Finding The Bull Inside The Bear

Bull
Finding
the
Inside the Bear
Active Management Strategies
for Expansions, Contractions,
and Everything in Between
Robert N. Stein
Senior Portfolio Manager and Economist, Astor Asset Management
Global Head of Asset Management, Knight Capital Group, Inc.
Marketplace Books
Columbia, Maryland
Copyright © 2012 by Robert N. Stein
Published by Marketplace Books Inc.
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ISBN: 978-1-59280-559-4
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DEDICATION
In Memory of My Father, Jerry Stein

April 5, 1929 -- December 5, 2011
ACKNOWLEDGEMENTS
When sitting down to write a book, it truly becomes a labor of love from
so many sources, expected and unexpected. A simple thank you is never
enough, but hopefully the meaningful words of gratitude mentioned here
will somehow express the appreciation I have for their support.
My colleagues at Astor who work above and beyond the call of duty to give
our clients the best service and products are truly dedicated to our cause.
On the Astor Team, I wish to thank Jeff Feldman, Bryan Novak, Scott
Thomas, Althea Trevor, Brian Durbin, and our intern Patrick Commins.
Special thanks go out to Stephanie Yuskis who is my personal GPS.
Of course support outside of business is also very important in completing

this project. My family has always been supportive of me in almost all of my
endeavors; my wife, Eileen, and my son Spencer are my biggest fans.
I hope all enjoy this book and take away from it a new understanding of
the importance of active management and investing, to “find the bull
inside the bear.”
Thank you,
Rob Stein
CONTENTS
INTRODUCTION VII
THE CASE FOR ACTIVE MANAGEMENT VII
Responding to a New Investment Climate with Active
Management ix
CHAPTER 1 1
ACTIVE MANAGEMENT AND ECONOMIC REALITY 1
Active Management—Knowing When to Buy
and Sell 3
The Business Cycle 3
Defining the Business Cycle in Real Time 5
Participating in the Broad Market 10
The Active Management Advantage 11
Economics in Action 16
CHAPTER 2 17
OUTLOOK 2012: IT’S ALL ABOUT THE MONEY 17
2012 Outlook 19
What’s the Problem? My Financial Picture, That’s What! 21
The Money “V” 24
Stock Market–It’s About Valuations 26
Fixed Income, Interest Rates, and Inflation 28
The Dollar, Commodities, and Energy 29
Real Estate and Housing 29
Conclusion: The Year of Zero 30
CHAPTER 3 33
RISK, REWARD, AND TRUE DIVERSIFICATION WITH
ETFS 33
v
Understanding Active Management 34
The Investment Process Using ETFs 35
Avoiding Catastrophe 36
Praise for the ETF 37
Active Management Scenarios 39
Model Portfolios 40
CHAPTER 4 47
ACTIVE MANAGEMENT
A VALUE PROPOSITION 47
Risk and Reward 51
Why You Should Worry About Drawdowns 51
The Case Study 52
Conclusion 53
Summary: Strategies for Tomorrow’s Markets 54
ABOUT ASTOR ASSET MANAGEMENT 57
The Astor Advantage 57
About Knight 58
ABOUT THE AUTHOR 59
GLOSSARY OF ECONOMIC TERMS 61
ECONOMIC CALENDAR 81
vi Finding the Bull Inside the Bear

Introduction
THE CASE FOR ACTIVE
MANAGEMENT
O
ver my years as an economist, I have combined in-depth study
of the economy and a passion for the markets into a single
discipline: investing based on the economic cycle. This enables
me, as an investor and portfolio manager, to put the power of the “big
picture” behind each investment decision.
From the start of my career as an intern at the Federal Reserve, when

Paul Volcker was chairman, to my move to Wall Street, where I was a
senior trader for several prestigious banks, I was witness to the value
of economic data. Data not only influence the markets, but also deter-
mine the overall tone and direction of the economy. I quickly saw that,
when making investment decisions, forecasting the economy was not
as important as identifying the current stage of the economic cycle.
Today, as senior managing director and portfolio manager of Astor
Asset Management, LLC, my emphasis remains on the current eco-
nomic cycle. We use economic analysis to make informed investment
decisions through all phases of the economic cycle, from expansion to
contraction and back again. This strategy is called active management.
Active management is a general term and may encompass a variety of

