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Opportunity Knocks on the 2016 Door Ronald Surz, Ron@PPCA-Inc.com , (949)488-8339

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” ― Winston S. Churchill

In my 2014 end-of-year commentary I forecast a 19% loss in 2015 for U.S. stocks, as measured by the S&P500, when in fact the S&P actually earned a positive 1.4% return, so I was wrong. 2015 was disappointing, but not as bad as I thought it would be. The total U.S. stock market (not shown) was down 1%. Other asset classes weren’t so lucky, especially precious metals and commodities, as shown in the following exhibit.

My fickle finger of gloom was misdirected in 2015; it should have pointed at other asset classes. But I’m repeating my forecast for a 19% loss in 2016, in stark contrast to Wall Street’s 7-11% gain forecast. U.S. stock market fundamentals have deteriorated with lower dividend yields and higher Price/Earnings ratios, especially if you consider the effects of stock buy-backs. We’re entering 2016 with a frothy and expensive stock market that begs to be humbled. I don’t think it can dodge a bullet two years in a row.

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If you think I’m right, you can profit in 2016 in a number of ways. You can buy puts or inverse ETFs, or you can short market indexes. The stock market’s difficulty is your opportunity. Also, in the discussion that follows I examine market segments like styles, sectors and countries. Some segments will thrive in 2016 while others will bomb. There are plenty of opportunities to profit from these movements. These market opportunities are available to everyone, but I have a special opportunity to offer to a select few. Are you one of these select few? A Special One-Time Opportunity (Carpe Opportunitatem) As is customary in market commentaries like this one, which I’ve written for more than 20 years, I use Surz Style Pure Indexes®. SSPI were launched in 1986, a decade before Morningstar introduced their version. They’re the original, the real deal. I have been providing my indexes for 30 years now, and hope you find them useful. Some prominent people like them, for good reasons. Most wouldn’t appreciate this fact but maintaining style indexes is expensive, especially for an individual who is semi-retired: think S&P, Russell & MSCI versus Ron Surz, and surviving 30 years. SSPI have been a work of love but it’s time to step it up and move it on. There’s a treasure trove waiting for the right partner(s).

My challenge creates your opportunity. Here’s how:

• If you collect stock information, like prices, P/E etc, I’d like to talk to you about sharing that data. It won’t cost you anything, and you’ll be rewarded with something valuable in exchange.

• We could partner to pursue the following business opportunities: Create ETFs and mutual funds that track my indexes. The DOL Rule could drive a $Trillion into passive indexes, especially style indexes. SSPI

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is perfect for style bets/rotation because they are Pure. Large is really HUGE and Small is really tiny. Growth is really aggressive and Value is really defensive. No stocks are in both value & growth, as they are in Russell & MSCI. Importantly, SSPI are Smarter than Smart Beta style indexes (no kidding). And my Centric Core is an exceptionally smart beta that creates smart alpha by bringing out the best in active managers.

Provide & perfect Style Scan holdings-based style analyses with 3-D graphic displays, style-based attribution and momentum analyses and Success Rankings.

You could be my successor. 30 years of progress would become yours.

I really want to continue providing Surz Style Pure Indexes, and trust you would like that too. Please contact me to discuss. If you personally aren’t interested in the opportunities, please suggest someone who could be. My contact information is provided at the end of this commentary. Don’t let SSPI fade away. The following uses SSPI to examine market performance in 2015 and the 5 years ending 2015, with an eye toward identifying opportunities in 2016. Part 1: Winners and Losers in 2015 and the 5 Years Ending 2015 U.S. stocks As was the case in 2014, large cap stocks led the way in 2015, with large-cap growth stocks performing best, earning 10.5%. By contrast, small-cap growth companies lost 15%. The S&P500 returned 1.4% (not shown), exceeding the total market’s 1% loss.

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On the sector front, Healthcare fared best, earning 7%. By contrast, energy stocks lost 25.5%, and materials lost 14%. In a repeat of 2014, it was another bad year for infrastructure companies, and a good year for technology, both IT and medical.

