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Sector Investing and Business Cycles. G. Dagnino

Managing a portfolio is not easy. If someone tells you there is an easy formula to
successful investing it is not true. Especially if you want to manage all your money, not just play money. A portfolio requires time, study, and analysis. If you want to manage play money, find someone who gives you tips, and go gamble. In order to manage all your assets, you need an investment process. This book starts from where “Profiting in Bull or Bear Markets” concluded. Profiting in Bull or Bear Markets presented a detailed analysis of the relationships existing between financial markets and business cycles. In any economic system, business cycles impact financial markets and financial markets impact business cycles. That book provided a framework to understand these relationships and showed that history does indeed repeat itself.

Most investors are not satisfied with their investment results because they do not have an investment process. In fact, investors may not know about an investment process. When markets rise, their portfolio performs well and investors feel satisfied with their financial results. In a bull market environment, any stock tip may show profits because a rising tide lifts all boats. Of course, as the market goes up, investors become confident that they are superb investors and that they do not need any help. As a gradual and steady upward move of the market takes place, financial conditions change. Many investors do not recognize the meaning and implications of how these changes impact portfolio returns. When investors make money, they feel secure. Eventually, the gains do not seem to materialize anymore as they did earlier. Their portfolio begins to show mixed results. What to do?

At this point, typical investors convince themselves that the market is in a minor correction and think they should not worry. They do not take action because they are hoping that their stocks will come back. They may buy more of the declining stock thus averaging down their positions. Investors continue to lose money. They worry more and more about the market and begin to act irrationally.
Soon the market goes through a serious correction of 10 – 15%. The losses begin to accumulate and investors rationalize the painful losses. They put their heads in the sand and the losses become staggering. At this point, they are so disgusted with their portfolio performance they do not even look at their portfolio. They do not know what to do. This is why investors need an investment process.

The reason portfolios show disappointing results is because of the changing
financial and economic environment. Investors need an investment process to
accommodate these changes. An investment process answers the following questions:

1. What to buy and what to sell;
2. When to buy and when to sell;
3. How much to buy and how much to sell.

These crucial questions need to be answered often -- at least every month -- after evaluating the performance of the portfolio. An investment process lets data not emotions rule decisions. The first question -- what to buy and what to sell -- addresses the issue of asset selection, purchase, and sale. To make a selection, the process must lead investors to make a decision to add or delete a particular asset in the portfolio.

The second issue -- when to buy and when to sell -- guides investors to time a
purchase or sale of an asset. The need is for a method to find the correct and consistent answer. Once you have selected and bought an asset, how do you manage the amount invested in that particular position? Some people think, “Buy.” Others think, “Sell,” or “Hold.” This is not the most successful way to look at investing. Investors should think in terms of how much to add or how much to sell from an existing asset. The objective of money management is to increase or decrease a position, gradually, reflecting changes in the financial environment based on the levels of risk of a particular stock, stock sector, or asset.

The investment process evaluates the relationship between financial markets and the business environment. Investors can determine the stock sectors most likely to outperform or under perform the market. Once the strongest stock sectors are targeted, techniques are developed to find the strongest stocks within the strongest sectors. As the business environment changes, the strongest sectors become less attractive and other sectors become more attractive. Our investment process helps investors decide when to buy or sell, what to buy or sell, and how much to buy or sell. This dynamic approach to money management uses the attractiveness of stock sectors depending on the phase of the business cycle. For example, if the Fed aggressively lowers interest rates, financial sectors are likely to benefit. When interest rates rise, other sectors become attractive and financial stocks become risky.

As the economy changes, investment strategies and asset attractiveness change. The decision making process is dynamic. Investors adjust their strategy to changes in the business cycle.

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