strategies. The one we will discuss in this book is active management
using economic analysis. As we will illustrate throughout this discus-
sion, identification of the current economic environment—as it goes
through the four distinct cycles of expansion, peak, contraction, and
trough—is paramount to our active strategy. By reviewing and analyz-
vii
ing specific economic data, we can identify the existing cycle for the
overall economy or within a particular sector. Once we have confirmed
with a high degree of certainty where the economy is, the portfolio
selection process becomes much easier.
As history has shown, how the stock market, and therefore investment
portfolios, react to economic data and events depends largely on the
current economic cycle. When the economy is expanding, it is much
easier (and more likely) for the market to shake off bad news. When the
economy is contracting, however, that same negative news intensifies
the downward momentum. The current economic climate is every-
thing. For example, the so-called stock market “crash” of October 1987
is easily recalled by investors. But how many people remember that
stock market averages were actually up for that year? The reason was
that the economy, as I define it, was actually expanding. Thus, it was
fairly easy for the market to recover from the crash (which was more
like a hiccup) and resume its upward momentum.
There are other, similar examples throughout the 1990s: currency

defaults, the Russian debt crisis, and the failure of hedge-fund giant
Long Term Capital Management. All of these events had only a short-
term impact on the market, which eventually recovered due to the fact
that the economy was expanding during these times. Had the events
occurred against a negative economic backdrop, the result would
have been far different. Consider the bursting of the internet bubble
in 2000, followed by the horrific events of September 11, 2001, which
occurred during an economic contraction. Because of the deteriorat-
ing economy at the time, the market reacted more negatively and took
longer to recover than if these events had happened under more posi-
tive conditions.
A more recent example is the European debt problem, which resur-

faced following the “flash crash” of May 2010 in which the Dow Jones
Industrial Average dropped more than 1,000 points in a day. The mar-
ket recovered from both of these negative events and, in the process,
put in new post-recession highs within about 90 days. The reason? The
economy was growing again. If these events had occurred during an
economic contraction, recovery would have taken far longer, and a new
post-recession high would not have been established.
viii Finding the Bull Inside the Bear

The lesson here is to use economic data to construct portfolios that
have the best chance of producing a favorable return, and also to use
the data to know when to scale back your holdings. In other words, the
data will tell you when to “hold ’em” through a relatively short period
of market turbulence and when to “fold ’em” because what was bad has
just gotten worse.
As we review recent economic history, there were significant events

that changed the behavior of the markets forever. The financial crisis
of 2008 to 2009 did just that, resulting in permanent changes to financ-
ing, bank-to-bank lending, and securitization of loans. The tools of
the Fed to navigate around sharp turns have been expanded, as has its
balance sheet.
In the wake of the financial crisis, it also appears that the role of govern-
ment will become more prevalent. This is not a political statement as
much as an observation of fact. Each party may go about it differently,
but the result will be the same. It appears the tails of risks (and returns)
are being chopped off (which is unfortunate, I might add). Returns
will eventually look more like utilities. It is clear, at least for now, that
risk and loss are intolerable, no matter what the potential reward. In
fact, this might be one of the reasons U.S. treasuries are still attracting
investor flow.
Regardless of these changes, the longer-term direction of the markets

is a function of economic activity. Further, despite counterproductive
policies over the decades, capitalism wins. As Adam Smith pointed out,
as long as the basic fundamentals of democratic capitalism exist—the
division of labor, freedom to trade, and the ability to work for profit—
the economy will endure. There will be ups and downs, but this is the
best system to allocate resources for overall growth and benefit.
Responding to a New Investment Climate with

Active Management
Today, we are in a new investment climate. A distinctive feature of the
new climate is the fact that investment cycles are not as pronounced or
as long in duration as prior cycles. As a consequence, shorter cycles will
have a significant impact on the economic order. Add to that the explo-
Introduction ix
sion of information availability and heightened investor awareness of
economic developments and news events. With shorter and often less
pronounced cycles, investment professionals and their clients must be
more vigilant than ever. They need to be astute about the underlying
condition of the economy and the likely impact on the stock market.
Consequently, they must be agile in both their decision-making and
their actions. In other words, in this new investment paradigm, inves-
tors need to embrace a new way of approaching and reacting to the
market by applying active management.
Active management means taking a proactive approach to investing

by utilizing fundamental and technical analysis to create value in a
portfolio. This approach allows financial professionals and their clients
to make profits in any type of market climate, regardless of market
direction, volatility, or bull or bear condition. Using active manage-
ment, professionals and their clients make investment decisions to
either buy (go long) or sell (go short) the market, depending upon a set
of predetermined criteria. This is markedly different from buying and
holding or constructing a portfolio of supposedly diversified holdings.
Furthermore, active management reduces risk by limiting losses during
bear markets and providing a better base from which to build profits
during bull markets.
The most important issue is for investors to dedicate a portion of their

assets to active management. Active management is a necessary strate-
gy to pursue an independent and empowered financial future. Through
active management, investors and their advisors are no longer held
captive by traditional buy-and-hold strategies, and have an important
defense against the vagaries of the stock market.
At Astor Asset Management, our economics-based approach to active

