THE

INDICATORS
OF STOCK MARKET MACRO TURNING POINTS
DURING GLOBAL FINANCIAL CRISIS
APPLICATION TO DYNAMIC ASSET ALLOCATION INVESTMENT
STRATEGY USING INDEX AND EXCHANGE TRADED FUNDS

February 21, 2012

GEORGE BIJAK
Managing Director
Investment Strategist
G B Capital Pty Ltd
www.cpgli.com

2012 Copyright by George Bijak

Electronic copy available at: http://ssrn.com/abstract=2061478

ABSTRACT
The formulation of a winning investment strategy for the 2007-2009 Global Financial
Crisis (GFC), also known as the Great Recession, essentially required making one
key judgement that the global banking system would survive the Lehman Brothers
collapse and identifying the two macro turning points: 2007 top and 2009 bottom of
the market.
Back in late 2008, investors should have concluded that the massive Central Bank
liquidity injection supported by the global fiscal stimulus had the capacity to save the
global banking system after the September 2008 Lehman Brothers Bank collapse.
There was a good chance the GFC would not turn into a 1930s style Great Depression
contrary to a popular bearish conviction.
Investment strategists need non-subjective indicators to help them make rational
decisions in times of irrational and emotional market behavior. The Author has
developed a proprietary Corporate Profits Growth Leading Indicator (CPGLI) for this
purpose (not fully disclosed here), supplemented by the analysis of coincident
indicators of the macro-turning points discussed in this paper.
The analysis identified the following macro indicators of the 2007 market top:
subprime write-downs, M&A at high prices, overleveraged shadow banking system,
Central Banks interest rate cuts, massive Fed liquidity injection and market
disconnecting from corporate profits trend.
The 2009 market bottom was signalled by the following indicators: extremely bearish
investors, very low valuations, dominating risk-off trade, interest rates near zero,
falling liquidity injection, expansion of Feds balance sheet, corporate profits
turnaround, falling initial unemployment claims and rising ISM Manufacturing Index.

2012 Copyright George Bijak www.cpgli.com | INTRODUCTION

Electronic copy available at: http://ssrn.com/abstract=2061478

The paper provides evidence of validity of the active investment methodology. It

describes the Authors actual independently audited CPGLI Dynamic Asset Allocation
Investment Strategy based on the coincident indicators discussed here and the CPGLI
that after extensive testing has proved to work in normal markets as well as the
most unusual conditions of the start and end of the GFC. The CPGLI signals not just
the direction of corporate profits growth but also the strength of growth which
determines conviction and thus whether to use gearing as well. The strategy returned
83% for the 5 year period from 2006 to 2010 (or 12.9% compounded per annum)
whilst S&P 500 recorded a negative return during the equivalent period.
Exchange Traded Funds were the ideal, most convenient, and cost effective
investment products for the execution of this actively managed CPGLI Dynamic Asset
Allocation investment portfolio strategy.

2012 Copyright George Bijak www.cpgli.com | INTRODUCTION

1 Table of Contents
2

INTRODUCTION....................................................................................................................................... 5

THE TWO TURNING POINTS .................................................................................................................... 7

THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM WILL SURVIVE THE GFC .............................................. 9

4.1

Central Banks & Governments saved the global banking system ...................................................... 9

4.2

Fed led the rescue by injecting liquidity ......................................................................................... 10

4.3

Liquidity Injections: comparing 2008 and 2001 Recessions with 1930s Great Depression .............. 11

4.4

GFC Comparisons to 1930s Great Depression were misplaced ....................................................... 13

4.5

The liquidity injections helped economy ........................................................................................ 13

MARKET TOP INDICATORS 2007 ............................................................................................................ 15

5.1

Subprime write-downs .................................................................................................................. 15

5.2

M&A frenzy at high prices ............................................................................................................. 15

5.3

Highly leveraged shadow banking............................................................................................... 15

5.4

Fed began cutting interest rates .................................................................................................... 15

5.5

Fed began injecting unprecedented liquidity ................................................................................. 16

