

Form of risk management (not insurance) No single method or product; many

approaches Time consuming, sometimes works/doesn’t Not taught in MBA programs at university Not taught to CFP/CFA pass-exam designees Planners/brokers are generalists and not

portfolio managers; mostly buy-and-hold diversified portfolios for long term. No market timing. Product sales may lead to conflict of interest.

Timing is all about:

Buy low and sell highidentifying what to buy/sell wheninvest in up markets and not (or

short) in down marketsinvest in good sectors, indexes,

countries when they have profit potential and not when they don’t

Markets

Don’t have laws of motion...not predictable

Quantitative systems of HCMMany try to build “logical systems”Many look for patterns to repeatTechnical analysis is used by many

Timing is advanced technology

Many planners/brokers: timing is irrelevant

Investors feel the pain of buy-and-hold during bear markets.

May lose faith in buy-and-hold stay-the-course advice

Many investors wonder if advisor knows anything more than investor knows

Recent bear market losses, so timing is back in favor as an investment strategy

One approach: Technical Analysis (TA) indicators, pros & cons

Price higher/lower than 20 week ave (MA)21 day moving average, 30 week MA, etc.What MA or EMA to use when?momentum = price (t)/price (t-dt)Relative strength index, RSI= [p(t) / P(t-

dt)] /[ S&P500(t) / S&P500(t-dt)]The Encyclopedia of Technical Market

Indicators, Robert W. Colby, McGraw-Hill, 2003, 820 pg. >100 technical indicators

TA indicators: Pros & Cons, cont’d

Qualitative: people read same chart differentlyMany use TA, ubiquitous, on-line graphsSold in many cities through infomercialsFun: lots of indicators to discuss and reviewGraphics appealing and requires judgement;

beauty in the eye of the beholder Indicators may not work for different markets,

sectors, indexes, (ex. gold or bonds)

TA indicators: Pros & Cons, cont’d

Usually relative, rarely absolute: may ride down when market goes down

Empirical: don’t know when TA will stop working Gives hope ........that individual can compete

with professions with much more sophisticated analyses and computer power

Individual up against Ph.D.’s, banks, hedge funds

To win, need better tools or intuition than banks!

Doesn’t account for business cycle concepts

HCM gave up on TA as an investment system

In early 1990’s Harloff found computerized back-testing of TA indicators not profitable

Graphs different than back-testing indicators Indicator overload: one says buy another sellTA: may lead to false sense of capabilityOne index illustrative even if it lags

Vix index: 11 month delayed risk surrogate, recession started Dec. 2007

Other strategies

Buy-and-hold a diversified portfolio: usually cite MPT:1952 method (Nobel prize)

MPT all in all for planners/brokersSome count Morningstars: based on 3 year

averages=> not profitable in bear market60/40, 40/60 equity/bond ratio (buy-hold)Age dependent: older- buy more bonds Endowment practicesBusiness cycle concepts

Buy-hold a diversified portfolio Nobel prize method- problems

1952 technology called “modern”: pre computer

Markowitz in 1952 developed “MPT”MPT (buy-hold)=> not useful in bear marketNon-correlated assets supposed to lower

portfolio risk, but don’t, assets highly correlated today

Statistics input into computer programs are assumed constant........ but aren’t

Return vs. Risk is time dependent (HCM analysis)

Return vs risk; Harloff Capital Math Model 8-14-09

-1

0

1

2

3

4

5

0 1 2 3 4 5 6 7 8

sigma, %

retu

rn, %

/wk

5/14/2009 6/15/2009

7/14/2009 8/14/2009

60/40, 40/60... ratio

Many retail advisors: 60/40 equity/bond ratio w/o regard to market conditions

May be optimum ratio if correctly forecast: (1) market return vs. risk, & (2) risk tolerance

60/40 not optimal in bear or bull market Market return vs. risk always changesIvy league endowments use 86/14, see

next slide

Ivy League endowment allocation 86/14 (source Barrons, 6-29-09)

Asset Avg. endowment allocation, %

Est. 12 mo. return since June 2008, %

Hedge funds (accredited investors only)

22 -20

Domestic equity

22 -27

Bonds 12 6 Foreign equity 20 -31 Private equity 9 -50 Real estate, timber, oil and gas

