Dion Market Timing Model

Europe Equity Research 05 - Sep Sep - 2012 2012

Market Timing Model Methodology, Methodology, Thinking Process and Strategy to time t ime the market

Marco Dion AC Global Head of Equity Quant Strategy (44-20) 7134-5909 [email protected]

See the end pages of this presentation for analyst certification and important disclosures. J.P. Morgan does and seeks to do do business with companies covered covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Backtesting the “opinion of derivatives traders” → the VIX

VIX Index - Signal Backtest

Annualised Returns Max Drawdown Success Rate

MSCI World MSCI Europe 4.1% 3.0% . . -39% -49% 51% 51%

Source: Bloomberg, MSCI, JP Morgan

DAX 4.2% . -61% 53%

CAC 4.3% . -52% 51%

SMI 7.4% . -47% 51%

FTSE 2.5% . -51% 52%

S&P 500 Dow Jones 11.3% 9.6% . . -34% -40% 53% 52%

How does our Model work ?

How to define the directional position to take – position construction via a “voting mechanism”

Long or Short?

Vix Index Bond Yield AUD-CHF

VOTING

Market Trend

BOOTH

Seasonality

Valuations

Source: JP Morgan

Long Neutral Short

Stop-Loss and Risk Management Hypothetical example of the application of a (2 standard deviation) Stop-Loss rule


Model Backtests Improved Strategy Backtest Annualised Returns Sharpe Ratio Max Drawdown Success Rate

MSCI World MSCI Europe 6.2% 11.4% 0.61 1.02 -18% -10% 74% 74%

DAX 10.0% 0.73 -21% 74%

Improved Strategy - Backtest analysis (MSCI Europe)


CAC 11.1% 0.89 -13% 75%

SMI 10.4% 0.89 -19% 75%

FTSE 7.2% 0.72 -17% 74%

S&P 500 Dow Jones 6.5% 6.1% 0.62 0.62 -18% -15% 74% 74%

Further result analysis (1) Improved Strategy Backtest – Yearly distribution of returns

1995 1996 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2012

MSCI World MSCI Europe 4.8% 6.9% -7.5% -2.7% . . 30.1% 53.7% 5.4% 20.0% 12.1% 11.6% 1.9% -1.4% 3.7% 14.8% 10.3% 29.4% 0.3% 3.3% 1.1% 3.7% 7.5% 13.4% 1.6% 0.2% 43.0% 29.8% 2.1% 20.9% -3.2% -6.7% . - . 0.1% 3.9%

DAX 4.9% -2.2% . 57.7% -0.2% -5.7% -4.9% 16.8% 30.3% 4.3% 1.8% 15.1% 5.5% 26.6% 26.4% -2.1% - . 3.8%

CAC 2.3% -2.4% . 73.9% 19.9% 1.7% -0.2% 20.0% 35.6% 3.3% 3.6% 12.7% 0.4% 13.9% 26.2% -6.9% . 3.1%

Source: Bloomberg, MSCI, JP Morgan (the 2012 returns stop at the end of March)

SMI 3.6% -1.5% . 74.9% 17.6% 1.9% -10.5% 16.9% 25.6% 5.8% 6.2% 8.2% 0.5% 37.5% -4.4% -6.9% . 1.0%

FTSE 11.1% -3.0% - . 39.4% 22.3% -2.1% -1.8% 18.0% 23.3% -0.6% 0.7% 14.6% 3.3% 31.4% -6.9% -0.5% - . 0.3%

S&P 500 Dow Jones 2.9% 1.4% -8.0% -4.6% . . 25.6% 27.4% 3.5% -0.9% 12.5% 2.1% -5.5% -2.2% 7.0% 6.3% 1.4% 2.2% 3.8% 2.1% 4.0% 1.0% 8.3% 2.0% 6.1% 8.4% 46.6% 49.9% 2.6% 14.8% -0.6% -0.9% - . - . -0.2% 0.1%

Further result analysis (2) Distribution of weekly returns

Drawdown analysis


Further result analysis (3) Average Model performance during large weekly Market moves Market Move > +3%

0.28%

Market Move < -3%

0.28%

Market Move > +5%

0.20%

Market Move < -5%

0.48%

Market Move > +10%

1.51%

Market Move < -10%

1.45%

Stress-test analysis Dotcom Bubble End of Dotcom Bubble 2008 GFC 2009 March market bottom January 2011 rebound Greek 'default' 2011 January 2012 rebound

Start period 29-Dec-97 27-Mar-00 31-Dec-07 23-Feb-09 27-Dec-10 27-Dec-10 26-Dec-11


