Investment Model Criteria

Though I am assuredly under invested in the market, if I had to state what my "investment model" is it is being overweighted in sectors that are "harmonic" with where we are in the economic cycle. Currently, my investment model is full hand-wringer mode!

I'll accept right up front that even knowing where we are in the business/economic cycle is difficult. I can think of no recession in my adult life for which there was a consensus opinion regarding: (1) Has a recession started?; (2) Are we still in a recession; (3) When will the recession end; (4) Whether we are in a "growth" recession......

In this space I have repeatedly lauded George Dagnino. I use his service, and it has probably given me the greatest foundation in understanding the "madness" around in the media, as well as provide a backdrop for understanding the opinions of others. He also does very detailed work to help his subscribers understand where we are in the cycle. Here is George's diagram. I URGE you to read and print out his document on sectors and business cycles. I can think of no one better document that will give you a solid foundation in understanding how your portfolio exposures at various points in the business cycle may inhibit your investment performance. Jim Cramer--yes, I know all of the criticisms--but when he' not acting manic, actually has some keen insights. He talks about these in his book. I still recommend George's book Profiting in Profiting in Bull and Bear Markets to give you the fullest view and to enhance your investor education. BUT, if you print out the document I reference above, you will have gained 90% of the ACTIONABLE information in that book.

Why do I stress actionable information? Think about all of the information that you receive. YOUR responsibility is to systematize that information and act on it. Further, that information needs to be dynamic--meaning it needs to change as circumstances change. Does your investment model do that?

What I like about George's service (forgive my sounding like a commercial, I don't mean to sound that way, but his service is the best and only example that I know of; accordingly, I'm laying this out as a benchmark more so than a recommendation per se.) is that it fulfills that requirement.

Systematic: His underlying system is that you weight your sectors based on (1) the overall trend in the market AND based on the underlying fundamentals of the economic cycle. These two items are key. You can have a terrific economy, but if there is an asset bubble waiting to burst (dot.com!!!), then you have great market risk--your weightings then change among cash/bonds/stocks. (It probably goes without saying, BUT....part of being systematic means that it has to be understandable to mere mortals.)

Dynamic: Based on the changes in the economic cycle and in the backdrop of the market, sector weightings are changed accordingly to (1) reduce risk for sectors that will be falling out of favor (financials v. commodities); (2) increase exposure to sectors that are gaining in favor (financials/bonds v. commodities); (3) allocation among cash, bonds, equities based on expected market risk.

Actionable The actionable part is that for each sector there are several stock picks which of course reduce individual stock risk within the sector.

The other thing that I have learned from George is "we move slowly". So exposures are either gradually increased or decreased over time. However, if there is a bow-wow in the bunch it is cut immediately.

If it is true that a stock's performance is predicated at least 50% based on being in the right sector, I have to believe that a portfolio management strategy that does not take this sector rotation into consideration to be somewhat deficient. Remember, too, that within this strategy one can have dividend/income, value and momentum sub-strategies. FOR ME this is a strategy that I understand--it provides a MODEL for me to evaluate the ocean of information that submerges us.

Remember, I'm not an expert and I'm not recommending one thing over another. However, I am an expert (through my business experience) in having to make decisions with conflicting and often-times ambiguous information. Isn't the market that way? I think so. Accordingly, for YOU to make decisions (or even to evaluate decisions made on your behalf) you need to have a model from which to frame your reference. If you do not have one, I'm recommending a resource. If you do have one, evaluate it for being

Systematic
Dynamic
Actionable