5.6

Market disregarded falling and worsening forecast for Corporate Profits ...................................... 17

MARKET BOTTOM INDICATORS 2009 .................................................................................................... 19

6.1

95% of professional investors were bearish at the start of 2009 .................................................... 19

6.2

Low Market Valuation P/E = 10x (forward) .................................................................................... 20

6.3

Risk-off trade was dominating .................................................................................................... 20

6.4

Fed reduced Interest Rates to near zero ........................................................................................ 21

6.5

Corporate Profits resumed growth underpinning the stock market recovery ................................. 21

6.6

Liquidity injection started falling.................................................................................................... 22

6.7

Fed expanded balance sheet to buy any unwanted toxic assets ..................................................... 23

6.8

Initial Unemployment Claims began falling .................................................................................... 23

6.9

ISM index resumed growth ............................................................................................................ 24

7 APPLICATION TO DYNAMIC ASSET ALLOCATION INVESTMENT STRATEGY USING INDEX AND EXCHANGE
TRADED FUNDS............................................................................................................................................. 25
8

CONCLUSION ........................................................................................................................................ 27

REFERENCES.......................................................................................................................................... 28

2012 Copyright George Bijak www.cpgli.com | INTRODUCTION

2 INTRODUCTION

The 2007-2009 Global Financial Crisis (GFC), also known as the Great Recession, was a
challenging period for investors and advisors. Conventional investment strategies
designed to reduce risk did not perform satisfactorily. Diversification failed to protect
investment portfolios as the crisis significantly increased the correlation within global
markets and across normally uncorrelated asset classes.
Investment strategists need non-subjective indicators to help them make rational
decisions in times of irrational and emotional market behavior. The Author has
developed a proprietary Corporate Profits Growth Leading Indicator (CPGLI) for this
purpose (not fully disclosed here), supplemented by the analysis of coincident macroturning points indicators discussed in this paper.
It is postulated that the formulation of a winning investment strategy for the GFC,
essentially required making one key judgement that the global banking system would
survive the Lehman Brothers collapse and identifying the two macro turning points:
2007 top and 2009 bottom of the market.
Section 4 explains why in late 2008 investors should have concluded that the massive
Central Bank liquidity injection supported by the global fiscal stimulus had the
capacity to save the global banking system after the September 2008 Lehman
Brothers Bank collapse. There was a good chance the GFC would not turn into a
1930s style Great Depression contrary to a popular bearish conviction.
Section 5 discusses the indicators that helped identify the 2007 market top:
Subprime write-downs,
M&A frenzy at high prices,
Highly leveraged shadow banking,
Fed began cutting interest rates,
2012 Copyright George Bijak www.cpgli.com | INTRODUCTION

 Fed began injecting unprecedented liquidity,

Market disregarded falling and worsening forecast for Corporate Profits.
Section 6 analyses the indicators associated with the 2009 market bottom:
95% of professional investors were bearish at the start of 2009,
Low market valuation P/E = 10x (forward),
Risk off trade was dominating,
Fed reduced interest rates to near zero,
Corporate Profits resumed growth underpinning the stock market recovery,
Liquidity injection started falling,
Fed expanded balance sheet to buy any unwanted toxic assets,
Initial Unemployment Claims began falling,
ISM Manufacturing Index resumed growth.
The last Section 7 describes the Authors actual independently audited CPGLI
Dynamic Asset Allocation Investment Strategy based on the indicators discussed here
and the proprietary Corporate Profits Growth Leading Indicator (CPGLI) that after
extensive testing has proved to work in normal markets as well as the most unusual
conditions of the start and end of the GFC. The CPGLI signals not just the direction of
corporate profits growth but also the strength of growth which determines conviction
and thus whether to use gearing as well. The strategy returned 83% for the 5 year
period from 2006 to 2010 (or 12.9% compounded per annum) whilst S&P 500
recorded a negative return during the equivalent period.
The strategy actively switched between Cash and Index and Sector Exchange Traded
Funds to maximize returns and reduce risk.

