NVES ECH RESEARCH

Vol16 Iss02

FEBRUARY 12, 2016

2300

4 Weeks Ending February 5, 2016

2250

S&P 500 Index

2200

High Low Last

Federal Funds
0.40%
0.27%
0.38%
30yr T-Bonds 2.97% 2.66% 2.67%

2150
2100
2050
2000

Gold (London PM)

1950

$1156.35

$1085.40

$1150.35

1900

High
Low
Last
200D M.A.
DJIA
16516.22 15766.74 16204.97 17338.84
DJUA 626.64 578.66 624.62 576.26
NASDAQ 4685.92 4363.14 4363.14 4937.90
S&P 500 1940.24 1859.33 1880.05 2040.81

1850
1800
1750
1700
1650
1600

AUG SEP OCT NOV DEC JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC JAN

2014

S&P 500 P/E

2015

Current: 20.7

88 yr Avg: 17.0

AL

I
EC

SP

MONEYSHOW ORLANDO ISSUE

If it Looks like one Walks like one and Growls like one
(Technically A Confirmed Bear Market)
For more than 12 months, as technical warning flags have increased, we have been steering a more defensive course in
both our strategy and portfolio allocation. In hindsight, our only regret was not fighting the bullish headwinds more
decisively. But the sirens of Wall Street have been compellingly convincing, even to the seasoned investor:

Vanguard says bull market will keep sparkling in 2016

Bull market to stampede through 2016, Deutsche Bank predicts

MarketWatch 12/2/15

MarketWatch 12/4/15

U.S. Stocks Seen Rising Next year in Barrons Outlook Survey

A Brighter Outlook for 2016: J.P. Morgan Funds

Bloomberg 12/12/15

Barrons 12/22/15

While 2016 opened with headline-grabbing weakness as the worst start

to any year in history, it was the spike in day-to-day volatility that
caught our attention. As we first noted in December 2014, a notable
increase in volatility would almost certainly accompany the onset
of the next bear market just as it did in 2007 and in the late 1990s.

Major bear market bottoms

# of Days w/ 1% gain or loss

# of Days w/ 2% gain or loss

150
120
Total Days

It might prove misleading or dangerous to extrapolate the first five

weeks to a full year; however, there is little doubt that daily volatility
(both large UP and DOWN days) is at extremes. This is a tug-of-war
between the bulls and the bears and, so far, the bulls are losing.
As youll note in this issue, our Negative Leadership Composite is
locked in bear market territory and warning flag divergences are
not improving. A market with narrowing participation and failing
leadership is a market in trouble.

Day-to-Day Volatility
DJIA

90
60
30
0

60

65

70

75

80

85

90

95

00

05

10

15

2016 extrapolated from Jan-Current data

InvesTech Research

Yet at the same time that technical evidence of a bear market seems overwhelming, most leading economic indicators
are resilient in not forecasting any recession on the horizon. So either this is a market-induced decline (or bear market)
that might not have too many more months to run, or we should soon start seeing confirming negative signals on the
macroeconomic side that Main Street is heading for trouble too. Inside, we tell you where to watch
EDITOR: JAMES B. STACK

2472 Birch Glen Whitefish, MT 59937 406/862-7777

www.investech.com

COPYRIGHT 2016 INVESTECH

Where are we on the Wall Street road map?

Extended bull markets always create excesses. And those excesses can take many forms in valuation, speculation,
margin debt, and simply investor complacency. Historically, 5-10% corrections are a healthy part of every bull market.
And the longer a bull market runs without a significant correction of 10% or more, the more likely the end result will be
a [sizable] bear market.

Longest Correctionless Bull Market Runs

In the table at right, we show the 5 longest bull

market runs without a 10% correction, and this bull
markets recent run through last May falls right in the
middle at 44 months. It has not been comforting to
be sandwiched by bear market endings on both sides
of that ignominious record.

Oct 1990 - Oct 1997:

Mar 2003 - Oct 2007:
Oct 2011 - May 2015?:
Oct 1962 - Feb 1966:
Jul 1984 - Aug 1987:

Bull Market Duration

Time From Market Bottom to Bull Market Peak (S&P 500)

5/21/15
Bull Markets

2009
2002
1990
1987
1982
1974
1970
1966
1962
1957
1949
1947
1942
1938
1935
1932

6.9yrs (through 2/12/16)

84 mo.
55 mo.
44 mo.
40 mo.
37 mo.

29 mo. until 2000 Bear

2007 Bear!
?
1966 Bear!
1987 Crash!

Longest periods without a 10% correction since 1928

We have repeatedly warned over the past 18 months

that this bull market could be getting long in the tooth.
While bull markets never die of old age alone, most bull
markets expire between 2-5 years [see shaded region in
graphic at left]. If the current bull market remains intact
and new highs still lie ahead, then it would turn 7 years
old next month. By summer, it would be the 2nd longest
bull market in Wall Street history. That is, of course, if
the bull market is still intact!

