MTA Education Seminar 2006 New York, NY Thursday, May 18, 2006 Friday, May 19, 2006 Saturday, May 20, 2006

1. MTA Education Seminar 2006 New York, NY Thursday, May 18, 2006 Friday, May 19, 2006 Saturday, May 20, 2006

2. GLOBAL EMERGING GROWTH CAPITAL Fusion Analysis in Small-Cap Investing PRESENTED FOR THE MTA EDUCATION SEMINAR By V.John Palicka CFA CMT May 19, 2006 V. John Palicka CFA CMT

3. Introduction • Since 1980, Technical Analysis has played an important role in small-cap investing for me • The Investment Discipline includes the proprietary blending of Fundamental, Technical, Behavioral Disciplines Into a Quant Model • Returns of about 19% p.a. have generated risk-adjusted returns for clients, including billions for institutional investors. Presently, Global Emerging Growth Capital has high rankings in the reporting agencies. Past performance is no guarantee of future results, of course • I will present a sample of Fusion Analysis, highlight some of my key technical indicators, and briefly show a quant model V. John Palicka CFA CMT

4. FUSION INTRODUCTION • This Fusion Introduction will give a flavor of the many topics that are discussed in my Fusion Analysis Workshop • This Introduction will: • Start with a discussion of the Fusion Overview, Niche, and Bodies of Knowledge, • Then, select one area to illustrate the use of Fusion, namely, the Selling Climax • Finish with concluding remarks, and list other uses of Fusion V. John Palicka CFA CMT

5. OVERVIEW • An increasing number of portfolio managers have realized that Fundamental Analysis alone often does not make the best investment approach. • They have increasingly included the benefits of Technical Analysis, as well as Behavioral Finance whose path at times crosses that of Technical Analysis. Also, the volatile trading markets have focused increasing attention on the proper blend of Fundamental and Technical analysis for a broad array of investors with various time horizons. Some call this new popular trend “Fusion Analysis". • Your instructor, John Palicka CFA CMT, has been managing money since the 1970’s using Fusion Analysis. His funds have been ranked among the leaders by various reporting agencies. He has taught Fusion Analysis for academic institutions and professional conferences. V. John Palicka CFA CMT

6. Course Niche • The number of managers, especially hedge funds using a combined approach of Fundamental and Technical disciplines, Fusion Analysis, has escalated rapidly. Also, more applicants are taking the CFA and CMT exams. • Distrust of accounting and other fundamental issues, has lead more investors to use technical analysis. • Increasing academic evidence supports the use of technical analysis • Recent Noble Prize in economics recognized the contribution of behavioral finance V. John Palicka CFA CMT

7. Course Niche-2 • Most major MBA schools and leading textbooks now devote specific sections to technical analysis. • Few are skilled in both technical and fundamental analysis. New York City alone has only a few people who have both the CFA and CMT designation. Even fewer have a fund performance record. While the desire is there to combine both approaches, the course offerings and textbooks in Fusion are virtually nonexistent. • John Palicka’s workshop is among the very first to offer Fusion Analysis on a professional level. V. John Palicka CFA CMT

8. Bodies of Knowledge This workshop will stress three bodies of knowledge and use some of the leading tools of: (1) Technical Analysis and Behavioral Finance (2) Fundamental Analysis (3) Generating quant stocks screens that can be customized to meet investor risk profiles, and thus provide promising investment ideas using Fusion Analysis. V. John Palicka CFA CMT

9. Sample Topic- Selling Climax • A common occurrence in the market is the Selling Climax • This provides opportunities for traders • One can blend Technical, Fundamental, and Behavioral tools to reach an investment decision V. John Palicka CFA CMT