14 -47

Cash 2 2 Average return S&P500 = (-) 28.55%

(-) 22.9

Market timing & business cycle (BC) sector rotation (source: S. Stovall’s S&P’s Guide to Sector Rotation)

Stage: Full Recession

Early Recovery

Full Recovery

Early Recession

Consumer Expectations:

Reviving Rising Declining Falling Sharply

Industrial Production:

Bottoming Out

Rising Flat Falling

Interest Rates:

Falling Bottoming Out

Rising Rapidly (Fed)

Peaking

Yield Curve: Normal Normal (Steep)

Flattening Out

Flat/Inverted

Sector rotation model

Does sector rotation outperform business cycle investing? Relative performance from 1948-2006

(source:J.Stangl, B. Jacobsen, N. Visaltanachoti, Massey U., Dept of Commerce)

Optimal sector rotation (20/20 hindsight) timing business-cycles stages earned 2.01% alpha

Apparent out performance is quickly dissipated without hindsight and transaction fees

Alternate strategy switch to cash as business cycle enters a recession: superior returns to sector rotation

Market timing invests fully for all periods except the first period of a recession when only cash is held.

The terminal value for market timing is slightly higher than sector rotation at $1,142 and $1,094 respectively.

Does sector rotation outperform business cycle investing? Relative performance from 1948-2006 (cont’d)

Overall, market timing (0.18) also outperforms sector rotation (0.15) from a Sharpe ratio perspective.

Market timing advantage: forecast 1 business-cycle stage rather than 5 stages & lower transaction fees

Market timing: better diversification than sector rotation. Even for an investor with the ability to correctly time business cycles, a simple market-timing strategy would be optimal to sector rotation.

Conclusion: contrary to conventional market wisdom, rotating sectors over business cycles is not an optimal investment strategy and question the widespread acceptance of sector rotation.

Business Cycle Timing: source:(J.Stangl, B. Jacobsen,

N. Visaltanachoti, Massey U., Dept of Commerce paper)

Harloff & Eacott business cycle study

“U.S. Business Cycle Math Quantification”, Harloff and Eacott

Need reliable real time analysis as to when recession starts, NBER often 12 months late

Analyzed 32 business cyclesDeveloped new equations for expansion

and recession cycles

Used NBER dates and duration of 32 complete

expansion and recession from 1854 to 2001

Home-work for later BC math modeling

Free paper on web site, www.harloffcapital.com/articles.html

andwww.scribd.com/doc.../US-Business-

Cycle-Math-Quantification

Business

cycle no.

Trough Peak Trough Expansion(m

o)

Recession

(mo)

Total (mo)

Expansion/total =

ER

Recession/total

= RR

1854-1919

1 Dec-1854 Jun-1857 Dec-1858 30 18 48 0.63 0.38 2 Dec-1858 Oct-1860 Jun-1861 22 8 30 0.73 0.27

3* Jun-1861 Apr-1865 Dec-1867 46 32 78 0.59 0.41 4 Dec-1867 Jun-1869 Dec-1870 18 18 36 0.50 0.50

5* Dec-1870 Oct-1873 Mar-1879 34 65 99 0.34 0.66 6* Mar-1879 Mar-1882 May-1885 36 38 74 0.49 0.51 7 May-1885 Mar-1887 Apr-1888 22 13 35 0.63 0.37 8 Apr-1888 Jul-1890 May-1891 27 10 37 0.73 0.27 9 May-1891 Jan-1893 Jun-1894 20 17 37 0.54 0.46

10 Jun-1894 Dec-1895 Jun-1897 18 18 36 0.50 0.50 11 Jun-1897 Jun-1899 Dec-1900 24 18 42 0.57 0.43

12* Dec-1900 Sep-1902 Aug-1904 21 23 44 0.48 0.52 13 Aug-1904 May-1907 Jun-1908 33 13 46 0.72 0.28

14* Jun-1908 Jan-1910 Jan-1912 19 24 43 0.44 0.56 15* Jan-1912 Jan-1913 Dec-1914 12 23 35 0.34 0.66 16 Dec-1914 Aug-1918 Mar-1919 44 7 51 0.86 0.14

1919-1945

17 Mar-1919 Jan-1920 Jul-1921 10 18 28 0.36 0.64 18 Jul-1921 Mar-1923 Jul-1924 22 14 36 0.61 0.39 19 Jul-1924 Oct-1926 Nov-1927 27 13 40 0.68 0.33