Average = 3.8yrs
Median = 3.6yrs

Length of Economic Recoveries

Recovery

10yrs

InvesTech Research

The stock market leads the economy, yet bear markets do

not always mean a recession is imminent. However, the
bigger bear markets are accompanied by a recession and
thats why its helpful to learn early in a bear market
if recession warning flags start flying. It could prove
particularly important this time around since this
economic recovery has also turned into one of the longest
on record [see graphic at right]. This leads one to question
if a recession might be somewhere on the horizon.

6.7yrs*

2009
2001
1991
1982
1980
1975
1970
1961
1958
1954
1949
1945
1938
1933
1927
1924
1921
1919
1914
1912
1908
1904

Average = 3.8yrs
Median = 3.1yrs

InvesTech Research

10yrs

*through 2/12/16

After more than 6 years of seemingly continuous rising stock prices, the R word was rarely mentioned in any discussions
or forecasts from economists and Wall Street analysts last year. But what a difference a volatile month of declining stock
prices can make:

Last Oct
Citigroup urges investors to be brave as it forecasts
a 20% gain in global equities by end-2016

Today
Citi: World economy trapped in death spiral
CNBC 2/5/16

The Telegraph 10/6/15

Over the next few pages, we explore the dichotomy between leading technical and economic indicators, and lay out our
strategy for navigating the current Wall Street conundrum

InvesTech Research / February

12, 2016

Technical Evidence: Confirming a bear market

Its been 26 years since we developed our Negative Leadership Composite (NLC) to help identify the best buying
opportunities, as well as the highest risk markets. Its pure common sense that broad upside leadership (and absence of
downside or negative leadership) signifies or confirms a new bull market. It usually does the same for second or third
bull market legs. This is shown when a bullish SELLING VACUUM [*1] appears in the NLC. Conversely, broad and
increasing downside leadership shown by DISTRIBUTION [shaded region *2] will always confirm high risk early in
a bear market by dropping to -100.
Our challenge, at times like this, is distinguishing whether DISTRIBUTION might be caused by temporary factors,
which was the case three times in the current bull market the Congressional showdown over the debt limit, the
markets Fed taper tantrum, and the oil price collapse over a year ago. Judging by the depth, duration, and
broadening sector contribution to the DISTRIBUTION in leadership, we must conclude that Wall Street is currently
in a bear market.

S&P 500

2000

[2 DISTRIBUTION
[-BEARISH-]: This
signals that investors
are anxious to sell
stocks regardless of
whether their position
is at a loss, or the stock
market is tumbling to
new lows. It carries
bearish implications
as it suggests investors
will use any rallies to
get out of the market.

1500
1000
800
600
400

Bull Market
"launching pads"

[1 SELLING VACUUM
[-BULLISH-]: This
confirms the absence
of negative or
downside leadership.
It is normally a very
bullish signal since
a stock market
without any downside
leadership is destined
to move much higher.

300
200

100
70
50

Log Scale

67

69

71

73

75

77

81

83

85

87

89

95

97

99

01

03

05

07

09

Apr
2015

Margin Debt

11

13

15

1SELLING VACUUM
(very bullish)

2 DISTRIBUTION (high danger)

InvesTech Research

-100

Fears of Debt Ceiling

Fed Taper Announcement
Oil Price Collapse

(% Nominal GDP)

2.8%
2.4%

Next Release
~Feb 24

2.0%
1.6%
1.2%
0.8%
0.4%

67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15
Source: Ned Davis Research

S&P 500

2200

Market
Peak

Market
Peak

Market
Peak

1500
1000
600

Market
Peak

400
300
200

93

false
signal

0
-50
-100

0.0%

91

NEGATIVE LEADERSHIP COMPOSITE

false
signal

80
60
40
20
0

79

Market Market
Peak Peak

Market
Peak

The run up in margin debt has also become an

increasing concern in the past few years. This
represents hot money borrowed to buy stocks on
margin that will likely panic as selling in a true
bear market progresses.
Note that past peaks in margin debt have
coincided with, or led, peaks in the stock market.
That was also the case a year ago when margin debt
peaked a month before the blue chip indexes. But
as weve pointed out, the final peak cannot clearly
be identified until margin debt falls enough to make
new highs or peaks unlikely. Based on the volatile,
high volume down days weve experienced since
the start of this year, we anticipate margin debt
may confirm a bear market when reported later
this month by tumbling decisively through the
support levels of the past 18 months.

100
70
50

Log Scale

67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

3 /InvesTech
Research
February 12, 2016

Two (almost three) major U.S. indexes already qualify as bear markets
Investors might be surprised to learn that most
foreign stock markets including Londons FTSE
(Financial Times Stock Exchange) Index, the
German DAX, and Tokyo Nikkei are all off
more than 20% from last years highs. Chinas
Shanghai Composite has tumbled 46% from its
peak last June.

