1. Vitaliy N. Katsenelson, CFAChief Investment OfficerInvestment Management Associates, Inc. 1

2. 3 3. Active Value Investing Net of Fees performance is afterthe deduction of management fees, after reinvestmentof dividends, interest and other earnings (recorded onaccrual basis), and after the deduction of broker feesand commissions.S&P 500 market average includes reinvestment ofdividends but are not adjusted for any transactioncosts.Past performance is not necessarily indicative offuture results and is only one of several factors whichshould be used in evaluating a professionalinvestment organization.4 4. We are used to thinking about secular (longer than 5 years) markets inbinary terms: OR5 5. There is another type of long-term market Cowardly Lion or Sideways bursts of occasional bravery lead to stock appreciation, but are ultimately overrun by fear that leads to a subsequent descent Active Value Investing: Making Money in Range-Bound Markets 6 6. Dow Jones Industrial Average 100+ YearsThe bear markets were actually sideways markets and happened the time7 7. Dow Jones Industrial Average 2000 - 2010So far markets have gone sideways hell of a ride, but still sideways 8 8. Secular Bull and Sideways Market Cycles Were Not Caused by: Economy Earnings growth Interest rates InflationThey Were Caused by: Valuation 9 9. As Long As: Inflation Remained Reasonable / Deflation Was Absent / GDP And Earnings Growth Remained Positive Market Was Either Bull Or Sideways.Note: Real GDP growth was extremely stable throughout all secular markets10 10. Stock Market MathEarnings Growth Price+ + P/EDividends =Total Return from Stock(s) OREarnings Growth + P/E + Dividends = Total Return from Stock(s) 11 11. Sources of ReturnPractical Example: 12 12. Wal-Mart -- A Typical Sideways Market Stock 2001 - 2010 13 13. Sources of Return: Secular Sideways and Bear Markets (S&P 500)SIDEWAYS MARKETS Sideways Markets: P/E Contraction + Earnings Growth = Low Returns Bear Markets: P/E Contraction + Earnings Decline = Negative Returns 14 14. By the Book Bear Market Japan15 15. Sources of Return: Secular Bull MarketsBull Markets: P/E Expansion + Earnings Growth = Super Returns16 16. 17 17. 18 18. Bull Markets Start at Below-Average and End At Above-Average Valuations.Range-Bound Markets Start at Above-Average and End at Below-Average Valuations.19 19. Bull, Bear and Sideways Markets Happen WhenMarket Economic Growth Starting Valuation (P/E)BullGood (Average)LowRange-Bound Good (Average)HighBear BadHigh20 20. In a perfect world where humans have no emotionsstock market appreciation = economic growth = earnings growth = 5-6% 21 21. The Effects of Psychology on Market CyclesEnd of Bull MarketNew average expectations are NOTmet P/E stoppedexpanding P/E + EPS =Sideways Market0% + 6% 6%Returns are NOT new average, not average, butbelow average:P/E + EPS = -6% + 6% 0% 22 22. Interest rates and inflation are very important but they take a second seat to marketpsychology. They ultimately determine the length and the extremes of market cycles.Good/Bad forInterest Rates Move from Reason P/Es Move to Zone 1 Zone 2GOODnormalcy Zone 2 Zone 3BADRisk of inflation 1982Move to Zone 3 Zone 2GOODnormalcyIf interest rates /inflationwere higher, secular Zone 2 Zone 1BADRisk of deflationrange-bound may haveended sooner at highervaluation 2000 If interest rates /inflation were not that low, secular bull may have ended sooner at lower valuation23 23. Still in the Sideways Market? Valuations are still high (above average). Valuations need to stay below average for a while (see next slide). Real earnings growth will be lower in the future due to higher futuretaxes, higher interest rates (caused by government borrowing), consumerdeleveraging sideways market may last longer than we expect. High inflation will shorten sideways market duration, but final P/Ewill be lower as well. If nominal earnings growth doesnt materialize in the future (3,5,10years), earnings decline we are set for a secular bear market 24 24. 25 25. Brief Summary of Strategy and Analysis for Todays Environment Be a buy and sell investor. Buy and hold is in a coma (see next chart) . Time(price) stocks through a strict buy and sell process. Buy when undervalued, sellwhen fairly valued. Time stocks, not the market: Market timing is very difficult. In the short runemotions are in the drivers seat. Dont buy for the sake of being invested. Dont lose money by making marginaldecisions. In the absence of good stocks to buy, be in cash. The opportunity costof cash is not as high as in a secular bull market. Increase your margin of safety: Fewer (better) stocks will be in your portfolio. Favor dividend-paying stocks. Dividends were 95% of the return in previousrange-bound markets. (Warning: dividends are part of the analytical equation, notthe equation.) Look overseas -- increases return without increasing risk. 26 26. Bull Markets: Stocks Do Outperform Bonds Hands DownThrow money at stocks, and youll do much better than in bonds or cash. In general, the fewerdecisions you make the better off you are (buy and forget).27 27. Sideways Markets: Stocks Dominance Is Not SignificantAsset allocation is not as important as stock selection. 28 28. Conclusion: Stock Selection Matters A Lot! 29 29. Thank You!To signup for complimentary articles via email visitwww.ContrarianEdge.comInvestment Management Associates Inc.7979 E. Tufts Ave, Suit 820, Denver, Co 80237303.796.8333 / www.imausa.com 30 30. Secular Range-Bound Market Is Comprised of Many Cyclical Markets 31 31. 32 32. 33