How to Profit in a Falling Market Robert Rubin November 15, 2006 New York Investing Meetup Copyright 2006 All Rights Reserved

Overview Choose safer industries Inverse funds and ETFs Short sales Options Fixed returns Hedged funds Value investing

Choose Safer Industries Avoid interest-rate sensitivity: –Cyclical, financial services, utilities, importers, real estate, construction, autos –Growth / momentum stocks –Bonds paying U.S. $ dividends Buy: –Consumer non-cyclical, US exporters, strong sectors –If dollar weakening, tangible assets & strengthening currencies

Inverse Funds and ETFs Fund prices rise as stocks fall – sometimes double! The Prudent Bear ProShares ETFs –Double Inverse: QID NASDAQ 100, SDS S&P 500, MZZ S&P 400 MidCap, DXD DJIND –Inverse: PSQ NASDAQ 100, SH S&P 500, MYY S&P 400 MidCap, DOG DJIND

Inverse Funds and ETFs 2 ProFunds (double inverse) –UltraBear S&P 500 –UltraShort Mid-Cap S&P 400 MidCap –UltraShort Small Cap Russell 2000 –UltraShort Dow 30 DJIND –UltraShort OTC NASDAQ 100 –UltraShort International MSCI EAFE –UltraShort Emerging Markets BONY Emerging Markets 50 ADR –UltraShort Japan Nikkei 225 Stock Average

Inverse Funds and ETFs 3 ProFunds (inverse) –Bear S&P 500 –Short Small-Cap Russell 2000 –Short OTC NASDAQ 100 –Short Oil & Gas DJ US Oil & Gas –Short Real Estate DJ US Real Estate –Short Precious Metals DJ Precious Metals –Falling US Dollar US Dollar Index

Inverse Funds and ETFs 4 RYDEX (double inverse) –Inverse Dynamic Dow DJIND –Inverse Dynamic OTC NASDAQ 100 –Inverse Dynamic Russell 2000 Russell 2000 –Inverse Dynamic S&P 500 S&P 500 –Dynamic Weakening Dollar US Dollar Index RYDEX (inverse) –Inverse Government Long Bond Treasury Bonds –Inverse Mid-Cap S&P 400 Mid-Cap –Inverse OTC NASDAQ 100 –Inverse Russell 2000 Russell 2000 –Inverse S&P 500 S&P 500

Short Sales Profit as prices fall – inverse of long buys Just place short order with your broker –Must have margin account How it works (for your information): –You borrow stock from broker, who may have borrowed it elsewhere –Stock sold immediately – sell to open –Broker holds proceeds as collateral for loan –Eventually buy to close stock on market to pay back broker –Profit if buy stock for less than sell price; lose if buy stock for more than sell price

Short Sales 2 Many ETFs can be sold short Your stock loan must be adequately collateralized (like a long buy on margin) –If stock price rises too far, cash held by broker inadequate collateral, so you get margin call –You must immediately provide more cash, or buy back part or all of the stock you owe –If not, the short can be closed without your knowledge or consent

Short Sales 3 Short Squeeze possible if many shorts and price rises –Shorts must buy to cover their positions –Prices can soar, forcing more buys –Heavy volume of shorts a contrarian indicator –Short squeezes usually temporary Your broker may not have shares to loan –Small floats on some stocks

Short Sales 4 If your broker must return borrowed shares, and cant replace them, your short can be closed without your knowledge or consent – rare The Up-Tick Rule Short profits always taxed as short-term The law forbids IRAs and 401Ks from incurring debt, so no shorting

Options in Falling Markets Buy puts, including protective puts Write calls Write covered calls Buy spreads –Such as write call & buy call on same stock High-risk strategies

Fixed Returns High yield stocks Preferred stocks Bonds MITTs CDs, Money Market But remember risks –Rate increases –Calls –Price volatility before maturity

Hedged Funds Absolute Return funds Hedged Equity funds

Value Stocks Value stocks – Benjamin Grahams stocks – outperform other stocks in bear markets The Dow Jones almost flat , but –14.36% annual return for lowest decile P/B –6.06% annual return for highest decile P/B Ibbotson, Yale School of Management, 1986