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NED'S INSIGHTS

Ned Davis Research Group

INSTITUTIONAL HOTLINE

PUBLISHED DAILY  APRIL 13, 2015

Ned Davis Senior Investment Strategist

TREND UPDATE

Compounding Returns and Making the Trend Your Friend

S&P 500 = 2102.06 REFERENCED CHART LINKS

My philosophy in making money and how the trend fits into that is my subject today. I basically believe that most people get rich by compounding interest and probably the best investment to compound is the stock market. The reason I make that statement is shown on B437 (below). This is a chart of the history of

six “investments” over the past 90 years. There really has been no contest. Stocks have returned 10% per annum, almost double most other investments. We did not include houses, but the median home price, for the historical data we have, would be in the middle of the chart. Monthly Data 12/31/1925 - 3/31/2015 (Log Scale)

Comparative Investment Returns Since 1926

S&P 500 Total Return Barclays Corporate Bond Tot Return# Barclays Treasury Bond Return# Gold Bullion Treasury Bills Total Return CPI *

( ( ( ( ( (

) 10. 0% ) 5. 8% ) 5. 7% ) 4. 6% ) 3. 6% ) 2. 9%

19.1% 5.9% 8.3% 15.9% 1.0% 1.7%

* Data Lags Chart by One Month # Ibbotson data prior to 1973

Please see important disclosures at the end of this report.

1

2015

2010

2005

2000

1995

1990

1985

1980

1975

1970

1965

1960

1955

1950

1945

1940

1935

Source: S&P Dow Jones Indices 1930

(B437)

455812 357533 280445 219978 172548 135345 106163 83273 65318 51235 40188 31523 24726 19395 15213 11933 9360 7342 5759 4517 3543 2779 2180 1710 1341 1052 825 647 508 398 312 245 192 151 118 93 73 57

Gain/ Annualized Annum Std Dev

Investment

All Indexes allocated to 100 on 12/31/1925

455812 357533 280445 219978 172548 135345 106163 83273 65318 51235 40188 31523 24726 19395 15213 11933 9360 7342 5759 4517 3543 2779 2180 1710 1341 1052 825 647 508 398 312 245 192 151 118 93 73 57

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Ned's Insights: Institutional Hotline | APRIL 13, 2015

NED DAVIS RESEARCH GROUP

What does a 10% compounded return mean? One of my favorite studies on the magic of compound interest is featured below. Two investors opened IRAs. The first put only $16,000 into investments ($2,000 per year for eight consecutive years starting at age 19) and at age 65, due to compounding returns in an IRA at 10%, the $16,000 had grown to over one million dollars. The second 19-year old invested $78,000 starting at $2,000 per year at age 27 (at 10%); at age 65 that investor had a gain of only $805,000.

local American Indians for 60 guilders, or in excess of $25 at today’s exchange rates. The question debated by statisticians is this: who got the better deal – the white men or the American Indians? The settlers received land which is today part of one of the greatest and richest cities in the world; but the American Indians received 60 guilders. Had the American Indians invested their 60 guilders in an IRA with a combination of common stocks and government bonds (which have yielded 7.9% total return since 1926), the $25 would now be worth $175 trillion, with which they could purchase not only all the real estate in New York City but all the real estate in the U.S. Moreover, they would have plenty left over to purchase all the stocks listed on U.S. stock exchanges.

The lesson applies not only to savers and investors but also to debtors who get hit owing compound interest. The U.S. government (actually, we tax payers) are getting hit with compounding interest charges. In the year ending September 2014, interest payments on the federal debt were $447.9 billion (over 11% of total government expenditures).

Compounding returns on investments is one of the best ways to get rich. Compounding interest on debt is a good way to go broke.

The classic example of the virtues of compounding returns goes back to 1626 when the Dutch purchased Manhattan Island from Investor A $2,000 per year for first eight years Total Investment $16,000 Age Tax Deferred Year-End Contribution Value 19 2,000 2,200 20 2,000 4,620 21 2,000 7,282 22 2,000 10,210 23 2,000 13,431 24 2,000 16,974 25 2,000 20,872 26 2,000 25,159 27 0 27,675 28 0 30,442 29 0 33,487 30 0 36,835 31 0 40,519 32 0 44,571 33 0 49,028 34 0 53,930 35 0 59,323 36 0 65,256 37 0 71,781 38 0 78,960 39 0 86,856 40 0 95,541 41 0 105,095 42 0 115,605 43 0 127,165 44 0 139,882 45 0 153,870 46 0 169,257 47 0 186,183 48 0 204,801 49 0 225,281 50 0 247,809 51 0 272,590 52 0 299,849 53 0 329,834 54 0 362,817 55 0 399,099 56 0 439,009 57 0 482,910 58 0 531,201 59 0 584,321 60 0 642,753 61 0 707,028 62 0 777,731 63 0 855,504 64 0 941,054 65 0 1,035,160 (16,000) Total Invested $1,019,160 Net Gains Interest Rate = 10%


Investor B $2,000 per year for remaining 39 years Total Investment $78,000 Tax Deferred Year-End Contribution Value 0 0 0 0 0 0 0 0 2,000 2,200 2,000 4,620 2,000 7,282 2,000 10,210 2,000 13,431 2,000 16,974 2,000 20,872 2,000 25,159 2,000 29,875 2,000 35,062 2,000 40,769 2,000 47,045 2,000 53,950 2,000 61,545 2,000 69,899 2,000 79,089 2,000 89,198 2,000 100,318 2,000 112,550 2,000 126,005 2,000 140,805 2,000 157,086 2,000 174,995 2,000 194,694 2,000 216,364 2,000 240,200 2,000 266,420 2,000 295,262 2,000 326,988 2,000 361,887 2,000 400,276 2,000 442,503 2,000 488,953 2,000 540,049 2,000 596,254 2,000 658,079 2,000 726,087 2,000 800,896 2,000 883,185 (78,000) $805,185