20* Nov-1927 Aug-1929 Mar-1933 21 43 64 0.33 0.67 21 Mar-1933 May-1937 Jun-1938 50 13 63 0.79 0.21 22 Jun-1938 Feb-1945 Oct-1945 80 8 88 0.91 0.09

1945-2001

23 Oct-1945 Nov-1948 Oct-1949 37 11 48 0.77 0.23 24 Oct-1949 Jul-1953 May-1954 45 10 55 0.82 0.18 25 May-1954 Aug-1957 Apr-1958 39 8 47 0.83 0.17 26 Apr-1958 Apr-1960 Feb-1961 24 10 34 0.71 0.29 27 Feb-1961 Dec-1969 Nov-1970 106 11 117 0.91 0.09 28 Nov-1970 Nov-1973 Mar-1975 36 16 52 0.69 0.31 29 Mar-1975 Jan-1980 Jul-1980 58 6 64 0.91 0.09 30 Jul-1980 Jul-1981 Nov-1982 12 16 28 0.43 0.57 31 Nov-1982 Jul-1990 Mar-1991 92 8 100 0.92 0.08 32 Mar-1991 Mar-2001 Nov-2001 120 8 128 0.94 0.06 33 Nov-2001 Dec-2007 NA 73 NA 73 NA NA

Harloff BC math model: system of 9 ODE’s, cycles about 5 years, preliminary

Business Cycle, Harloff Capital Math Model, 9 variable ODE, 7-5-09

-0.200.000.200.400.600.801.001.201.401.601.80

0 2 4 6 8 10

years

GDP

unemployment

net profits

HCM math model of BC

Looking for unpaid researcher to join me in math modeling b.c. (8-16 system of stiff ODE’s).

HCM has running computer program, call me!

Need to be able to solve stiff system of ODE’s

HCM 3 new quantitative systems (not TA)

Significant resources expensed over many years by Ph.D.: HVI, trade, and vector.

Quantitative calculations and statistics to manage portfolios

Universal indexes, absolute momentum Compute, rank, sort funds

1) Harloff Value Index (HVI) system (>16 yrs) 2) Vector system (> 16 years) 3) Trade system (several years)

Current Market Conditions

The Intelligent Fund Investor monthly newsletter, 8-21-09 issue

employs Harloff Value Index (HVI) for all funds and indexes

The Intelligent Fund Investor Newsletter, employs HVI; Current Market Conditions

Performance of portfolios and timing calls

History of portfolios and tradesTiming S&P500, NDX, gold, bondsHVI used to select portfoliosExample how to use newsletter analysis

The Intelligent Fund Investor, 8-21-09

Portfolio Performance_ ________________YTD, % Ave of three portfolios (-11.54% 2008)........ 47.18Dynamic Frontier portf. ( -3.20% 2008)......... 26.61No-Load Agg Gr portf. ( -0.45% 2008)......... 56.13Rydex portfolio...............(-30.97% 2008)......... 58.81S&P500 index.2009......(-38.49% 2008).......... 13.60NDX100 index.2009.....(-41.89% 2008)........... 35.17

