The first thing that needs to be done is understand the macro-economic cycle and how it affects the market cycle. This is done by reviewing various economic statistics and seeing how they have progressed over time. With this information we are able to determine approximately where in the cycle the economy currently is.This is an economic overview, or top down approach. Macro-economic trends are the "big picture" if you will, and indicate what sectors of the economy and industries will do well and which will have a downturn. A solidly built economic view will insulate the investor from playing the "number of the day" game that causes so much volatility in the markets today. Once the economic overview is in place, the sectors of the economy and industries that will benefit from this view will become evident.
Actual CyclesThe previous charts are "idealized". They do not show thactual movements and shapes of the cycles. Below are the actual cycles. While not as smooth as the idealized charts, the cycles are clear.The Economic Cycle chart shows the ebb and flow of inflation to deflation.The Market Cycle chart shows the true measurement of value in the market, p/e’s. We averaged the p/e ratios over a 5 year time frame. The peaks and valleys of the cycle are obvious. We are currently at a peak in the market p/e ratio.None of the cycles were exactly the same as the previous one, but they had the same characteristics. The specific causes of the recoveries and downturns were all different, but the effects were the same.Excessive debt was usually the main cause of deflationary downturns. It is the same today in Japan and in the US.
Asset AllocationThe market cycle and economic cycle determine asset allocation. Asset allocation is the key to investment success. We at Cornerstone have determined the appropriate mix of assets for various economic and market conditions based on a thorough study of market history and application. An idealized allocation model has been developed for each part of the market cycle. Cornerstone has developed a model portfolio that fine tunes the allocation for today’s markets.