By comparison, the Dow Jones Transportation

Average is already in bear market territory with
a loss of -24%. And the premier small-cap
Russell 2000 Index has tumbled over 25%.
In summary, the bear market damage to
many investors portfolios has already
proven significantly more severe than what is
portrayed by the more resilient blue chip DJIA
and S&P 500. Even within the S&P 500 Index,
over 60% of component stocks are down 20%
from their 12-month highs, while 37% are down
more than 30%!

-13.1%

1400
1200
1000
800
600
500
400

Globally, one of the safest places to be has

been in solid blue chip stocks in the U.S.
The S&P 500 Index and Dow Jones Industrial
Average are approximately 13-14% off their
peaks last May. Meanwhile, the Nasdaq Index
is within several percentage points of hitting the
-20% threshold of qualifying as a bear market.

S&P 500

2200
1800

Log Scale

02

03

04

05

06

07

08

09

10

11

12

13

14

15

NASDAQ

6000
5000

-17.9%

4000
3000
2500
2000
1500
1200
1000

Log Scale

02

03

04

05

06

07

08

09

10

11

12

13

14

15

DJTA

11000
9000

-24.2%

7000
5000
4000
3000
2500
2000
1500

Log Scale

02

03

04

05

06

07

08

09

10

11

12

13

14

15

Russell 2000

1300
1000

-25.6%

800
600
500
400
300
200

Log Scale

02

03

04

05

06

07

08

09

10

11

12

13

14

15

Advance-Decline Line

+400K
+360K
+320K
+280K
+240K
+200K
+160K
+120K
+80K
+40K
0
-40K

We also find little to cheer about in

market breadth or participation. The
Advance-Decline Line, which showed
a bearish negative divergence with the
S&P 500s secondary peak in November,
continues to weaken with or ahead of the
blue chip indexes.
87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

3500
2500
1500
1000
700
500

Market
Peak

Market Market
Peak
Peak

Market
Peak

When the majority of troops are in retreat,

it can become increasingly difficult for the
generals to stand their ground. Without
a measurable improvement in breadth, we
believe this market will continue to struggle
in the coming weeks and months.

Market
Peak

S&P 500

300
200
100
60

Log Scale

87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

InvesTech Research / February

12, 2016

More bad (but also good) news

The Coppock Guide, which has been weakening for almost 2 years, is now confirming a bear market. Thats bad news for
the market in the near-term, but has positive implications down the road. This important indicator was developed more
than 50 years ago by Edwin S. Coppock and has often been described as a barometer of the markets emotional state. As
such, it methodically tracks the ebb and flow of equity markets, moving slowly from one emotional extreme to the other.
By calculation, the Coppock Guide is the 10-month weighted moving total of a 14-month rate of change plus an 11-month
rate of change of a market index. While that sounds complicated, its actually an oscillator that reverses direction when
long-term momentum in the market peaks in one direction or the other.
Historically, the value of the Coppock Guide lies in signaling or confirming low risk buying opportunities that emerge
once a bear market bottom is in place (black dotted lines on the graph below). And since market bottoms are typically
sudden V-shaped reversals, it works amazingly well as it did shortly after the bottom in 2009.

Coppock Guide

-Double Tops+60

+40
+20

-0.7

-20

false
signal

-40

20

25

30

35

40

45

50

55

60

1000
600
400
200
100
60
40

65

70

75

80

85

90

95

00

05

10

15

S&P 500

When Coppock turns upward from below "0"

it signals the "BEST BUY" opportunities

2000

false
signal

1-8
NOTE: Double Tops have preceded 1929, 1969, 1973, 2000,
and 2007 - five of the biggest bear markets this century.

20
8
4

NOTE: S&P 500 estimated prior to 1928 by correlation with a similar index.

Log Scale

20

25

30

InvesTech Research

35

40

45

50

55

60

65

70

75

80

85

90

95

00

05

10

15

Unfortunately, the Coppock Guide is generally not as useful in identifying market peaks. One reason is that bull market
tops are usually slow, rounding formations in which momentum and the Coppock Guide peak up to a year or more
ahead of the market. Yet there are certain instances when it has proven invaluable at a market top
In the late 1960s a technician named Don Hahn observed another phenomenon about the Coppock Guide. When a
double top occurs without the graph falling to 0 a phenomenon that Hahn referred to as a Killer Wave it confirms
an extended bull market where psychological excesses can reach extremes. In those situations, the appearance of a second
peak generally means a bear market has just begun or is not far off (see red dashed lines). The late 1990s was an exception.
Killer Waves are rare, and they can be dangerous. This is only the 8th bull
market in the past 95 years to see a double top in the Coppock. The table at
right shows that in 5 of the previous cases the second peaks were associated
with the start of the more notorious bear markets of the past century: 1929,
1969, 1973, 2000, and 2007.

