I once asked a brilliant strategist how he did it. How did he come up with insightful equity strategies month after month? How did he know we would recover from Asian Financial Crisis so quickly and that we could make so much money in Indonesian Banks? How did he know that the NASDAQ (and with it, the entire Asian Technology Sector) was going to roll over soon in 1999? The answer was simple, according to him: toss out your previous conclusions, take out a fresh sheet of paper and take stock of where you are today.

Raymond Foo’s strategy hinged on ordering all the available indicators into three batches: Leading, Lagging and Concurrent. His brilliance lay in recognizing that these indicators could change from Leading to Lagging to Concurrent. Past categorizations were not allowed to influence current ratings. He had to prove an indicator was still a leading one before he would use it.

How does that help us today?

Rather than troll through hundreds of indicators and assign one of three values to them, we can get similar results by objectively looking at the asset classes we have available for investment. There are two approaches, a mathematical and a more empirical approach.

The Fund King System takes a mathematical approach and the results are available on the website. Broadly speaking, in the last two weeks the Fund King System’s signals have been slowly recovering from very neutral 1st quarter readings. The picture is brightening but we are certainly far from broad bull market territory in risky assets. There are opportunities which are worth taking: Emerging Europe, India, Biotech and even Japan are coming out at the top of our mutual fund rankings. In the ETF space, Pharmaceuticals, Biotech, Russia and Medical Devices look promising on a global perspective while the small cap space looks like it is heating up in the US only portfolios. Consumer Discretionary is still close to the top of the lists but momentum is starting to fade.

From a more empirical point of view, we can start filling up our clean sheet of paper by dividing the world into four asset classes: Equity, Debt, Commodity and Property.

Equity is not cheap.

Whether measured on a Price/Earnings, Dividend Yield, Price/Book or an earnings growth measure, equity markets around the globe are not cheap on a historical basis. Following a Buy and Hold strategy from these levels will yield a pretty poor return over the long run as valuations are likely to fall rather than rise from these levels over the next few years. But, there are short and medium term opportunities that should not be overlooked. As excess liquidity sloshes around the globe looking for returns, opportunities will continue to pop up in equity assets.

Bonds are not cheap.

Even Greek bonds are not paying enough to compensate for the real risk of default. While all markets are subject to the laws of supply and demand, the bond markets in general and the US Treasury market (which provides a leading benchmark) in particular have seen outsized demand during the Global Financial Crisis. Those dynamics will change although more slowly than some of the bond bears think. One area that continues to show strength is the High Yield space. Many Corporates are managing their balance sheets with the same care as newly chastened consumers (and in stark contrast to many governments).

What about commodities?

Most commodities are not long term investments by definition. Because of substitution and demand elasticity, commodity prices can only rise so much before new supplies sources become economical and customers substitute cheaper alternatives. Alternatively, prices can only fall so much before mines are mothballed or new demand pops up to soak up the excess supplies. As cyclical markets, though, that does not mean that one should not include commodities on your investment radar screen.

Gold is a special case because of its historical role as “hard money.” Supply, demand and substitution do not impact the price as much because gold is almost never actually consumed. Most gold is held as an idle(non-income producing) store of wealth so the price of gold is largely determined by emotions. Gold quadrupled from under $300 (early ’02) to $1200 an ounce (Dec ’09) because investors lost faith in fiat currencies like the US dollar. But, how likely is Gold to double from current $1,100 levels? It may rise back to $1,200 or find a new high at $1,300 but there is also the risk that it could retrace 30% like it did from March to October 2008 (hardly a time of optimism).

And property?

Despite the efforts of Professor Shiller at Yale, property is still not a tradable commodity. Property prices have fallen in many parts of the world but that was from bubble levels. Affordability indices suggest that housing is still overpriced in many desirable locations in the US and Europe. In Hong Kong and China, there is a reflating bubble as China’s heroic stimulus efforts have funded a massive property rush. That said, there are several studies that show property markets decoupling from one another suggesting that some well researched REITs will once again add non-correlated returns to your portfolio in the not too distant future.

The conclusion?

Many of the “Buy and Hold”, “Buy the Dips”, “Property Always Goes Up” and “Stocks for the Long Run” ideas that we grew up with in the great asset bull markets of 1982 to 2006 need to be tossed and replaced with a more opportunistic trading strategy.

How should you start to formulate that strategy? One way is to secure a good supply of clean sheets of paper. It is not easy to let go of previous assumptions, especially if they have worked out and made us some money. But, if you can approach the market with a fresh attitude each time you evaluate your portfolio, those sheets will come in handy over the next few turbulent years.

The Fund King System is a web based way to achieve the same goal. If you need more information about how the Fund King System can help you invest more efficiently, let us know how we can help you use it for your portfolio.

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