2012 Copyright George Bijak www.cpgli.com | INTRODUCTION

3 THE TWO TURNING POINTS

The Global Financial Crisis (GFC) amplified the importance of making correct topdown macro calls on the broad direction of the economy and the stock market at a
time of extreme turbulence. There were two major macro-turning points (2007 top &
2009 bottom) which, when spotted on time, helped to determine the winning
dynamic asset allocation investment strategies for the GFC period (on Chart 1).
Chart 1. The USA Stock Market Turning Points during GFC - Top & Bottom

Recognizing that a stock market bubble was nearing its top in 2007 and switching
funds to more defensive positions, such as cash and USA Government Bonds, would
cushion investors from the subsequent crash that saw the S&P 500 index down by
56%.

2012 Copyright George Bijak www.cpgli.com | THE TWO TURNING POINTS

Then, investors should have recognized the bottom of the market in March 2009 and
the beginning of its sharp V-shape recovery and decisively reallocated more assets to
equities to participate in a strong 85% rally till the end of 2011.
Traditional investment strategies, such as diversification within and across asset
classes that normally have little correlation, are designed to reduce risk and volatility
of an investment portfolio. But when all risk asset classes fell together, these
strategies could not sufficiently protect investors on the downside. The crisis
unnerved most investors around the globe and synchronized their risk-averse
behaviour resulting in a very high correlation between all global market risk asset
classes. The crisis disarmed the risk reduction benefits expected from diversification
in normal times.
There were basically two trades during the GFC to choose from: risk off or risk on.
The risk-off approach dominated after the heavy falls and essentially involved
moving to cash, USA or German bonds, Swiss Franc and Gold whilst avoiding anything
perceived risky i.e. all global equities, all corporate debt (even the best quality) and all
alternative investments.
Investors needed to focus on the key political macroeconomic policy decisions and
unemotional, reliable indicators signalling the major market turning points to make
correct investment decisions in a time of crisis. These issues will be now discussed in
more detail.

2012 Copyright George Bijak www.cpgli.com | THE TWO TURNING POINTS

4 THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM WILL

SURVIVE THE GFC

Lehman Brothers, one of the largest and oldest Wall Street investment banks,
collapsed under massive debt in mid-September 2008, pushing markets to horrific
depths and dashing hopes for a quick end to the recession. The stock market reacted
assuming the worst - the repeat of the 1930s Great Depression was now widely
expected. Global financial credit shut down and banks stopped overnight lending
between themselves. The next likely scenario was a global run on the retail banks.
At times of extreme financial crisis, investors have to first answer the fundamental
question: will the global banking system survive in its current ownership structure?
If the answer in 2008 was no the global economy would most likely end in a major
depression similar to the 1930s when stocks fell 90% across the board. In this case,
investors would have been wise to get out of the market altogether, cutting losses
and putting away their cash in a very safe place guaranteed by the Government, or
the safety of their homes.
The correct yes answer in 2008 would justify holding on to the stocks that were not
sold in time, while looking for an opportunity to top up equity investments as soon as
the market formed its ultimate bottom.
4.1 Central Banks & Governments saved the global banking system
The main Central Banks supported by their Governments effectively stopped the
global economy from turning into the Second Great Depression by undertaking
decisive policy initiatives commensurate with the extent of the crisis. Central Banks
and Governments behaved very differently during the GFC compared to the 1930s.
Fed Chairman Ben Bernanke, a scholar of the Great Depression and business cycles,
2012 Copyright George Bijak www.cpgli.com | THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM
WILL SURVIVE THE GFC