10. Technical Considerations • Based on the definition of a leading technical analyst, John J. Murphy* a Selling Climax is: • A significant reversal occurring at chart top or bottom. At a bottom, it is called a selling climax • It is “…usually a dramatic turnaround at the bottom of a down move where all the discouraged longs have finally been forced out of the market on heavy volume”. • “The subsequent absence of selling pressures creates a vacuum over the market, which prices quickly rally to fill”. • “…while it may not mark the final bottom of a falling market, it usually signals that a significant low has been seen * Murphy, John J., The Technical Analysis of the Financial Markets, New York Institute of Finance,1999, pp 91-93. V. John Palicka CFA CMT

11. Fundamental Considerations • Selling Climaxes may reflect earnings outlook disappointments based on corporate announcements. • Optimistic PEG and DDM models are scaled down substantially. • Upon sell-off, a stock may reach valuation levels that offer the opportunity to generate future risk-adjusted excess returns (Alpha). That would then be an exception to the Semi-Strong Form of the Efficient Market Hypothesis. Under this form of the Efficient Market Hypothesis, historical financial information should not be useful for generating an Alpha. The Selling Climax would also be an exception to the Weak form which precludes the use of technical analysis. V. John Palicka CFA CMT

12. Fundamental Considerations-2 • These levels would show more attractive valuations evidenced by relatively lower price/book value and smaller market cap size, based on the work of Fama and French*. • Some would also claim that the lower p/e ratio of the stock should enable it to show future risk-adjusted returns. This is based on the belief that over long periods, low p/e stocks perform better than high p/e firms. * Fama,Eugene and Kenneth R. French, “The Cross Section of Expected Stock Returns”. Journal of Finance 47 (June 1992), pp.427-465. This is cited in a leading financial textbook,Bodie, Kane, Marcus, Essentials of Investments, 5th Edition, Irwin, 2004, p.241. There is ample literature exploring the Fama/French thesis. Note also, that in the Bodie textbook, Chapter 19 is devoted to behavioral finance and technical analysis. V. John Palicka CFA CMT

13. Behavioral Considerations • James Montier*, a leading observer of Behavioral Finance on Wall Street has commented: • “ ..if a stock price drops, then in theory if the analyst were correct in their initial price target, it should become even more attractive to buy. However, in practice, analysts actually reduce their target prices in response to a drop in the current market price”. * Montier, James, Behavioural Finance, Wiley,2002, pages 9,11,79. V. John Palicka CFA CMT

14. Behavioral Considerations-2 • One Behavioral influence on analyst forecasts is Representativeness. It is a “…tendency to evaluate how likely something is with reference to how closely it resembles something rather than using probabilities”. For example, one could see initial accounting scandals of Tyco as similar to those of Enron, even though upon subsequent events it wasn’t even close. • “Representativeness generates excessively extreme forecasts..”. This would partially account for the willingness to trade the stock at much lower levels. Other behavioral factors would also come into play. V. John Palicka CFA CMT

15. Example- Impath • On the upcoming slide, we shall highlight IMPATH, a clinical lab that had a few Selling Climaxes. • Initially, they were tied to earnings disappointments (the current example), but soon proved profitable for traders upon subsequent rallies. • A few years later, a massive corporate fraud caused Impath to enter bankruptcy and liquidation (enabling another massive but profitable opportunity with a Selling Climax) V. John Palicka CFA CMT

16. Example- Impath-2 • In the sample slide, the chart met the technical definition of a Selling Climax and note the relatively large volume. • The fundamentals entered the Fama/French territory for potential risk-adjusted outperformance • The Street and the leading fund holders became despondent with earnings downgrades and large selling. V. John Palicka CFA CMT

17. When IMPH went below 30 at the end of April, why may a short-term trader have bought the stock at that point? The stock’s P/E and P/B relative to the market was markedly more attractive at the approximate 30 selling climax low and appealed more to value investors and technical analysts. The expected P/E was 26 (1.2 x the SP 500), the trailing P/E was 33 (1.3 x the SP 500) and the P/Book was 3.3 (about 60% of the SP 500). Just a few months ago, IMPH traded at 60 with much higher absolute and relative valuations. The stock rallied nicely but in 2003 due to corrupt management, it was forced to file for bankruptcy. However, by then nice profits were realized. Selling Climax Example V. John Palicka CFA CMT