Coppock Guide
2nd Peak
in Coppock
1 Oct 1929
2 May 1946
3 Feb 1969
4 Jan 1973
5 Sept 1987
6 Apr 1998
7 Jul 2007
8 Mar 2014

Start of
Bear
S&P 500 Bear Market Loss
Sept 7, 1929
-86.2%
May 29, 1946
-28.8%
Nov 29, 1968
-36.1%
Jan 11, 1973
-48.2%
Aug 25, 1987
-33.5%
Mar 24, 2000
-49.1%
Oct 9, 2007
-56.8%
May 21, 2015?
?

The Coppock Guide is now projected to drop through 0 in February, which

in the past carries over a 75% probability that a bear market has taken hold.
Of course, that does not mean the bear market will soon end, and it would be
foolish to attempt to second guess when or where the Coppock might bottom.
But the more important message for defensive investors is this: Once the
Coppock Guide does hit bottom and turns upward by even 1 point we will be
InvesTech Research
presented with one of those historical buying opportunities that comes around
only once or twice a decade. We cant rush it and we certainly cant forecast it but we can look forward to it and quickly
recognize it when it does occur. So be patient, stay defensive, and remember that there is light at the end of the tunnel.

5 /InvesTech
Research
February 12, 2016

Economic Outlook: Not (yet) confirming a recession

The investing dilemma today is that leading economic evidence is not pointing to an imminent recession. In fact, for
the most part, economic indicators are showing no recession on the horizon. The U.S. Leading Economic Index [see the
January 29, 2016 Interim Bulletin] has barely turned down, and is considerable distance from falling under its 18-month
moving average a warning flag that typically occurs 4-12 months prior to the start of recession.
Consumers also commonly provide early confirmation of an imminent recession with a drop in confidence. There are
two gauges for measuring this from the Conference Board (top graph) and the University of Michigan/Reuters (bottom
graph). Both are holding up surprisingly well.
The two caveats we have in tracking these gauges are:
Sometimes consumer confidence doesnt fall significantly until the recession is well underway (1981 and 1990).
Even though consumer confidence leads the start of recession, that does not mean it leads the stock market. Very
often confidence will start falling after the peak on Wall Street.
That makes the upcoming reports on consumer confidence and sentiment particularly important.

Consumer Confidence
160
120
80
40
0

Next Release
Feb 23

49-yr
average

RECESSIONS
Conference Board

67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

Consumer Sentiment

120
100

Next Release
Feb 12

80
60
40

49-yr
average

RECESSIONS
University of Michigan/Reuters

67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

NAHB Builder Confidence Survey

80
70

60

60
50
40

Our caveat here other than the

limited historical data is that perhaps
builder confidence is being artificially
buoyed by the perpetually low
(attractive) mortgage lending rates.

30
20
RECESSIONS

10
0

Source: National Association of Home Builders/Wells Fargo

85

87

89

91

93

95

97

99

01

03

05

07

09

11

13

It is also rare to see a recession start

without a deterioration in outlook for
the housing sector. A downturn in the
NAHB Builder Confidence Survey
usually leads both the peak in the
stock market and the start of recession.

15

One area of confidence that is NOT holding up lies in the Conference Boards survey of corporate CEO confidence.
This recent drop is significant, and unrelated to political showdowns in Washington like the previous two drops in
this recovery. More importantly,
that December quarterly survey
CEO Confidence
doesnt include the effects of the
80
market rout since the start of the
70
year, or what CEOs are revealing
in their earnings calls:
60

U.S. CEOs unleash recession

fears in earnings calls

50

Reuters 2/2/16

40

Unfortunately, the next CEO

survey will not be available until
early April.

30

InvesTech Research / February

12, 2016

20

fear of
fiscal cliff
fear of
debt ceiling
showdown

RECESSIONS
Conference Board

77

79

81

83

85

87

89

91

93

95

97

99

01

03

05

07

09

11

13

15

The Institute for Supply Management (ISM) surveys are also not confirming a recession yet. The ISM Purchasing
Managers Index for manufacturing has dipped below 50. But that is not uncommon in mid-cycle slowdowns of past
economic recoveries.

ISM Purchasing Managers Index

80%
70
60
50

48.2%
mid-cycle
slowdowns

40
30
20

RECESSIONS

Institute for Supply Management

49 51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

However, in what might be

a warning shot across the
bow of the economy, the
ISM Service Sector survey
experienced a serious drop
in last weeks release. It is
still in expansion territory
above 50 and new orders
(not shown) did not see a
significant decline.