publically stated many times that the Fed would do whatever it took to stabilize the
financial system and not repeat the mistakes of the 1930s when it did not inject
liquidity, did not reduce interest rates sufficiently and was not supported by any
meaningful fiscal stimulus. The other leading central banks concurred. (Source:
http://www.federalreserve.gov/newsevents/speech/2009speech.htm ).
The Fed in concert with the major foreign central banks, pumped unlimited liquidity
into the financial system, drastically reduced interest rates and followed with massive
rounds of quantitative easing aiding the later recovery. Governments around the
world supported the effort with strong fiscal stimulus to ease the pain of the Great
Recession and rekindle economic growth over the next few years (the role of
Governments is not discussed in detail in this paper because its programs have
lagging impact on the stock market). The strategy worked: the financial system
survived without bankrupting any of the remaining big institutions that were
considered too big to fail and the economy and stock market recovered.
4.2 Fed led the rescue by injecting liquidity
The major leading force that saved the financial system was the unprecedented level
of liquidity injected by the USA Federal Reserve Bank beginning in December 2007 at
the first sign of the cracks.
The Fed extended the eligibility for central bank funds to non-banks and was
accepting any quality assets as collateral for cash at rock bottom discount window
rates. Prime interest rates were reduced drastically. Moreover, the Fed with
Government came directly to the rescue of major financial institutions including AIG,
Freddie Mac, Fannie Mae and coordinated similar actions with the central banks
around the world. In a nutshell the Fed, in concert with the other central banks,
engaged all monetary policy tools to the maximum and publically stated it was
prepared to continue using an open cheque book for as long as it took to wash the
toxic debt from the banking system.
2012 Copyright George Bijak www.cpgli.com | THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM
WILL SURVIVE THE GFC

10

Back in late 2008, the Central Banks and Governments behaviour should have led
investors to a conclusion that the financial system was, in all probability, to survive as
long as the supportive monetary and fiscal policies continued. In parallel, many
Governments immediately guaranteed bank deposits to prevent potential runs on the
banking system.
4.3 Liquidity Injections: comparing 2008 and 2001 Recessions with 1930s
Great Depression
The following analysis focuses on one of the main indicators of the liquidity
injections: The Total Borrowings of Depository Institutions from the Federal
Reserve.
Liquidity injections are important to the health of the banking system in times of
extreme crisis. The following analysis shows that the large liquidity injection in 2001
was followed by an economic recovery. By contrast, the lack of such intervention in
the 1930s was one of the factors leading to the Great Depression.
During the GFC, the Fed applied the same monetary tools as in 2001- only on a much
bigger scale. The total injection topped $700 billion which makes all other injections
look like an insignificant noise around the zero line as the Chart 2 below shows.
Hence, investors would have been justified to expect an economic and market
recovery given the unprecedented scale of this action.

2012 Copyright George Bijak www.cpgli.com | THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM
WILL SURVIVE THE GFC

11

Chart 2. Borrowings from Fed were unprecedented during the GFC (in $bn)

Source: cpgli.com, Fed

A dollar today is worth less than a century ago so we need to look at the change:
Chart 3. Borrowings from Fed (% change)

Source: cpgli.com, Fed

The story is the same: the 4,000% change in Liquidity during the GFC was the biggest
ever.

2012 Copyright George Bijak www.cpgli.com | THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM
WILL SURVIVE THE GFC

12

Ben Bernanke has no equals in the 100-year history of the USA Central Bank the
injection that began in December 2007 was the biggest, measured in dollars and in
percentage change terms. The change was more than double that of the previous
record set by Fed Chairman Alan Greenspan in Sept 2001. The Greenspan injection is
the second largest spike on the change chart, but in dollar terms Greenspans
injection was a small drop in Bernankes ocean of liquidity.
4.4 GFC Comparisons to 1930s Great Depression were misplaced
Parallels between the GFC and the 1929 stock market crash, which was followed by
the 1930s Great Depression, were misplaced because the Central Banks behaviour
was totally different this time around.
In the 1930s, the Central Banks, as admitted by Fed Chairman Ben Bernanke, did not
do enough to save the banking system by failing to inject any meaningful liquidity on
time.
4.5 The liquidity injections helped economy
The 2001 liquidity injection was followed by GDP recovery, while the 1930s period
suffered the Great Depression in the absence of any major injection.
Chart 4 tells the story: GDP (red line - right axis) was up following the strong 2001 and
2007-09 spikes in liquidity (blue line left axis). By contrast, GDP fell in 1930s Great
Depression in absence of the Feds intervention.