The collapse of energy stocks this year and last year has been the big story. Energy stocks plummeted in the second half of 2014 and continued to decline in 2015 as oil prices crashed , due in large part to increased supply coming out of the U.S. from fracking operations. Crude oil ended 2015 at $38 per barrel, which is less than the cost of exploration in several countries like Brazil and the UK. Consequently oil rigs have been shut down as have pricier shale regions including Eagle Ford in Texas and Bakken in North Dakota.

OPEC is employing a strategy of putting oil producers out of business, at least temporarily. OPEC is increasing oil supply in the face of decreasing prices, a strategy that may be good for consumers in the short run, but can’t be good in the long run. Lower prices increase consumption, so we use more of a commodity that has a limited supply. The day that this supply is used up has drawn closer, as has the day that energy prices rebound.

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Looking back over the past 5 years we see that larger companies have performed best, especially large cap growth stocks. The sector returns in the chart below are shown in the same sequence as the year, so you can see that the 5 year rankings are similar to the year 2015. Healthcare and consumer discretionary companies have performed best. Infrastructure stocks – materials and energy – have performed worst.

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But the interesting details lie in the cross-sections of styles with sectors, especially if we are interested in exploiting momentum effects, as discussed in “Part 2: The Future” below. Foreign stocks Looking outside the U.S., foreign markets earned 1%% in 2015, exceding the U.S. stock market’s 1% loss, and exceeding EAFE’s 0.5% return because, unlike the U.S., smaller companies performed best . Japan and Europe have see-sawed over the years, thriving in 2013, suffering in 2014, and winning again this year. Canada was the worst performing country with a 20% loss in $US.

Looking back over the past 5 years, foreign market returns of 5% per year have lagged the U.S. 11% per year appreciation, but exceeded EAFE’s 4% return. Europe and Japan have had the best performance, earning 8% per year. By contrast, Latin American markets have lost 3% per year. Unlike the U.S., value stocks have fared best over the past 5 years, earning twice as much as growth stocks, 7.5% versus 3.5% for growth.

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We can’t change the past or the present, but we can plan for the future, as addressed in the next section.

Part 2: The Future: Winners and Losers Forecast for 2016 In Searching for Alpha in Heat Maps, published in early April, 2013 I showed how heat maps could be used to profit from momentum effects. I then published my forecasts each quarter, and momentum effects “worked”, with winners continuing to win and losers continuing to lose. So now I’ll offer forecasts for the first quarter of 2016 using heat maps. A heat map shows shades of green for “good,” which in this case is good performance relative to the total market. By contrast, shades of red are bad, indicating underperformance. Yellow is neutral. The table below is the U.S. heat map for the year ending December 31, 2015. We see that the best performing market segments are mostly in the healthcare sector and the large cap growth style. These would be the stocks to bet on if you want to make a

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momentum bet. Of course you could make a contrarion bet that these sectors will not do well. As for underperforming segments, energy and materials stocks are the place to look,especially smaller companies in these sectors. Many quantitative managers employ momentum in their models, buying the “green” and selling the “red.” Fundamental managers use heat maps as clues to segments of the market that are worth exploring, for both momentum and reversal potential.

U.S. Heat Map for the Year Ending December 31, 2015

STAP DISC HLTH MATL TECH ENER INDU UTEL FINC TOTL

LGVL -0.9 -6.6 2.5 0.2 -11.8 -44.4 -5.1 -0.8 -1.5 -6.2 LGCO 3.7 8.8 12.5 -13.9 9.3 -22 -3.4 -9.6 0.2 2.8 LGGR 11.4 26.5 5.1 -8.8 26.4 -20.6 -0.4 45 -5 10.4 MDVL 26.8 -12.6 12.9 -15.3 0.3 -35.4 -4.8 -4.5 -0.1 -5.2 MDCO 7.3 -6.4 12.9 -7.8 7.2 -31.4 -6.8 -16.4 3.9 -2.6 MDGR -8.9 2.1 7.5 -19.3 4.2 -28.3 -4.3 -11.4 -1 -2.5 SCVL 8.4 -8.9 0.6 -20.5 -0.8 -43.2 -12.1 -1.8 0 -7.1 SCCO -5.5 -12.3 24.9 -41.6 5.9 -38.2 -15.5 5.8 0.6 -3.4 SCGR -16.8 -20.3 0.8 -35.9 -7.2 -53.8 -29.8 -16.6 -17.7 -15.6 TOTL 3.9 4.8 6.6 -13.9 5.4 -25.5 -5.1 -2.4 -1.3 -1.0

