Contrarian Investing Prof. Gerlach Sacred Heart University Deborah J. Weir, CFA Author, TIMING THE MARKET (Wiley, 2005)

2 Fundamental Economics As Contrarian Investing Because Emotions Get In the Way

3 Background SEC Registered to sell hedge funds MBA in finance: NYU Stern School of Business Stamford CFA Society, Past President Deutsche Bank/Scudder: United Technologies, Rockwell, Mayo Clinic Instructor: NY Institute of Finance

4 We Will Forecast  GDP  Interest rates (up or down)  Direction of stock & bond markets

5 Economic Forecasting Tools 1)Yield curve shape 2)Quality spreads 3)Central bank actions

6 Contrarian Tools? These tools are fundamental economic analysis People get caught up in emotion and overlook them It is always “different this time”

7 Ground your thinking in solid economic analysis to rise above hysteria. Old adage, “Keep your head while all about you are losing theirs.” New adage: Make money when all about you are losing theirs.

8 1) Yield Curve Shapes Positive Slope (normal) Negative Slope (inverted)

9 Curve Reflects Investor Expectations for Future Rates Investors stay short if they expect rates to increase Investors go long if they expect rates to decrease

10 Positive slope – increase risk: buy stocks, real estate, gold Negative slope – decrease risk: buy bonds or cash US Federal Reserve uses the shape of the yield curve to help forecast the economy Asset Allocation Using Yield Curve Shapes

11 Normal Curve, Normal Growth: Nov Equities Inverted Curve, Recession: March 2007 Fixed- income or Cash Steep Curve, Inflation: July 2009 Gold, Foreign Currencies, Real Estate Economic Forecasting Theory

12 Forecasting Practice Click on the “animate” option to see how these two markets move: The yield curve helps forecast the recent US investment cycle.

13 Inverted Curve 2006 Forecast the financial crisis of 2007 – 2009 and the decline of the S&P 500 Index.

14 Normal Curve Forecast strong stock market.

15 Steep Curve 2010 (3mo./10yr. Spread > 300 bp) Forecast inflation expectations.

16 Steep Curve Inflation expectations weakened the US dollar.

17 Steep Curve Inflation expectations increased the price of gold

18 Steep Curve 2009 – 2011 Inflation fears may end the decline in real estate.

19 Inverted Curve Forecasts recessions Lower stock market Higher bond prices (& lower yields) Lower inflation Stronger currency

20 Ten-yr./Three-mo. Spread 1953–2012

21 Stocks Inverse of Bonds Curve forecast stock market losses, bond market gains. S&P 500 Index 30-yr Bond Price

22 Federal Reserve Bank Uses the Yield Curve

23 This Site Has Monthly Updates October 26, 2012 Covering September 26, 2012–October 26, 2012 Highlights October September August 3-month Treasury bill rate (percent) year Treasury bond rate (percent) Yield curve slope (basis points) Expected real GDP growth (percent) Old Formula: GDP = (.97 X spread) New Formula: GDP is weighted by the previous growth rates Probability of recession in 1 year

24 Applications to Global Economies BRIC PIIGS Managed economies limit the use but still can indicate the direction of growth 2011 indicators were negative

25 Outlook for the BRICs trade-exchange-rates-budget-balances-and-interest-rates%20%20 trade-exchange-rates-budget-balances-and-interest-rates%20%20 Country 3-month 10-year BP Spread Brazil 7.10% 9.57% +274 Russia 7.66%7.36% - 30 India 8.18%8.21%+ 3 China 3.80%3.19%- 61 Given these spreads, what’s your forecast: GDP Interest rates (up or down) Inflation Currency Direction of stock & bond markets

26 Outlook for PIIGS Country 3-month 10-year BP Spread *Portugal0.19% 7.89% +770 Italy0.90% 4.84% +394 *Ireland0.19% 4.58% +439 Greece0.19% 16.08%+1589 Spain0.19% 5.74% trade-exchange-rates-budget-balances-and-interest-rates%20%20 No information for Portugal or Ireland in 2011 Given these spreads, what’s your forecast: GDP Interest rates (up or down) Inflation Currency Direction of stock & bond markets

27 2) Quality spreads Forecasts trouble in emerging markets (1998 Russian bond default) Forecasts trouble in developed markets (1987 S&L crisis, 2008 crisis)

28 Merrill-Lynch High-yield Index Constrained Less the Ten-year US Treasury Note: (sometimes not available & no history)

29 Wall St. Journal Publishes High-yield Index Nov Nov = 4.87%

30 Other Sources Federal Reserve Bank of St. Louis (two-day lag) Gives previous five days for easy comparison

31 You Can Get the Spread in Real Time Good for trading options during the day… High-yield ETF (JNK) – Ten-year yield

32 Is This Stock Market Recovery Sustainable? Fiscal Cliff Greek Default Global Slowdown

33 Bull Market Confirmed by Quality Spreads Merrill-Lynch High Yield Less the Ten Year Note

34 3) Central Bank Actions Open Market Operations Money Supply

35 Federal Reserve Open Market Operations Normal repurchase agreements = $3.25 billion daily prior to 9/11 September 11, 2001 = $35 billion What is the Fed doing today? Tightening? Easing?

36 Federal Reserve Controls Money Supply and the Shape of the Yield Curve Financial Crisis Market Turn QE2 QE3 Turn Turn?

37 Global Economic Forecasting Tools 1)Yield curve shape 2)Quality spreads 3)Central bank actions

38 Fixed-income Is a Good Data Set for Forecasting Economies and Markets Large Data Set (Eight Times the Volume of Equities) Depicts Investors’ Actions Rather Than Opinions Forward-looking; No Reliance on Historical Financial Statements Low Turnover and Transactions Costs Government influence on the shape of the yield curve works for you; not fighting City Hall

39 Updates Blog: Voices of New York Institute of Finance Faculty:

Contrarian Investing Prof. Gerlach Sacred Heart University Deborah J. Weir, CFA Author, TIMING THE MARKET (Wiley, 2005)