2012 Copyright George Bijak www.cpgli.com | THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM
WILL SURVIVE THE GFC

13

Chart 4. GDP recovered following Liquidity Injections in 2001 & 2007-09

Source: cpgli.com, Fed

Timing and forecasting the extent of the economic recoveries as a result of the
injection of liquidity is difficult. It depends on many variables and is subject to
countless risks. Predicting the stock market behaviour is even harder because it is
influenced by many more risks and psychological factors. For example, the 2001
September liquidity spike was followed by one and a half years of a declining stock
market that only recovered in 2003-04.
Other tools and leading indicators are needed to fine-tune a forecast of the market
macro-turning points. Especially useful is an outlook for Corporate Profits growth
because profits lead the stock market which in turn leads economic growth during
recoveries. Other indicators may serve the same purpose.

2012 Copyright George Bijak www.cpgli.com | THE KEY JUDGEMENT: GLOBAL BANKING SYSTEM
WILL SURVIVE THE GFC

14

5 MARKET TOP INDICATORS 2007

Looking back at 2007, the USA Subprime Housing Loans Crisis had to eventually burst
the stock market bubble. However, back in 2007 it was not that obvious.
5.1 Subprime write-downs
Investors got used to enjoying the four long years of the bull market from 2003 to
2007. The S&P 500 index doubled and even the initial large subprime write-downs by
Merrill Lynch, Bank of America, Citibank and others in 2007 were shrugged-off by the
market. Confidence was extremely high that current conditions would continue.
5.2 M&A frenzy at high prices
The stock market gains were additionally fuelled by an unprecedentedly strong M&A
activity around the world. Particularly, Private Equity players on borrowed steroids
following their successful multi-year run, engaged in an acquisition frenzy
leveraging their already leveraged bets and paid record prices. M&A transactions
added to brokers short term profits and delayed the market collapse.
5.3 Highly leveraged shadow banking
Much of the financial engineering wealth generating activities were financed by the
extremely leveraged shadow banking system functioning outside the more
controlled and regulated traditional banking. The structured products, consisting of
subprime mortgage assets of doubtful quality, were offered as the safest income
investments, sometimes with an independent AAA stamp of approval.
5.4 Fed began cutting interest rates
The continuous market optimism was aided by initial cuts to interest rates by the USA
Central Bank in mid-2007. This came at the first sign of problems in response to a 10%
market correction. The Fed only delayed the inevitable collapse.

2012 Copyright George Bijak www.cpgli.com | MARKET TOP INDICATORS 2007

15

The fact that Fed had to start easing interest rates, following many years of bull
market, was an indicator of the looming problems and a weaker stock market ahead.
The arrow on Chart 5 points to the beginning of the USA rates cuts cycle in mid-2007
that has lasted until today. In early 2012, Fed surprised the market by extending a
previously announced target for holding the interest rates near zero to mid-2014.
This will aid the economy and jobs recovery.
Chart 5. Beginning of Interest Rates cuts coincided with market Top

Source: cpgli.com, Fed

5.5 Fed began injecting unprecedented liquidity

The coincident indicator of the market top from Feds perspective was the massive
injection of liquidity that began in December 2007 (see Chart 2&3 above). It was a
clear sign that the financial system was stretched to the limit and beginning to crack
under the mountain of debt secured by near worthless subprime mortgages. The Fed
probably sensed the looming crisis early and responded with unprecedented force
and without a delay.
The response saved the banking system but could not stop the stock market from
crashing.
2012 Copyright George Bijak www.cpgli.com | MARKET TOP INDICATORS 2007

16

The NBER Business Cycle Committee officially declared, 18 months after the initial
December 2007 liquidity injection, that the Great Recession started in December
2007 (grey bar on Chart 6).
Chart 6. Fed began injecting massive liquidity at the Top of the market and beginning
of the Great Recession