Source: PPCA Inc Moving outside the U.S., the healthcare sector and the small cap growth style thrived in 2015, while energy stocks in all countries and styles have suffered as has Canada.

Foreign Heat Map for the Year Ending December 31, 2015

STAP DISC HLTH MATL TECH ENER INDU UTEL FINC TOTL

LGVL 9.9 3.1 16 -23.9 -5.9 -13.6 -3.4 -2.3 -4.9 -3.2 LGCO 10.2 -1.9 5.1 -1.1 -1.3 -15.2 2.6 3.1 -0.7 0.3 LGGR 4.7 -5.5 8.1 -10.8 -4.4 -30.2 -3.7 -4 -5.7 -1.8 MDVL 4.1 5.7 21.3 -7.4 5.9 -18.7 -3.1 -3.2 -1.3 -1.4 MDCO 8.2 7.5 21.5 -9.2 11.6 -31.2 4.9 -8.9 0.7 2.4 MDGR 7 14 25.1 -6.2 17.9 -17.1 6 -6 12.7 8.4 SCVL 9.4 8.7 12.9 -1.8 10.4 -28.3 2 -0.8 3.1 3.4 SCCO 10.6 7.9 22.5 -0.4 11.9 -37.2 5.2 -1 -4.5 3.1 SCGR 27.7 26.3 30 23.6 33.4 -8.9 31.5 -2 8.9 20.8 UK 11.5 7.2 7 -23.2 7.9 -16.6 -2.1 3.7 -3.8 -0.8 JAPN 32.5 11 34.3 2.9 9.6 -1 7.8 25.9 10.1 14.1 CANA -6.5 -14.3 -29.8 -31.6 -5.2 -32.9 -24.7 -12.9 -14.6 -20.8 AUST -2.5 10.7 5.6 -24.8 8.8 -27.5 8.2 2.9 -0.9 -3.4

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APXJ 11.3 8.5 39.2 9.8 5.6 -18.9 8.7 -5.5 -5.3 1.8 EURO 11.1 2.3 10.5 -1.5 9.3 -10.1 4.5 -3.2 -0.4 3.6 EMRG -2.3 3.5 6.3 -9.9 1.3 1.2 -11.3 -5 -12.2 -5.8 LATN -1.1 -15.9 -31.4 -24.9 -32.4 -42.2 -24 -24.1 10.9 -10.3 TOTL 9.3 4 13.2 -8.3 6.4 -16.4 2.3 -1 -2.5 0.8

UK JAPN CANA AUST APXJ EURO EMRG LATN LGVL -4.3 11.2 -22.1 -10.8 -7.8 0.7 -8.8 -22.8 LGCO -0.9 13.6 -25 17.5 -11.4 4.3 -10.7 -5.4 LGGR -2.6 11.8 -29.1 5.9 -4.8 1.6 -6 14.3 MDVL 7.7 14.4 -30 6.1 -7.1 8 -8.4 -17 MDCO 7.2 21 -23.1 9.7 3.1 10.4 -9.4 -24.6 MDGR 0.6 20.3 -25.1 4 18.5 9.9 6.3 15.6 SCVL 10.6 19.1 -28 0.8 -1.9 9.4 -1.7 -20.9 SCCO 3.9 16.1 -30 1.7 -0.9 8.7 -2.4 -3.3 SCGR -0.5 6.8 -26 7.9 54.9 9.6 -4.4 -10.2

Source: PPCA Inc In forecasting the future, it helps to have an understanding of the past. Those who are unaware of the mistakes of the past are more likely to repeat them. In the final section of this report, I provide a longer term 90-year history of stocks, bonds, T-bills and inflation. There are many lessons to be learned from this history.