70%
65
60
55
50
45
40
35
30

ISM Service Sector

(Business Activity Index)

53.9%

RECESSIONS
Institute for Supply Management

97 98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

13

14

15

In Summary

Technical evidence is confirming that we are in a bear market that will likely take blue chip indexes to at least a 20%
loss. However, the most leading economic evidence is not signaling a recession on the horizon which Fed Chair Janet
Yellen confirmed this week in leaving the possibility of further interest rate hikes on the table.
Our Model Fund Portfolio shown below is already the most defensively positioned since the start of this bull
market in both cash allocation and sector weighting. If technical evidence continues to deteriorate, or leading
economic indicators finally confirm the possibility (probability) of recession, then we will take increasingly defensive
steps in our Model Portfolio.

NEXT ISSUE: March 11, 2016

MODEL FUND PORTFOLIO

CHANGES SINCE THE LAST ISSUE: We have reduced our net long exposure
to 65% and hold minimal exposure to the two riskiest sectors, Consumer
Discretionary and Financials. On the January 15 Financial Hotline, we recommended
increasing the position in ProShares Short S&P 500 ETF (SH) from 3% to 8% in the
Model Fund Portfolio. That changes the overall invested position from 76% to 81%
(73% long plus 8% short) but, due to the inverse relationship of SH to the market,
lowers the net long exposure to 65%. The remainder of the Portfolio (19%) is held
in short-term Treasuries or a money market fund. Continue to monitor the Financial
Hotline for important strategy updates.

Cons. Discr. Bear Fund

5% 8%
Cons. Staples
14%
Energy
7%
Financials
2%

PERCENT FUND
SYMBOL

19%
5%
14%
7%
2%
17%
9%
16%
3%
8%

T-BILLS/ CASH/ MONEY MARKET

CONS. DISC. SELECT SECTOR SPDR
CONS. STAPLES SELECT SECTOR SPDR
ENERGY SELECT SECTOR SPDR
FINANCIAL SELECT SECTOR SPDR
HEALTH CARE SELECT SECTOR SPDR
INDUSTRIAL SELECT SECTOR SPDR
TECHNOLOGY SELECT SECTOR SPDR
MATTHEWS ASIAN GROWTH & INCOME
PROSHARES SHORT S&P 500

52-WEEK
Hi
Low

INIT. RECOMMENDED
Date
Price

International
3%

Health Care
17%

FOR NEW SUBSCRIBERS: Purchases after our initial recommendation must be made
at your discretion. We currently advise bringing your portfolio in line with our recommended
allocation by phasing into the market over approximately two to three months.

Industrials
9%

RECENT
PRICE

------- -----------------------------------------------------------------------------
XLY
81.43 70.16 11/18/11
35.54
70.16
XLP
51.24 45.07
7/1/11
27.82
49.63
XLE
81.02 51.77
7/1/11
69.13
55.94
XLF
25.29 20.85
6/8/12
13.21
20.95
XLV
76.61 64.01
7/1/11
33.28
64.40
XLI
56.94 48.01
7/1/11
34.48
50.04
XLK
44.34 37.34 11/18/11
23.34
39.50
MACSX
18.48 14.90
5/8/09
9.52
15.53
SH
23.31 20.38 12/15/15
20.91
22.54

Cash
19%

Technology
16%

ALTERNATE FUNDS
Money Market Fund

iShares MSCI Pacific EX-Japan (EPP)

7 /InvesTech
Research
February 12, 2016

PERSONALPERSPECTIVE

Choosing Your Own Investment Odds

One of the most valuable lessons I have learned in over 40 years of Wall Street experience is that investing
opportunities always come around again. There is no last train out of the station. And even if one misses the
initial launch of the next Apple, Netflix, or Facebook, there will always be attractive reentry points at the next
bear market bottom.
Wall Street pundits spend an extraordinary amount of time and resources trying to convince John Q. Investor
that the only strategy is to stay fully invested 100% of the time. They use games like showing how poorly your
portfolio would have done by missing the xx most profitable days of the past XX years. Anything other than a
strict buy-and-hold is called market timing. And no one, they say, can forecast where the stock market is headed.
While that last claim for the most part is true, it is possible
to measure market risk and recognize historical warning flags
of past bear markets. Wall Street and economic cycles never
exactly repeat themselves, but they do experience similarities
in both rhyme and reason. Bear markets do not drop out of
thin air. Neither do market crashes which we can attest to as
one of the few who recognized the warning flags prior to the
1987 Crash.

USA TODAY

Jan. 4, 1988

EXPERT ADVICE ON INVESTING

From his office overlooking Whitefish Lake in the
Rocky Mountains of Montana, Jim Stack foresaw
the stock market crash of Oct. 19. On Sept. 30,
his InvesTech newsletters told stock investors to
move to 94% cash.