Source: cpgli.com, Fed

5.6 Market disregarded falling and worsening forecast for Corporate

Profits
It was only a matter of time for the market to fall because aggregate Corporate
Profits were falling throughout the whole year in 2007 and valuations could not hold
up for much longer. The Fed intervention, M&A frenzy and the bullish momentum
only prolonged the inevitable closing of the gap between the Corporate Profits trend
and market levels.
Corporate Profits is a fundamental driver of stock market valuation. Value equals
profits multiplied by a valuation multiple such as Price Earnings ratio (P/E).
Historically, over the past 60 years, there was a high, 90%+, correlation between USA
Corporate Profits and S&P 500 index. The stock market usually finds it hard to grow
when profits are falling for an extended period. Year 2007 was the classic case in
2012 Copyright George Bijak www.cpgli.com | MARKET TOP INDICATORS 2007

17

point. By the end of 2007, USA Corporate Profits had been falling for four consecutive
quarters and, despite that, the market was marching up and valuation multiples were
remaining high (forward P/E ratio was above 15). The market fell 10% in mid-year
but the Fed managed to bring it back to life for a while by cutting rates. Then, more
subprime write-offs were announced and profits kept falling. The Profits-Market Gap
was widening signalling the inevitable end of the bull market.
Chart 7. The widening Gap between Corporate Profits and Market throughout 2007,
signalled the looming market top.

Source: cpgli.com

Investors should have followed the widening gap during 2007 with a gradual
reduction of exposure to equities to protect their capital and reduce the risk across
their investment portfolios. Catching the last gains of the bull market against the
clearly emerging negative Corporate Profits trend carried a very high risk.
The bubble was ready to burst and could be pricked by any bad enough news. When
it suddenly happened, everyone looked for the exit and it was too late to protect the
gains of the previous four years of the bull market.

2012 Copyright George Bijak www.cpgli.com | MARKET TOP INDICATORS 2007

18

6 MARKET BOTTOM INDICATORS 2009

Investors who survived the 2008 stock market crash followed by the Great
Recession, second only in severity to the 1930s Great Depression, were
understandably not in a mood to think about re-entering the market. The GFC left the
market in tatters after a 56% fall (S&P 500 index fell from 1,565 level on October 9,
2007 to 676 on March 9, 2009 see Chart 1).
Instead, investors were collectively licking their wounds, investing what was left
cautiously, mainly in risk-off strategies. This trend has more or less persisted to this
day (early 2012). Long bonds, a perceived risk-off asset class, have been receiving
strong funds inflow whilst equities have been avoided thereby missing an 85% rally
over the last three years.
Investors do not seem to be overly concerned that bonds can be also a very risky
asset when interest rates start rising again. The 10-year USA bond yield, currently
below 2%, is historically low and may eventually go up, leading to the loss of capital
value.
6.1 95% of professional investors were bearish at the start of 2009
Retail investors panicked first during the GFC and professional managers had no
choice but to follow the avalanche of relentless sell orders while the media was
predicting an inevitable re-run of the 1930s Great Depression.
The Bloomberg Global Confidence Index was at rock bottom by the end of 2008. Only
5% of professional investors were bullish about the future of the stock market. The
overwhelming 95% of investors were completely bearish, expecting a total collapse of
the global financial system and the stock market.

2012 Copyright George Bijak www.cpgli.com | MARKET BOTTOM INDICATORS 2009

19

6.2 Low Market Valuation P/E = 10x (forward)

Low investor confidence combined with a very low P/E multiple of around 10x
forward, should had been treated as a contrarian indicator of better times ahead assuming the banking system was to survive and cyclical upswing was to begin.
6.3 Risk-off trade was dominating
Overly bearish fund managers invested accordingly to risk-off principles were often
guided by their conservative fiduciary duties and risk reduction demands from
understandably paralysed clients. Their over-cautiousness led to missing some of
the strong V-shape recovery that followed in 2009-2011.
Chart 8 shows the prevailing conservative investment approach. Average allocation to
stocks by major Wall Street strategists was reduced in line with the falling stock
market through to early 2009 and then gradually increased with the rising market.
Chart 8. Allocation to stocks followed the direction of the market with a delay

Source: Bespoke Investment Group, Bloomberg Survey of Wall Street Strategists, Jan 2010. Reproduced with permission.