18. Selling Climax Example-2 • IMPH showed a technical opportunity with a Selling Climax • Fundamentally, valuations were more attractive • Behavioral opportunities could also be exploited • As we shall see on the upcoming slides, derivative strategies could benefit from the above analysis V. John Palicka CFA CMT

19. Other Considerations-Derivatives • Selling Climaxes are becoming more common, especially with the increased use of momentum strategies by hedge funds. • In a Selling Climax, one can attempt to buy the stock at the low and hedge risks with derivatives, namely buying a protective put option with an elasticity that is a close as possible to –1.0. Should the stock not have options, one could create a synthetic options from other securities. • In this section we shall not do the computation for this synthetic strategy (discussed in another section of the Fusion course). • Using tools from technical analysis, such as trend line analysis, one can better estimate risk/reward possibilities using derivative strategies. V. John Palicka CFA CMT

20. Other Considerations-Derivatives-2 • One can also do a “spread” trade on an intermarket basis. For example, if the stock was a housing stock that sold off because of a sharp rise in interest rates, one can evaluate which area (namely, bonds, the stock, or the ETF) overdid the sell-off, and try to position a ‘spread’ trade. A ‘spread” trade may try to buy the “cheaper” security, say the housing stock, from the proceeds of a short on the “more expensive” asset, say the ETF, which could be the TLT (20-year Government Bonds). Hopefully, the spread will narrow and thus generate profits after carrying and transaction costs. • Other, more complex strategies could also be used, such as analysis of the stock’s implied and historical Vega (assuming it had options) and attempting to arbitrage the volatility (again, discussed in another section). V. John Palicka CFA CMT

21. Other Considerations-Quant/AI • Traders and Hedge Funds may seek Selling Climaxes as a major strategy for profitable trades by combining technical, fundamental, and behavioral tools. • Using Fuzzy Logic one can create algorithms to identify technical patterns*. These should lead to a Quant decision-making process. This is discussed in another section of the Fusion Workshop. • Using fundamental databases, one can select fundamental filters to screen for optimal valuations. • Examining stock holders from SEC filings, one can better ascertain behavioral characteristics. *Zhou and Dong, Can Fuzzy Logic Make Technical Analysis 20/20?, Financial Analysts Journal Volume 60, Number 4, 2004, CFA Institute, pp.54-75. V. John Palicka CFA CMT

22. Other Considerations-Quant/AI-2 • Combining the tools, one can have Artificial Intelligence programs automatically present real-time trading opportunities. In fact, these trades could be done without human intervention under strict parameters. • Leading Wall Street funds spend in excess of $10,000,000 a year on quantitative trading techniques. Fusion should be a part of this program. • A very simple approach that I use for my funds is demonstrated in the Fusion Workshop. V. John Palicka CFA CMT

23. Summarizing Key Points • As this is a Technical Presentation, I will comment on some of my key Technical Indicators • And, some key Behavioral Issues • I will show a very simple Quant model V. John Palicka CFA CMT

24. Concluding Remarks • Fusion Analysis can enable better decisions for profitable trades. • Few can master the combined Technical, Fundamental, and Behavioral Aspects of an Investment situation. Focusing on Fusion Analysis should help. • In my Fusion Analysis workshops, we examine other investment situations with other technical tools, such as: • Evaluating the real estate outlook within the context of Elliot Wave analysis, • Hot IPOs and Gann Analysis, • Momentum trading, and • Strategic Asset Allocation using Technical measures with the Fed Model • Upon completion of the basic Fusion Workshop, one is invited to attend my Advanced Fusion Workshop. V. John Palicka CFA CMT

25. Thank You Thank you for your interest and hopefully, Fusion Analysis will prove to be rewarding in your investments. V. John Palicka CFA CMT