Observations

I gave a talk recently on how I develop investment strategies. I told the audience of professional investors and advisors about my approach. I look at cause and effect relationships between events and try to relate them to movements in asset classes.

Some people in the audience suggested that it is difficult to make forecasts. Besides, forecasts are always wrong. They are absolutely right. But I am not making “forecasts”. Let me explain.

One of my basic assumptions is that the markets ultimately win. The Fed and OPEC and other cartels like the federal government create the kind of “noise” that drives the investment strategies of the astute investor.

I realize this is a strong statement. The point I am trying to make, however, is that all the information is available to you. The issue is how to process it. You can make a forecast like: “The economy is going to grow at a 4% pace next quarter”. This forecast is going to be wrong. The inferences you make from this forecast will also be wrong.

If, on the other hand, I say “Rising short-term interest rates increase equity risk,” this is a statement that establishes a valid relationship. It also has strategic implications.

This approach falls in the field of pattern recognition, a field I was exposed to in my post-graduate courses. It amounts to saying: If a set of indicators is in a given position, this is what you should do. The end result has been to divide the growth cycle in four phases.

Phase 1. Business growth rises (below trend); money growth, stocks, and dollar rise; yield curve steepens, inflation, commodities, and short-term interest rates bottom.

Phase 2. Business growth rises (above trend); money growth, stocks, and dollar peak and the yield curve flattens before the end of this phase; inflation, commodities, and short-term interest rates rise.

Phase 3. Business growth declines (above trend); money growth, stocks, and dollar decline and the yield curve flattens; inflation, commodities, and short-term interest rates peak before the end of this phase.

Phase 4. Business growth declines (below trend); money growth, stocks, and dollar bottom and the yield curve steepens before the end of this phase; inflation, commodities, and short-term interest rates decline.

If you look at the indicators discussed in this report, we are in phase 3. This is not a forecast. It is a reliable statement concerning current events. Historical data suggest, furthermore, the next phase will be phase 4.

(This Observations appeared in the 11/08/04 issue of The Peter Dag Portfolio ).

George Dagnino, PhD Editor,
The Peter Dag Portfolio.
Since 1977
2009 Market Timer of the Year by Timer Digest
Portfolio manager

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