An important consideration today is to recognize that you have total control over your own investment odds.
Following a blind 100% invested allocation in the 7th year of a bull market is a high-risk strategy. That is why we
have been gradually, yet methodically, moving toward
a more defensive position when the first technical
Bear Market Repos
warning flags started appearing early last year.
S&P 500 Bull Market Gains
Repossessed by Subsequent Bear Market
We also recognize the potential downside risk of this
bear market if economic evidence starts to confirm
2007
a probable recession. In that case, it would most
2000
1990
likely not be just the 20-25% decline that one might
1987
anticipate. Over the course of the past 85 years,
1980
bear markets have typically repossessed one-half or
1973
more of the previous bull markets gain. The table
1969
1966
at left which we have shown several times over
1962
the past year is another important reminder to not
1956
underestimate the risk of this bull market if bearish
1948
evidence continues to mount. Based on the S&P 500
1946
1938
gain during this bull market from the March 9, 2009
1937
low to the May 21, 2015 peak, if the next bear market
1933
repossessed half of that gain, it would equate to a
0
1/4
1/2
3/4
All
-34.1% bear market.
InvesTech Research

Although that might sound scary, its also important to know that: 1) We are defensively positioned, and our
portfolio is currently holding up much better than the broad market. And 2) Were fully prepared to move more
defensive if evidence reveals this bear market will turn into a bigger one. And lastly, on an encouraging note,
we want to re-emphasize the message conveyed by the 95-year Coppock Guide graph (inside) that this bear will
ultimately lead to the best buying opportunity in this decade.

The INVESTECH RESEARCH newsletter is published 13 times per year and includes access to the weekly InvesTech Financial Hotline, as well as Online Interim Bulletin available between issues. This
publication is not a solicitation to buy or offer to sell any of the securities listed or reviewed herein. The contents of this letter have been compiled from original and published sources believed to be
reliable, but are not guaranteed as to accuracy or completeness. James B. Stack is also President of Stack Financial Management (SFM), a registered investment advisor, and a separate company from
InvesTech Research. Clients of SFM and individuals associated with InvesTech Research may have positions in, and may from time to time make purchases or sales of, securities mentioned herein.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance
of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by InvesTech Research), made reference to directly or
indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various
factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or
information contained in this newsletter serves as the receipt of personalized investment advice from InvesTech Research. Please refer to our website at www.investech.com for full disclosure information.

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InvesTech Research Special Report

The Bare Necessities About Bear Funds

Managing risk in the final stages of a market cycle is vitally important for preserving capital and generating superior
long-term investment returns. With a safety-first investment strategy, the first line of defense for protecting assets is to
selectively take profits off the table and hold the proceeds in cash. Adjusting stock and sector weightings toward more
resilient areas of the market can also fortify a portfolio. When bear market warning flags begin to wave, adding a bear
fund can further reduce exposure to downside market movements and lower portfolio volatility.
A bear fund is a mutual fund or exchange-traded fund (ETF) designed to increase in value as the market drops. Conversely,
the fund will lose value when the market rises. The original bear market mutual funds have been around since the
mid-1990s, and several bear fund ETFs following the same principles were incepted about a decade ago, prior to the
last bear market. At InvesTech Research, the primary reason for using a bear fund is as an insurance policy to offset
potential losses in core holdings of the portfolio during market declines. Our recent recommendation to add a bear fund
to the Model Fund Portfolio has raised some questions from our subscribers. The most frequently asked questions some
simple, some more complex are addressed below.

Why use a bear fund instead of selling positions and raising cash?

Increasing cash in the portfolio is an important part of a defensive strategy, but there are several reasons for maintaining
select long positions and partially offsetting them with the insurance policy of a bear market fund:
Diversification: Bear fund insurance allows you to hold onto more stocks in a portfolio, thus maintaining
greater diversification while counteracting the impact of a stock or sector that doesnt perform as anticipated.
Lower portfolio volatility: Market volatility usually increases as risks rise. A strategy that manages risk
is inherently less volatile, and by neutralizing a portion of the portfolio, volatility is reduced.
Dividends: Dividend payments continue for the positions that are maintained in a portfolio.
Reduce capital gains tax: In taxable accounts, selling stocks can create sizeable realized gains. Limiting
sales can lessen the tax bite.
Prepare for the next bull market: When risks begin to resolve and the time is right to increase market
allocation, new additions for the portfolio must be properly vetted prior to purchase. In the meantime,
exposure can be quickly increased by removing the bear fund, which de-neutralizes a portion of the
portfolio to participate in the market recovery without delay.
InvesTech Research
Model Fund Portfolio

What do you mean by a net long position?