End period Performance 27-Dec-99 84.4% 30-Sep-02 23.1% - . 29-Dec-08 29.8% 29-Jun-09 7.3% 31-Jan-11 1.7% 26-Dec-11 -0.4% 30-Jan-12 0.0%

Market Timing Model implemented via Dax Futures, Eurostoxx Futures and a mix of Dax and Eurostoxx Futures (pre commissions and transaction costs)

Implementation 1) Beta exposure management 2) In/Out- Flow management 3) Cyclical vs Defensive 4) Futures trading 5) Application to longer positioning

Market Timing Model implemented via Dax Futures, Eurostoxx Futures and a mix of Dax and Eurostoxx Futures when transaction costs are considered

5bp of Annualised Returns transaction Sharpe Ratio costs Max Drawdown 10bp of Annualised Returns transaction Sharpe Ratio costs Max Drawdown Source: Bloomberg, MSCI, JP Morgan

DAX Future 10.5% 0.75 -16% 8.9% 0.64 -19%

Eurostoxx Future 11.4% 0.83 -13% 9.3% 0.68 -14%

DAX & Eurostoxx Futures 12.4% 0.92 -15% 10.7% 0.79 -15%

Further improvements? •

VIX → VDAX ?

•

Call to Put ratio ?

•

Yield curve?

•

Z-score ranking?

•

Quant Factors input?

•

Credit signals?

•

Dynamic Factor weights?

•

Baskets of currencies instead of single crosses?

•

Sophisticated market trend signals?

•

Macro based Factors?

•

Emerging Market inputs?

•

Etc

Appendix Backtesting the “opinion of bond traders” → the US 10-Years Bond Sharpe Ratio Max Drawdown Success Rate

MSCI World MSCI Europe . . 0.12 0.00 -36% -56% 49% 50%

DAX . 0.05 -64% 51%

CAC - . -0.05 -74% 50%

SMI . 0.04 -49% 52%

FTSE - . -0.12 -62% 49%

S&P 500 Dow Jones . . 0.07 0.03 -49% -50% 48% 51%


Backtesting the “opinion of equity traders” → the market valuations Annualised Returns Sharpe Ratio Max Drawdown Success Rate



DAX 4.4% 0.18 -57% 51%

CAC 7.9% 0.34 -44% 52%

SMI 7.7% 0.36 -41% 52%

FTSE 11.8% 0.63 -34% 54%

S&P 500 Dow Jones 5.1% 3.4% 0.26 0.18 -42% -41% 52% 52%

Backtesting the “opinion of currency traders” → the AUD-CHF cross MSCI World MSCI Europe Annualised Returns 1.3% 7.0% . . Max Drawdown -54% -41% Success Rate 51% 51%


DAX 2.9% . -70% 50%

CAC 10.4% . -53% 50%

SMI 6.7% . -53% 50%

FTSE 8.1% . -36% 52%

S&P 500 Dow Jones 2.4% 2.4% . . -62% -70% 51% 51%

Backtesting the “medium term trend”→ 3-month market trend MSCI World MSCI Europe Annualised Returns 1.8% 8.6% Sharpe Ratio 0.10 0.43 Max Drawdown -62% -37% Success Rate 52% 55%

DAX 8.6% 0.35 -56% 52%

CAC 3.1% 0.13 -83% 51%

SMI 4.4% 0.21 -204% 53%

FTSE -0.3% -0.02 -82% 52%

S&P 500 Dow Jones -0.6% 2.9% -0.03 0.15 -143% -92% 52% 51%


Backtesting the “seasonality” argument” → the turn-of-the-month effect Annualised Returns Sharpe Ratio Max Drawdown Success Rate



DAX 9.2% 0.38 -47% 50%

CAC 13.2% 0.57 -40% 51%

SMI 10.8% 0.51 -43% 50%

FTSE 11.1% 0.59 -39% 51%

S&P 500 Dow Jones 6.5% 5.0% 0.33 0.27 -46% -41% 51% 52%

Backtesting the “opinion of commodity traders” → the Gold-to-Oil ratio MSCI World MSCI Europe Annualised Returns -6.8% -7.0% Sharpe Ratio -0.36 -0.35 Max Drawdown -77% -76% Success Rate 49% 49%

Gold to Oil ratio - Backtest analysis (MSCI World)


DAX -6.2% -0.25 -75% 50%

CAC -7.0% -0.30 -81% 50%

SMI -8.6% -0.41 -84% 48%

FTSE -6.3% -0.33 -74% 47%

S&P 500 Dow Jones -6.6% -6.3% -0.34 -0.34 -78% -74% 48% 49%

Historical performance of our Market Timing Model compared to the performance of the HFRX Systematic Macro Diversified Macro Diversified Index


Dion Market Timing Model

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