The Intelligent Fund Investor timing signals, 8-21-09

Market Timing, long term gain,%

S&P500: 08/21/09 1026.13 33.51

last signal(e): buy 03/20/09 768.54 NDX100: 08/21/09 1637.78 37.96

last signal(e): buy 03/20/09 1187.18 Gold, XAU: 08/21/09 147.37 -1.42

last signal(e): buy 07/24/09 149.50 US10 yr bnd yield %: 08/21/09 3.56 0.00

last yield signal(e): sell 08/21/09 3.56

INDEX FUNDS

1 ProFunds INV:Banks Ultra BKPIX g 544. 0. 6.94 36.9 43.1 7.7 4.6 1.4 5.6 h b 2 ProFunds INV:UltraSector REPIX sr 464. -9. 12.86 23.8 42.6 7.9 1.8 1.1 5.4 h b 3 ProFunds INV:UltraSector FNPIX sf 411. -4. 6.83 23.5 37.1 4.7 3.9 1.7 7.9 h b 7 ProFunds INV:Ultra MidCa UMPIX i 311. -10. 22.68 12.3 41.7 2.9 -0.1 2.1 14.4 h b 8 Rydex LargeCap Value-H RYZAX i 309. -5. 64.30 15.6 28.7 3.2 2.6 1.9 8.9 h b 9 ProFunds INV:Ultra Small UAPIX i 309. -8. 11.48 12.2 45.3 2.9 -0.7 2.1 15.8 h b 10 Rydex SmallCap Value RYAZX i 306. -9. 24.51 14.6 45.7 2.1 1.6 2.8 21.4 h b 11 ProFunds INV:Basic Mater BMPIX g 293. -13. 29.20 10.9 27.7 3.3 -0.6 1.7 8.5 h b 13 Rydex Real Estate-H RYHRX i 282. -9. 19.81 14.6 27.3 4.6 1.6 1.2 6.0 h b 14 Rydex Titan 500-H RYTNX i 269. -7. 18.77 10.5 34.6 1.9 0.5 2.7 17.9 h b 15 Rydex Long Dynamic Dow 3 RYCVX i 260. -9. 14.57 9.6 32.2 2.2 -0.1 2.3 14.9 h b 16 ProFunds INV:Ultra Dow 3 UDPIX i 258. -9. 18.70 9.5 31.4 2.2 -0.1 2.3 14.5 h b 17 ProFunds INV:Ultra Bull/ ULPIX i 256. -8. 27.63 9.7 32.5 2.0 0.0 2.4 15.9 h b 18 Rydex MidCap Value-H RYAVX i 252. -11. 23.88 11.7 30.8 2.4 0.9 2.0 12.8 h b 19 ProFunds INV:Ultra Secto IDPIX g 248. -9. 22.25 10.9 26.6 2.2 0.8 2.2 12.3 h b 20 Rydex INV:Banking/242 RYKIX sf 243. -5. 45.99 15.2 19.9 3.8 2.8 1.2 5.2 h b

8-21-09 R-F obj HVI %ch nav 4wk 13w rsk rsk HVI 13w rsk b/ adj rsk rsk lvl s

The Intelligent Fund Investor absolute momentum, 8-21-09

Table 3, HVI, change, nav, 4wk % change, 13 wk % change, risk, risk adjusted, HVI/risk, 13 wk/risk, risk level (high, medium, low), and buy/sell

Current market conditions, cont’d, S&P500 buy signal

The Intelligent Fund Investor Monthly Newsletter: 3 Portfolios, 8-21-09 may differ from managed account portfolios

Dynamic Frontier , Ticker % Direx Latin Am, DXZLX 34 Rydex SmCp Vlu, RYAZX 33 Rydex Titan, RYTNX 33

No-load, Aggressive, Ticker %ProFnds U Bank, BKPIX 34ProFnds U Real Est, RYPIX 33

ProFnds U MdCp, UMPIX 33

Rydex Real Est, RYHRX 33Rydex Sm Cp Vl, RYAZX 33

Rydex LgCp Vl, RYZAX 34

Rydex Portfolio, Ticker %

Optimal timing with HCM’s “trade” system

Trade: single system that times S&P500, oil, bonds, .... All funds

Trade computes optimal timing for each fund and index

Trade system: different signals for each

HCM S&P500 optimal timing: 167%

HCM Oil optimal timing: 123%

HCM 30-year yield (inverse bond) optimal timing: 211.%

Summary and conclusions

average individual under-performs S&P500 by 9.24% before commissions and fees; may need professional help beyond planner/broker

Market timing needed over full investment cycle

Asset allocation should change with market condition

Business cycle awareness important MPT isn’t modern or useful in bear market

Summary and conclusions, cont’d

Timing is difficult and opposite of buy-and-holdTA doesn’t add value when put to computerized

back testing test. Graphics are deceptive“Intelligent Fund Investor” monthly timer

newsletter: good performanceTiming illustrated for S&P500, gold, bonds, fundsCurrent market conditions: new bull market March

2009. Good areas now are emerging markets, value, commodities, real estate, and banks

Any questions?

Contact me to request an investment talk for your group of 20 or more

Call me if I can help you

Dr. Gary J. Harloff, Ph.D.

Harloff Capital Management (HCM)

Registered Investment Advisory Firm, 1994

Monthly newsletter: The Intelligent Fund Investor, 1993

795 Sharon Dr., St. 226, Westlake, Oh 44145

Meetings by appointment

440-871-7278, www.harloffcapital.com

Market Timing: Important Again 9-3-2009, Porter Library, Westlake, Oh