Investing Tools for
Investors Looking to Excel
10/21/02
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Investing Tools for
Investors Looking to Excel |
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A top down approach to investing employing industry sector rotation by moving from equities in one industry to another industry group sequentially, by anticipating the various stages of economic recovery and contraction. Economic Timing and Sector Rotation Specifically, you
buy those industry groups most likely to be benefited and short those likely to be
disadvantaged by economic developments over the next 6 to 9 months. This approach also
allows a framework to develop asset allocation between cash, bonds, equities, and
commodities as well as which equities. It is not necessary to be an economist with a perfectly accurate forecast. However, it is necessary to understand the consensus view and how new economic data may alter the perception and move money from defensive groups like drugs and beverages, to more economically sensitive groups like metals, papers, or chemicals. Typically, bull markets end with inflation, rising interest rates, and aggressive federal reserve action to slow money growth and stifle a booming economy. When all the market has to look forward to is rising rates and slowing economic activity, the market is in for trouble. Commodity prices rise, bond and equity prices fall. and cash performs very well relatively. The decade of 90's was a period where economic timing, as a strategy tool, performed poorly. While economic expansion and job creation was strong and of an unprecedented length, inflation declined. Contrary to other periods of expansion, the expansion of the 90's conveyed no pricing power to cyclical industries who were beset by worldwide industry overcapacity, and serious economic problems in the rest of developed and emerging markets, making these countries deflation exporters to the US. Automation, corporate restructuring, and the internet as a new and efficient distribution channel, kept the lid on prices through the decade. Organizations were flattened as layers of unproductive middle management were axed. Costs were either reduced by exporting jobs abroad, moving the business to right to work states, or replacing human capital with computers. Analysis done by expensive layers of financial and marketing analysts was accomplished by the computer. However, while we have had a paradigm shift, it is quite possible a worldwide economic recovery together with the fact we may have wrung most of the redundant costs out of our system, may bring economic timing back into favor. Governments have privatized, rationalized, and lowered taxes. Further, we may have experienced the bulk of technology savings for a while. It is still important to be aware of the methodology, and the fact that it could be a real performance enhancer and protection if inflation resurfaces. The UOutPerform.com chart describes the Business Expansion, which historically averages 36 to 44 months, and Business Contractions (with have ranged between 10 and 19 months) all have different stages and different beneficiaries and victims. Let's take a look. The chart is busy but fairly self explanatory. In essence, you are trying to identify, in advance, moves in the stock price of those companies who will benefit from both the unit volume and pricing perspective. Suffice it to say, if commodity prices are rising, bonds are in trouble. If commodity prices are declining, bonds can rally. Commodity prices rising will benefit cyclicals, and more often than not, hurt the consumer non-durables like KO, MRK, PG, etc. Money is finite and will move between groups viewed as more attractive. Please note that stocks are a tremendous predictor of economic activity. Before the data can reflect recovery, often you will see the cyclicals base and start a phase of accumulation and favorable price action. Be turned on to this because your sector rotation and stock selection will key off these subtle movements. Money is finite and much of the money to enter and move sectors will come from money exiting another sector. Use technical analysis and on-balance volume to pick up these early stage shifts in money flow. Any significant or major announcement of economic activity higher than consensus expectation will trigger the following trading opportunities under most circumstances;
Whether the pattern persists is a function of whether the announcements were an aberration, the result of seasonal adjustments, or weather related, or actually the result of a significant change in the economic fundamentals. Conversely, a lower than expected piece of economic data can trigger the following response;
A Critique of Economic Timing- The 90's were a total washout for economic timing from an investment perspective although they offered some opportunity for traders. From an investment perspective, it is difficult to tell exactly what stage of the economy you are in. Secondly, secular factors as we have experienced in the 90's can overwhelm the normal cyclical pattern, as discussed above. Sound fiscal and monetary policy aimed at non-inflationary growth, the final impacts of automation on costs and margins, the restructuring of business for greater efficiency, and the global economy have created a far higher level of gross domestic product growth than was ever thought possible without incurring substantial increases in inflation, interest rates, and risks of a bear market. These secular phenomena may continue and sustain the bull market and non-inflationary growth. If that is so, companies with sustainable growth, like technology and telecommunication, will probably rule the roost. However, our success may be a by-product also of the fact, Europe, Japan and the emerging markets were suffering stagnation or recession for much of the late 90's. This served to keep import prices very low. If these countries have synchronized recovery of some magnitude, the halcyon days of the 90's may prove an unprecedented era of no boom and bust and a distant memory. Further, if our government starts new entitlement programs and deficits reemerge, our treasury bonds would suffer as well. While Economic Timing is out of favor and even unknown to many investors, its time will come and that time may be soon. Investors need to be aware of just how spectacular and optimal the 90's were from the perspective of long term "buy and hold" investment techniques. |
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