The point of lowest allocation to equities coincided with the March 2009 market
bottom and, looking back, it was the best time to buy equities at the beginning of the
multi-year V-shape rally.
2012 Copyright George Bijak www.cpgli.com | MARKET BOTTOM INDICATORS 2009

20

6.4 Fed reduced Interest Rates to near zero

The Fed followed the market on the way down by cutting rates to almost zero by the
end of 2008. Soon after, the market reached its bottom and began the recovery
Chart 9.
Chart 9. Rates cut to near zero preceded market Bottom.

Source: cpgli.com, Fed

6.5 Corporate Profits resumed growth underpinning the stock market

recovery
The market must eventually go up when profits are growing strongly while valuation
multiples are very low (Chart 10). This is the time when fundamentals drive the
valuations regardless of the pessimism. If the market did not rise in the face of rising
profits it would lead to an unsustainable misalignment between the yields available
from stock dividends and debt products.

2012 Copyright George Bijak www.cpgli.com | MARKET BOTTOM INDICATORS 2009

21

Chart 10. Corporate Profits V-rebound was followed by market recovery

Source: cpgli.com, Fed

6.6 Liquidity injection started falling

The peak of liquidity injection (measured in $bn) coincided with the bottom of the
market Chart 11. Less borrowings from the Fed indicated stabilization of the
financial system.
Chart 11. Reduction of Borrowings from Fed coincided with market recovery

Source: cpgli.com, Fed

2012 Copyright George Bijak www.cpgli.com | MARKET BOTTOM INDICATORS 2009

22

6.7 Fed expanded balance sheet to buy any unwanted toxic assets
Early in 2009, the Fed embarked on the assets purchase program; mainly U.S.
Treasury Securities (TREAST) and Mortgage-backed Securities (MBST). This required
an expansion of its Balance Sheet from approximately $500bn in the early 2009 to
above $2.4 Trillion in 2011. The program helped clean out the toxic debt that was
clogging the banking system. The fresh funds enabled banks to re-engage in economy
to actively support job creation initiatives. The stock market viewed it positively with
a rise Chart 12.
Chart 12. Fed Asset Purchase programs coincided with market rise

Source: cpgli.com, Fed

6.8 Initial Unemployment Claims began falling

Unemployment is a lagging indicator of the stock market and economic growth.
However, the Initial Unemployment Claims trend usually improves much earlier.
Historically, the peaks in Initial Claims signalled the end of recession and the stock
market usually sensed it even earlier. This was the case again during the GFC
recession: Initial Claims started falling soon after the market & economy began
recovery - Chart 13.

2012 Copyright George Bijak www.cpgli.com | MARKET BOTTOM INDICATORS 2009

23

Chart 13. Initial Unemployment Claims peaks coincided with the end of recessions

Source: cpgli.com, Fed

6.9 ISM index resumed growth

Once the economy started to recover - the ISM Manufacturing Index followed
consistent with its behaviour in the previous cycles. Chart 14 shows that recessions
ended after a sharp upward reversal of the ISM index.
Chart 14. ISM Manufacturing Index began recovery at the end of recessions

Source: cpgli.com, Fed

2012 Copyright George Bijak www.cpgli.com | MARKET BOTTOM INDICATORS 2009

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7 APPLICATION TO DYNAMIC ASSET ALLOCATION INVESTMENT

STRATEGY USING INDEX AND EXCHANGE TRADED FUNDS
This section describes the Authors actual CPGLI Dynamic Asset Allocation Investment
Strategy based on his proprietary Corporate Profits Leading Indicator (CPGLI) and
coincident macro-turning points indicators discussed in this paper. The strategy was
monitored and audited in real time by an independent organization Timertrac.
The CPGLI strategy returned 83% for the 5-year period from 2006 to 2010 (12.9%
compounded per annum) whilst S&P 500 recorded negative return (0.9%). The CPGLI
Dynamic Asset Allocation Investment Strategy actively switched between Cash/
Inverse Exchange Traded Funds (ETF) and Index/ Sector leveraged ETF to maximize
returns and reduce risk Table 1.
Table 1. The CPGLI Dynamic Asset Allocation investment strategy performance.
Return %