Part 3: The Past: The 90-year history of the U.S. capital markets The table on the following page shows the history of risk and return for stocks (S&P 500), bonds (Citigroup high grade), T-bills and inflation. There are many lessons in this table, so it’s worth your time and effort to review these results. For example, here are a few of the lessons:

1. T-bills paid less than inflation in 2015, earning 0.1% in a 1.3% inflationary environment. We paid the government to use their mattress, as we have for the past ten years, with a 1.21% return in a 1.85% inflationary environment.

2. Bonds were more “efficient,” delivering more returns per unit of risk than stocks in the first 45 years, but they have been about as efficient in the most recent 45 years. The Sharpe ratio for bonds is .48 versus .34 for stocks in the first 45 years, but the Sharpe ratio for both is the about the same in the more

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recent 45 years. Both stocks and bonds have returned about .32% per unit of risk.

3. Average inflation in the past 45 years has been more than twice that of the previous 45 years: 1.83% in 1926-1970 versus 4.09% in 1971-2015.

4. Bonds returned 2% above inflation in the first 45 years, and that doubled to

above 4% in the past 45 years. 5. Stock market volatility was much higher in the 20-year period 1926-1945 than

it has been since. Volatility subsided from 20-35% down to 15% in the most recent 70 years.

6. By contrast, bond markets have become more volatile, more than doubling in

the most recent 45 year to 9.23%, versus 4.52% in the first 45 years.

MARKET HISTORY FOR YEARS ENDING DECEMBER, 2015 stocks bonds t-bills cpi --------------------- --------------------- -------------- -------------- RETURN STNDEV SHARPE RETURN STNDEV SHARPE RETURN STNDEV RETURN STNDEV ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ 2015 ( 1 Year ) 1.38 13.64 0.10 1.07 2.93 0.31 0.10 0.02 1.30 1.15 ______________________________________________________________________________________________ 1926-2015(90 YRS) 10.02 18.85 0.34 6.08 7.28 0.35 3.46 0.89 2.95 1.81 ______________________________________________________________________________________________ 1926-1970(45 YRS) 9.62 21.91 0.34 4.17 4.52 0.48 1.94 0.52 1.83 2.18 1971-2015(45 YRS) 10.42 15.22 0.34 8.02 9.21 0.31 5.01 0.97 4.09 1.27 ______________________________________________________________________________________________ 1926-1935(10 YRS) 5.85 35.39 0.11 8.14 4.60 1.28 1.93 0.51 -2.42 2.62 1936-1945(10 YRS) 8.41 22.35 0.37 4.80 2.00 2.30 0.17 0.06 2.81 1.93 1946-1955(10 YRS) 16.69 13.38 1.15 2.83 4.42 0.38 1.14 0.15 3.96 2.85 1956-1965(10 YRS) 11.07 11.77 0.68 2.49 4.10 -0.08 2.82 0.23 1.73 0.69 1966-1975(10 YRS) 3.27 15.58 -0.14 3.59 8.28 -0.23 5.61 0.41 5.71 1.02 1976-1985(10 YRS) 14.30 14.21 0.34 9.82 12.56 0.06 9.05 0.85 7.02 1.26 1986-1995(10 YRS) 14.86 15.01 0.58 10.71 6.97 0.68 5.76 0.54 3.46 0.72 1996-2005(10 YRS) 9.11 15.72 0.33 7.46 6.60 0.54 3.77 0.51 2.71 0.86 2006-2015(10 YRS) 7.33 15.07 0.40 5.19 9.71 0.40 1.21 0.55 1.85 1.47 ______________________________________________________________________________________________ 1926-1930( 5 YRS) 8.67 21.65 0.24 5.76 1.86 1.19 3.36 0.39 -1.80 2.17 1931-1935( 5 YRS) 3.11 45.36 0.06 10.57 6.19 1.59 0.53 0.19 -3.03 3.02