T_HOT201504131.1

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So the main key to getting wealthy is to compound investment returns. And long-term investing in stocks has certainly been one of the best choices. But one must also find a method of investing that one can live with – that meets one’s psyche. It’s important to understand the market does not go up constantly over time.

note DAVIS128A (below). Here, we’ve calculated how the market performed whenever the 50-day smoothing of the trend goes above the 200-day smoothing. We used data going back to 1929 and all the net gains in stock prices came when the trend was upward as measured by this simple trend formula. The results are based upon price alone and do not include dividends or interest earned when out of stocks. The reason this indicator worked is that it lets profits run, but cuts losses short, a great money management rule.

These examples used constant annual gains to illustrate how compounding works. I’ve also learned this about compound returns. If you buy something at $100, and it goes to $50, that is a 50% loss, but it will take a 100% advance to just get back to even. So when asked how to make money, Warren Buffett said he had two rules: “Rule #1 – Don’t lose money. Rule #2 – Don’t forget Rule #1.”

The investment business is a business of making mistakes. The only difference between the winners and losers is the winners make small mistakes while the losers make big mistakes. Please keep in mind that what worked in the past may not always work in the future, and it’s important to monitor any investment strategy continuously.

I don’t like to take big losses. For me, this means the trend is your friend or “don’t fight the tape.” As one example of this,

Daily Data 2005-04-12 to 2015-04-10 (Log Scale)

Standard & Poor's 500 Index 1,995

1,995

1,778

1,778

1,585

1,585

1,413

1,413

1,259

1,259

1,122

1,122

1,000 891

% Gain/ Annum

% of Time

* Above 200-Day Moving Average

9.15

66.05

Below 200-Day Moving Average

-1.09

33.95

50-Day Moving Average is:

794 708

1,000

S&P 500 Index Performance When Analysis Dates 1929-11-19- 2015-04-10

Source: S&P Dow Jones Indices 2006 2007

2008

2009

2010

2011

50-Day Moving Average 2015-04-10 = 2077.93 200-Day Moving Average 2015-04-10 = 2016.69

1,995 1,884 1,778 1,679 1,585 1,496 1,413 1,334 1,259 1,189 1,122 1,059 1,000 944 891 841

2012

2013

2014

891 794 708 2015 1,995 1,884 1,778 1,679 1,585 1,496 1,413 1,334 1,259 1,189 1,122 1,059 1,000 944 891 841

50-Day vs. 200-Day Moving Averages DAVIS128A

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But I also like to diversify. I think it cuts risks. So I don’t just want to be limited to compounding stock returns. The next chart illustrates the returns one could have enjoyed using a similar formula as DAVIS128A, but using it to allocate a portfolio among stocks, bonds, and gold. Just being in these three investments during uptrends has beaten the record of just being long stocks (DAVIS221, below). This indicator starts in 1968 because that is

158,489

when gold started trading freely. Why did this indicator work? As I learned in Economics 101, prices are determined by supply and demand. And prices are also the equilibrium points of supply and demand. Thus, if prices are rising, demand must be greater than supply, and I want to be in. To not lose money, I hedge my risks when we get into downtrends.

Monthly Data 1968-12-31 to 2015-03-31 (Log Scale)

Three-Way Asset Strategy (Stocks, LT Bonds and Gold)

158,489

S&P 500 Total Return (GPA: 9.88%) Always 100% Long Positively-Rated Assets (GPA: 12.27%)

125,893 100,000

125,893 100,000

79,433 63,096 50,119 39,811

79,433 63,096

To hold one of the three assets (Stocks, Bonds or Gold), the assets' three-month moving average must be above its 10-month average.

50,119 39,811

31,623

31,623

25,119

25,119

19,953

19,953

15,849

15,849

12,589

12,589

10,000

10,000

7,943

7,943

6,310

6,310

5,012

5,012

3,981

3,981

3,162

3,162 Current Assets: Stocks 50.0% - S&P 500 Total Return Bonds 50.0% - Barclays Capital Long-Term Treas Total Return Gold 0.0% - Gold Bullion

2,512 1,995

2,512 1,995

1,585

1,585

1,259

1,259

1,000

1,000

794

794

631

631 Source: Barclays, Commodity Systems, Inc. (CSI) www.csidata.com, S&P Dow Jones Indices

1970 DAVIS221

1975

1980

1985

1990

1995

2000

2005

2010

2015

© Copyright 2015 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.

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NDRG EDITORIAL BOARD Ned Davis Senior Investment Strategist

Ed Clissold, CFA U.S. Market Strategist

Tim Hayes, CMT Chief Global Investment Strategist

Brian Sanborn, CFA Global Quantitative Equity Strategist

Joseph Kalish Chief Global Macro Strategist

Neil Leeson ETF Strategist

Lance Stonecypher, CFA Chief U.S. Equity Sector Strategist

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communication reﬂects our analysts’ opinions as of the date of this communication and will

subject to change without notice. NDRG or its affiliated companies or their respective shareholders, directors, officers and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. Using any graph, chart, formula or other device to assist in deciding which securities to trade or when to trade them presents many difficulties and their effectiveness has significant limitations, including that prior patterns may not repeat themselves continuously or on any particular occasion. In addition, market participants using such devices can impact the market in a way that changes the effectiveness of such device. Further distribution prohibited without prior permission. For data vendor disclaimers, refer to www.ndr.com/vendorinfo. Copyright 2015 (c) Ned Davis Research, Inc. All rights reserved.

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