Analysis of Economics

[cdrom]

Investment Process

1. Identify the U.S. Market Cycle

In order to determine an appropriate asset mix, we need to assess the stock market and determine where we are in the market cycle.

Top end of a rolling bull>>> The market is mature, with little potential for substantial growth. At that point, we favor large value stocks.

Sliding bull>>> The market is losing momentum, which means a bear market is probably just around the corner. We continue to own large cap stocks, but shift the asset allocation, with less emphasis on stocks.

Bear market>>> We ride out the bear market with a lighter position in stocks and more money allocated to fixed income and cash-based investments.

New bull, first phase>>> Since smaller stocks tend to lead the way in a bull market, we add to our stock position with stocks that align more closely with the small stock market, while maintaining our emphasis on a low standard deviation.

Second phase, bull market>>> Larger cap stocks tend to lead the second phase of a bull market, so we shift our portfolio emphasis to larger cap stocks.

2. Where in the World

We take a global approach in constructing our portfolio because it:

Reduces standard deviation (risk)
Provides additional return opportunities
To determine geographic asset allocation, we look at two primary areas:

1. Domestic market cycle analysis (where are we in the cycle?)

2. Foreign market cycle analysis (where are other markets in the cycle?)

(When possible, we prefer to use ADRs for our foreign investment component).

3. Style

We select individual stocks based on style, depending on the current state of the market:

We are large (and larger) cap stock investors (the weighed average capitalization of our holdings is $71 billion).
To maintain consistency and our standard deviation parameters, we attempt to capture small market cycle performance with large cap holdings that align closely with the small stock market.
Each phase of the market cycle suggests a dynamic bias (see Axiom #1) toward a particular style--growth, value or GARP (growth at a reasonable price).
Over the course of the market cycles, our styles may change to fit the point in the cycle.

4. Sector Weightings

How do we determine our our sector allocation mix? We do a thorough analysis of the strengths and weaknesses of each sector to determine the role they should play in our portfolio:

We utilize sector business cycle analysis to determine optimum sector weightings in any give market cycle.
Deviation from the composite of the index at the sector level creates a basis for our spread
We also employee maximum coefficient correlation analysis at the sector level.
Our point of emphasis is that the nature of capitalism supports a reversion to a means on each sector level.

5. Individual Stock Selection

Once we've determined position in the cycle, optimum geographical allocation, style preference and sector weightings, the final step is to select individual stocks for the portfolio. We select our portfolio from a universe of 1,200 stocks from throughout the U.S. and around the world. We look at several factors in determining the right stocks for the portfolio:
Fundamental analysis. We look at sales and earnings, financials and cash flow and we prefer stocks in the top tier market position.
Style analysis. Depending on market cycle relevance, we decide whether to go with large or larger cap stocks--either growth or value. We use a natural and manual portfolio adjustment depending on a variety of factors.
Technical analysis. We use technical analysis to determine entry point in the market and we monitor alerts to stay atuned to events or changes in the economy that could affect the performance of certain stocks.

When we add a stock to the portfoliio, it is because it fits one of our key criteria:
> Market cycle location
> Geography
> Sector weighting
> Fundamentals
> Pairing relationships

We may sell a stock from the portfolio for one of several reasons:
> The stock has reached our price target
> The stock's fundamentals have deteriorated
> The sector is out of balance with the rest of the portfolio and needs to be reduced

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