The net long position in the Model Fund Portfolio is currently 65%. Fully one-third
of the portfolio is not exposed to the downside effects of the market due to the
protective cash and inverse index (short) bear fund. But how does this all add up?
As illustrated in the chart at right, current holdings include 73% long funds (blue), 8%
short bear fund (red), and 19% cash (yellow). The bear fund effectively neutralizes
or offsets the impact of an equivalent position of long holdings (shaded blue area). In
other words, if the long position moves down, the bear fund moves up and the return
on that combination should be negligible for the day. Therefore, the net long position,
or overall exposure to the equity market, is the 73% long position minus the 8% short
position which is equal to a 65% net long position.

100%
90
80
70

Cash 19%

Unaffected by
Market Movements

Bear Fund 8%

Bear Fund Short

Offset by Bear Fund

60
50
40
30

Long Funds
73%
Net Long 65%

20
10
0

*2/12/16

Why was the ProShares Short S&P 500 ETF (SH) chosen for the Model Fund Portfolio?

We recommended SH for a number of reasons. Our portfolio holdings are based on S&P 500 sectors, so its appropriate to
select an inverse index fund correlated to this broad market Index. ProShares Short S&P 500 was incepted in 2006 and
has a solid track record through the last bear market. It is the largest and most liquid inverse S&P 500 fund, currently
holding over $1.6B in assets. We also like some of the advantages ETFs have over mutual funds such as lower expense
ratios and the ability to trade throughout the day. Notably, on August 24 last year, when intraday volatility impacted the
liquidity of some exchange-traded funds and left investors asking, What the E-T-F happened?, SH continued to trade
smoothly throughout the day. (For more detail on ETF action that day, see our September 18, 2015 issue).
Finally, this fund is passively managed to inversely correlate to the Indexs daily returns. Actively managed funds typically
focus on profiting from shorting individual stocks, frequently use resource holdings, and may concentrate on attempts to
time the market. Performance can vary depending on the managers ability to pick the right stocks to short. Thus, for a
safety-first strategy, a more predictable passive fund is the best choice for our purposes.
February 12, 2016

(Over, please)

Can you provide a list of bear fund alternatives?

Weve assembled a list of some of the larger funds that have longer track records, including both ETFs and mutual funds.
Before purchasing any on the list, you should perform your own due diligence to determine the suitability for your
portfolio. Reasons for providing these
additional choices include:
Bear Market Funds
Some retirement accounts are limited to
mutual fund investments only.
Fund
Net Assets
Inception
Fund Name
Type
Fund Objective
($MM)
When using a passively managed
ProShares Short S&P 500 (SH)
ETF
Inverse S&P 500
$1,650
Jun 2006
fund, its best to choose one based on
ProShares Short Dow 30 (DOG)
ETF
Inverse DJIA
$327
Jun 2006
an index that most closely matches your
ProShares Short QQQ (PSQ)
ETF
Inverse Nasdaq
$254
Jun 2006
portfolio holdings.
Rydex Inverse S&P 500 (RYURX)
Mutual Fund Inverse S&P 500
$126
Jan 1994
If you are willing to accept the added risk
PIMCO StocksPLUS Short (PSSAX) Mutual Fund Total Return
$2,100
Jul 2006
Grizzly Short Fund (GRZZX)
Mutual Fund Total Return
$268
Jun 2000
that comes with an actively managed fund,

Federated Prudent Bear (BEARX)

Mutual Fund Total Return
$320
Dec 1995
you may want to consider one of the total

Source: Charles Schwab & Co.

return alternatives.
Fund may have front load
InvesTech Research

S&P 500

1600

If a passive bear fund offsets the market on a daily basis, what

happens over a longer period of time?

1400

Due to the compounding of daily returns, performance over periods longer than
one day will likely differ from the inverse of the target index. To demonstrate, lets
look at an exaggerated example of how compounding affects returns.

1200
1000

-56.8%

800
600
$110

+57.4%
2007

2008

2009

2010

ProShares Short S&P 500 (SH)

100
90

+92.3%

-43.5%

80
70
60
50
40

Bear Market
2007

2008

Bull Market
2009

2010

Assume that both ProShares Short S&P 500 (SH) and the S&P 500 start with a value
of $100. On Day 1, the S&P 500 loses 10% causing SH to gain 10%. The S&P 500,
therefore, ends Day 1 with a price of $90, while SH has grown to $110. If on Day 2
the S&P 500 loses 10% again, its price drops to $81 and SH increases to $121. While
achieving perfect correlation on a daily basis, after two days the S&P 500 is down
19% and SH is up 21%.
If the stock market continues to decline after purchasing a bear fund, gains can be
much more than you might expect due to progressively larger dollar changes based
on the increasing value of the investment. On the other hand, if the stock market
rises persistently after a bear fund is purchased, the daily percentage changes result
in progressively smaller dollar changes as the value of the investment decreases.
Hence, investors lose less than they might expect when the funds return over the
course of the rally is calculated.