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1936-1940( 5 YRS) 0.50 28.55 0.01 6.24 2.52 2.44 0.08 0.06 0.43 1.75 1941-1945( 5 YRS) 16.95 13.65 1.22 3.39 1.20 2.60 0.26 0.04 5.26 1.87 1946-1950( 5 YRS) 9.91 14.48 0.63 1.76 2.00 0.48 0.80 0.11 6.57 3.71 1951-1955( 5 YRS) 23.88 12.07 1.83 3.91 5.93 0.41 1.47 0.13 1.43 1.25 1956-1960( 5 YRS) 8.92 11.99 0.51 1.18 5.35 -0.25 2.56 0.25 2.13 0.80 1961-1965( 5 YRS) 13.25 11.62 0.85 3.82 2.25 0.31 3.08 0.19 1.34 0.56 1966-1970( 5 YRS) 3.34 14.20 -0.14 1.23 7.68 -0.53 5.45 0.31 4.53 0.60 1971-1975( 5 YRS) 3.21 16.98 -0.14 6.00 8.85 0.02 5.78 0.49 6.90 1.23 1976-1980( 5 YRS) 13.95 14.60 0.39 2.39 10.87 -0.46 7.78 0.83 9.22 1.15 1981-1985( 5 YRS) 14.66 13.92 0.28 17.80 13.83 0.49 10.34 0.74 4.86 1.09 1986-1990( 5 YRS) 13.19 18.79 0.31 10.20 7.93 0.38 7.01 0.44 4.11 0.89 1991-1995( 5 YRS) 16.56 10.07 1.16 11.23 5.92 1.11 4.52 0.38 2.81 0.42 1996-2000( 5 YRS) 18.35 16.33 0.76 6.51 4.72 0.25 5.29 0.15 2.61 0.58 2001-2005( 5 YRS) 0.59 14.84 -0.11 8.41 8.08 0.74 2.28 0.37 2.81 1.07 2006-2010( 5 YRS) 2.18 17.80 -0.01 5.97 12.87 0.27 2.33 0.63 2.17 1.71 2011-2015( 5 YRS) 12.74 11.72 1.08 4.42 4.93 0.87 0.10 0.02 1.53 1.20

Source: PPCA Inc

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Additional perspective is provided by the following histograms of stock and bond returns.

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Summary of 2016 Opportunities:

• Partner with Surz Style Pure Style Indexes. For example, Centric Core is an exceptionally smart beta that creates smart alpha by bringing out the best in active managers.

• Bet that the U.S. stock market will decline

• Decide on momentum or reversal versus 2015: Biggest U.S. winner in 2015: Large cap Growth (11%) Biggest U.S. loser: Small cap growth (-10%) Biggest global winner: Healthcare (8%) Biggest global losers: Energy (-14%), Materials (-8%) Biggest foreign winners: Small cap growth (18%), Japan (13%) Biggest foreign loser: Canada (-15%)

More quotes about Opportunities The Chinese use two brush strokes to write the word 'crisis.' One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger--but recognize the opportunity. ― John F. Kennedy When a great moment knocks on the door of your life, it is often no louder than the beating of your heart, and it is very easy to miss it. ― Boris Pasternak It still holds true that man is most uniquely human when he turns obstacles into opportunities. ― Eric Hoffer Ronald J. Surz is president of PPCA Inc. and Target Date Solutions in San Clemente, California. He is also CIO of Paladin Financial Technology, TDF Builder, and Sortino Investment Analytics. PPCA provides contemporary investment manager due diligence software and Surz Style Pure Indexes® including Centric Core. Target Date Solutions developed the patented the Safe Landing Glide Path®, the basis for the SMART Funds® Target Date Index collective investment funds on Hand Benefit & Trust, Houston, the only investable target date fund index. Ron is co-author of the Fiduciary Handbook for Understanding and Selecting Target Date Funds. He can be reached at (949)488-8339 or Ron@PPCA-Inc.com