Our investment approach recognizes that the basis of stock price disparity among groups is the difference in business conditions among segments of the economy. We analyze macroeconomic, technical, political and demographic trends as they relate to the securities markets. After determining the most attractive sectors, we select individual companies and fixed income securities that should benefit from the investment environment that we foresee. Earnings are a key driving force behind the differing price changes among groups of stocks or sectors of the stock market. The earnings of our averages, which are proprietary measures of valuation, vividly illustrate favorable and unfavorable investment periods.

The strategy is centered on the growth/cyclical stock market thesis, coined the "Dual Market Principle," which was first introduced to the investment community by our staff in 1960. Our approach has been particularly successful in identifying major divergences that have occurred in the stock market and is now commonly used by institutional investors. In more recent years, greater diversity has occurred within the economy and the financial sector. Consequently, we now monitor about 50 industry averages on a technical basis.

The importance of the awareness of sector rotation in the stock market is borne out by the historical record. Our major sector averages’ performance shows that sectors have reacted fairly independently of each other. However, they have also moved in harmony for considerable stretches, particularly when broadly based advances or declines were under way. When viewed in this way, the term "market" as usually understood becomes less than meaningful and the general terms "bull market" or "bear market" become misleading. Major stock groups may be in either a bull or bear trend while another group is acting very differently.

From 1957 through 2000, the Cyclical Average has outperformed the Traditional Growth Average during nine periods that averaged about two years in duration. The Traditional Growth Average has outperformed the Cyclical Average ten times during this period with an average length of about 2.7 years. One of these averages beat the S&P 500 Index in all but eight of the 43 years. Correct sector rotation investing on a year over year basis would have produced more than twice the gains earned by the S&P 500 Index. In our opinion, classifying companies according to the factors which influence their earnings is a crucial key to investment success. The failure to make this distinction has been the most obvious flaw of the popular averages and has often made them misleading at crucial turning points.

In 1971, when structural conditions caused the Federal Government to introduce wage and price controls, it became necessary to redefine some categories of the equity market. Those companies within the Cyclical Average, whose earnings were very sensitive to price changes, would be at a greater disadvantage if they could not increase prices as the economy improved. For this reason, a Capital Goods Stock Average (representing capital goods and commodity cyclical companies) and a Consumer Related Stock Average (made up of durable, nondurable and service companies directly dependent on the consumer segment of the economy) were developed by our staff. The resultant divergence between the capital goods and consumer sectors became dramatically evident in 1973 when, in that year, capital goods stock prices rose 22% while consumer related issues fell 38%.

Sector rotation has continued to be an important factor to investment success in the 1990's. In 1989, our Composite Forecasting Index (CFI) was the only leading economic series that we are aware of that forecast the coming 1990 recession. Thus, our Traditional Growth Average gained 2.5% in 1990 while our Cyclical Average fell 20%. Our CFI pointed to stronger than expected economic growth in the period 1991 to 1994. During the early part of the expansion, Cyclical shares rose 60% versus only a 40% rise for growth companies.

As the expansion matured and the benefits from corporate restructuring were realized, overall earnings growth became less robust and the Traditional Growth Average again took control. From 1995 to 1998, Growth stocks outperformed Cyclicals by more than 100%.

In 1999, as several companies in our Traditional Growth Average suffered setbacks due in large part to their exposure to foreign economies, investors’ search for earnings growth focused narrowly on the Technology Average, which surged more than 140%. Our Bank Average was down 9% in 1999 and our Consumer Related Average was up only 4.5%. Both these Averages, however, had superior earnings results that year. 

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