This point is illustrated in the graphs above, which show the S&P 500 and SH after the stock market peak in October 2007.
Clearly, bear funds can serve as valuable insurance in a declining market, even if the position is held past the market
bottom. One important note: bear fund performance in trendless, volatile markets is less predictable than in markets
persistently trending up or down. In fact, due to compounding effects, an inverse index fund may even decline as the
market remains flat.

Why dont you use a leveraged bear fund?

A leveraged bear fund is designed to go up two or three times as much as its benchmark goes down on a daily basis.
More might sound better to the average investor; however, trying to time bear markets or corrections rarely works, and
one can easily get burned with leveraged funds if the market doesn't move as anticipated and the compounding effect is
magnified. With this in mind, wed avoid the leveraged bear market funds due to the increased volatility and risk.

Summary

Bear market funds should be used to neutralize portfolio risk and help you sleep at night not as a tool for speculative
short-term trading. With a safety-first investment strategy, an inverse index fund can serve as an effective, low cost
insurance offering an efficient way to offset rising market risk and reduce portfolio volatility. When considering a bear
fund, the following guidelines should be helpful:
Use bear funds as an insurance to offset a portion of your portfolio investments.
Stay with the passively managed bear funds that inversely correlate with the broader indexes.
Choose the larger more liquid funds with longer track records.
Gradually implement a bear fund position as a bear market becomes more likely.
Do not use leveraged funds.
If bear funds are not an option for your portfolio, the alternative is to reduce your long positions to reach the target net
allocation and hold the balance in cash.

InvesTech Research 2472 Birch Glen Whitefish, MT 59937 1-406-862-7777 www.investech.com

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20000
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10000

5000
4000

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500

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62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Black Tuesday
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500

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Dow Jones Utility Average

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Collapse of German
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40
30

Fall of France
Germany invades
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Rome-Berlin
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Smoot-Hawley Act
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Watergate scandal
Pres. Nixon resigns

Pres. Kennedy
assassinated
NATO established

14
13
12

AT&T divestiture

Clinton $500 billion

tax increase approved

Gore contests
Presidential Election
outcome

200
150

100

U.S. takes
over AIG in
$85 billion bailout

Russia defaults
on foreign debt

80
70
60

Federal Govt takes over

Fannie Mae & Freddie Mac

Japan experiences
several 1930s-style
"run-on-banks"

50
40

$700 billion TARP Bailout

Nuclear disaster
at Chernobyl

Investment
Advisors Act
of 1940

30

$787 billion Economic

Stimulus Bill

Mexican Peso
collapses
-40% in 2 wks

20

Source: The World Almanac

The Century World History Factfinder

25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Inflation

Consumer Price Index

(% annual rate of change)

Gold hits
$1000/oz

Gold hits
$1895/oz

Gold hits $850/oz

Arab oil embargo
Gold fixed
at $35/oz

U.S. abandons
gold standard

Wage/price freeze

Gold price raised

from $35/oz

OPEC "quarrels"
Oil drops from
$30/bbl to $13/bbl

Becomes legal to own

gold in U.S.

IMF and World Bank

established

Oil hits
$77/bbl

Oil hits
$145/bbl
Oil hits
$44/bbl

Penn Square Bank

declared insolvent by FDIC

SFM

15
14
13
Peak in Real Estate Prices
(Housing bubble pops)

12
11

Recessions

10

Record Fed easing

11 Discount Rate cuts in 12mos

9
8

AAA Corporate Bond - %

90-Day Treasury Bill - %

Discount Rate - %

10
Fed Funds Rate
Target Range
0% to 0.25%

5
4
3
2

1
0

Fed revises
Discount Rate
calculation

10

+14
+12
+10
+8
+6
+4
+2
0
-2
-4
-6
-8
-10
-12
-14

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2472 Birch Glen, Suite A Whitefish, Montana 59937
(800)790-5001 www.StackFinancialManagement.com

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Congress passes
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Pres. Reagan shot

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Three Mile Island

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Republicans control
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USSR dissolves first time in 40yrs

Chinese Tiananmen
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Space shuttle
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United Nations
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Pearl Harbor
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Lindbergh makes
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Reagan 25% tax

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Armstrong walks
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Berlin Wall built

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Roosevelt declares
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-2
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Germany surrenders
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House votes to impeach

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8000
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6000

2000

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600

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80

10000

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1000

80
70
60

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1987 Crash
"Black Monday"
Market falls -23%

400

150

2000

15000
Janet Yellen appointed
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2010
Flash Crash

300

3000

Terrorist attacks
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Nasdaq hits 5048

Internet "bubble" pops!

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1000

20000

Iraq War

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40
20
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(Over, please)

Be Our Guest at

March 25, 2016

DISNEYS CONTEMPORARY RESORT
For 35 years, The MoneyShow has served as the individual investors one-stop resource for unbiased investment
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James B. Stack, President

Stack Financial Management
and InvesTech Research

For the current bull market to extend through 2016, it must become the second longest bull market
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