CPGLI strategy

S&P500

Total 5y

83.3

(0.9)

Annual 5y

12.9

(0.2)

2010

47.3

11.0

2009

79.5

19.7

2008

(24.8)

(37.5)

2007

(3.4)

3.6

2006

(4.5)

11.7

Sharp ratio

0.26

Ulcer index

20.67

1.33

CPGLI strategy 5 years Returns

Risk

2012 Copyright George Bijak www.cpgli.com | APPLICATION TO DYNAMIC ASSET ALLOCATION

INVESTMENT STRATEGY USING INDEX AND EXCHANGE TRADED FUNDS

25

The strategy anticipated that the market would reach a peak and correct sometime in
the second half of 2007 and avoided equities by re-allocating to cash and occasional
inverse ETF positions. Thanks to the cautious approach, the strategy avoided the first
phase of the market crash till March 2008 when Bear Stearns collapsed. In 2008,
despite using leveraged ETFs, the strategy registered a lesser fall (24.8%) than the
S&P 500 market index which fell by 37.5%. In addition, the strategys investment risk
was relatively reduced. The CPGLI Strategys Sharp Ratio and Ulcer Index were higher
than that of S&P500, reflecting the lower risk.
The strategy has been fully invested in bullish equities leveraged ETF since early 2009
at the market bottom through 2010 during the V-shape market recovery. This
resulted in the strategy significantly outperforming S&P500 market index. Table 2
summarizes the CPGLI strategy trading positions.
Table 2. CPGLI Dynamic Asset Allocation investment strategy trading positions
CPGLI

S&P 500

CPGLI Dynamic Asset Allocation strategy

strategy

return %

trading positions

return %
2010

47.3

11.0

100% in up to 3x bullish equities ETFs

2009

79.5

19.7

100% in up to 3x bullish equities ETFs

Up to March 2008 (Bear Stearns collapse) 100 % in cash.

2008

(24.8)

(37.5)

Post March 2008, gradually allocated to equities ETFs.

Failed to anticipate Lehman Brothers collapse in 09/2008.

2007

(3.4)

3.6

2006

(4.5)

11.7

Total 5 years return

83.3

(0.9)

Annual 5 years return

12.9

(0.2)

Mix of cash and inverse bearish ETFs

Predominantly cash

2012 Copyright George Bijak www.cpgli.com | APPLICATION TO DYNAMIC ASSET ALLOCATION

INVESTMENT STRATEGY USING INDEX AND EXCHANGE TRADED FUNDS

26

8 CONCLUSION

The 2007-2009 Global Financial Crisis (GFC) was a challenging period for investors and
advisors. Conventional investment strategies designed to reduce risk did not perform
satisfactorily. Diversification failed to protect investment portfolios as the crisis
significantly increased the correlation within global markets and across normally
uncorrelated asset classes.
The strategy that worked and was implemented, significantly outperforming the
market, involved application of the Corporate Profits Growth Leading Indicator
(CPGLI) and a range of macro-turning points indicators discussed in this paper. The
methodology, supplemented by making the key judgement that the global banking
system would survive the Lehman Brothers collapse, accurately identified the two
critical market macro-turning points: the late 2007 top and the early 2009 bottom.
Exchange Traded Funds were the ideal, most convenient, and cost effective
investment products for the execution of this actively managed CPGLI Dynamic Asset
Allocation investment portfolio strategy.
This paper has identified a number of the GFC market top and bottom coincident
macro-turning points indicators. It analysed factors that led to the conclusion that
global banking system would survive the Lehman Brothers collapse.
The Central Banks and major Governments played a pivotal role in preventing the
repeat of the 1930s Global Depression through a decisive use of all available
monetary and fiscal policy tools.

2012 Copyright George Bijak www.cpgli.com | CONCLUSION

27

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