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STOCK MARKET TIMING
PHILOSOPHY
Stock market timing is a major way that we add value to
our clients' portfolios. Academic studies and common sense
show that asset allocation is the most important decision
that an investor can make. We aim to match or exceed the
market returns during bull markets and significantly outperform
the market during bear markets.
Studies have shown that proper stock market timing will
typically outperform no market timing on a risk adjusted
basis but not on an outright gross basis. We leave it to
each client to determine their tolerance for risk and instruct
us as to the strategy they prefer. Risk tolerant clients
will generally prefer to forego stock market timing and
look to make extra returns over the long run. Risk averse
clients will generally prefer to use stock market timing
to protect against significant equity drawdowns while still
participating in most of the gains of bull markets.
STOCK MARKET INDICATORS
We do this through the exhaustive study of stock market
timing indicators. These include the major factors that
affect the market, such as:
· The economy · Monetary policy and interest
rates · Valuation · Market breadth ·
Stock Market trends · Sentiment
We have identified about three dozen key indicators that
have had a persistent and powerful influence on the market
through this century. We have discovered this through statistical
studies of the impact of each of the indicators on the stock
market. The individual market indicators are tested for
reliability and strength. Several hundred indicators were
tested over this century and especially since World War
II before selecting the most powerful indicators that we
use today.
This testing process is never finished. We are constantly
monitoring the veracity of our current market indicators
and look for better ones. Please see our chapter from the
recent book Fundamental Analysis (Jack Schwager, John Wiley
& Sons, 1995). This gives a good idea of the type of
market indicators that we use.
ASSET ALLOCATION
The Courtney Smith & Co. Approach is to use a two step
process to determine the asset allocation.
The first step is to create a diffusion index of the stock
market indicators discussed above. A diffusion index simply
adds up the percentage of the indicators that are bullish.
For example, if seven of the ten indicators are bullish
then our base allocation is 70% long the market. As another
example, if five of the ten indicators are bullish then
we would only recommend being 50% long the market with the
balance of the account in cash or fixed income securities.
The second step is to make minor adjustments to the base
asset allocation. We do this to account for special circumstances
that are not considered in the indicators that we use for
asset allocation. For example, the effect of changes in
the tax code are not considered because they happen irregularly.
We allow a deviation from the asset allocation model of
10% on either side of the suggested allocation depending
on the qualitative judgment of the Chief Investment Officer.
This two step process then gives a final asset allocation
to the stock market. We invest primarily in the stock market
because studies have shown that long term investment in
the stock market will outperform fixed income investing.
We therefore wish to have the odds in our favor.
The balance of the account is then invested in some type
of fixed income. The length of the maturity of the fixed
income is determined by the same process as the asset allocation
of the stock portion of the account. Courtney Smith &
Co has developed a model for investing in the bond market.
We invest the balance in bonds when the model is bullish
and invest it in money market instruments when the model
is bearish.
THE BOTTOM LINE
We believe that the Courtney Smith & Co. Stock Market
Timing Approach is disciplined and rigorous. At the same
time, there is enough flexibility to account for sudden
stock market movements. As a result, we believe that it
presents superior performance with controlled risk.
Go to Stock Selection
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