management means, in simplest terms, that we buy equities when the
economic conditions are most favorable (economic expansion) and sell
equities or even taking a short position in the market when the eco-
nomic conditions dictate (economic contraction). Given today’s shorter
economic cycles, there are also gradations to our long and short posi-
tions. Thus, we must be prepared, depending upon our analysis of the
economy and the market, to be 75 to 100 percent long equities at times,
and only 25 to 50 percent long at others, depending upon the strength
of the cycle. Or, I may take a 25 percent short position in one market,
x Finding the Bull Inside the Bear

such as the Nasdaq, while retaining a long position in another, such as
the S&P 500. It’s all determined by vigilantly analyzing economic indi-
cators that signal the current stage of the economy, rather than reacting
to the fluctuations of the market and the advice of TV pundits.
One finger must be kept on the pulse of the economy and another on
the trigger of investment decisions. Make no mistake: I am not talking
about capturing short-term moves that last only a few days. Rather,
I am proposing to be nimble enough in one’s economic and market
analysis and investment decisions to take on long and short positions
as conditions dictate.
Being vigilant and flexible—ready to switch from a partially long to a

partially short position and back again—will be the only way to reap a
positive portfolio return in the years ahead. Those who fail to recognize
this fact run the risk of having the gains they reap during the bull mar-
kets erased by the ensuing bear-market corrections, and with shorter
time frames to recoup their losses. If that happens, where will they be
in the end?
Active management is the new investment paradigm for today’s eco-

nomic climate and for the broad base of investors participating in
the market. The stock market, once seen as an exclusive club for the
wealthy, has more participation than ever before, largely through the
proliferation of 401(k) plans and other retirement accounts. Mutual
funds, individual stocks, exchange-traded funds (ETFs), and other
securities make up the portfolios of more Americans than ever before.
With their financial security on the line, these investors have become
hyperaware of market conditions, especially given the painful lessons
of the financial crisis. Investors who failed to take action in response
to changing market and economic conditions paid the price—literally.
My purpose in writing this book is to explain the benefits of active man-

agement and how this approach is a vitally important tool for today’s
investment professionals and their clientele. In upcoming chapters we
will address active management and economics-based investment; the
principles of economics-based investment; risk and reward and true
diversification using ETFs to gain exposure to the broad market and
specific sectors; and comparisons of active investment versus buy-and-
hold. In addition, we are including our latest outlook, an in-depth look
Introduction xi
at what’s happening in the economy, the markets, and all the factors
that influence them. In the Appendix, you will find a calendar template
to help you keep track of significant economic events and a glossary of
economic terms.
My hope is that, by reading this book, you will come away with a
working knowledge of how to put together the pieces of the economic
puzzle, and how to turn economic analysis and opinion into informed
decisions in the market. Along the way, you’ll also gain a clearer under-
standing of matching risk tolerance and investment objectives through
the sheer versatility of active management.
As investors have learned from the recent past, investing is more than
merely allocating assets and then walking away to let time perform
some sort of magic. Successful investing requires continual study and
decisiveness. You don’t have to be tuned to the market’s every move all
day long, but you should monitor a handful of key economic indicators
so that you can be aware of shifts and undercurrents in time to react
and preserve more of your hard-earned wealth. It is a discipline that
cannot be underestimated and, as we all know, its reward is well worth
the effort.
xii Finding the Bull Inside the Bear

Chapter 1
ACTIVE MANAGEMENT
AND ECONOMIC REALITY
The challenge we see is convincing investors to pay attention to what is

happening now, instead of getting caught up in all the predictions for the
future—predictions upon predictions and probabilities upon probabilities.
I
f there was one, single important lesson to be learned from the latest
bear market, it is the value of real diversification. By real diversifica-
tion we do not mean merely spreading equity exposure around to
different types of stocks and adding some fixed-income holdings. The
only strategy that has proven viable during bear markets—and the one
that holds promise during uptrends as well—is true asset diversification
through active management.
At Astor, active management means using economic analysis to deter-

mine the most opportune times to buy and sell equities. Namely, we
buy during economic expansions and sell, or even short-sell, during
economic contractions. We accomplish this by utilizing investment
instruments that represent a broad sector of the market, such as the
S&P 500 or Nasdaq 100. An effective way to accomplish this objective
is with exchange-traded funds (ETFs), which can be used by money
managers and individual investors alike to gain exposure to indices
and sectors (ETFs will be discussed in greater detail later in the book).
We believe that investing in the broader indices is a far more effective

way to profit from opportunities in bull and bear markets than trying
to pick individual stocks. Granted, traditional wisdom says that even in
1
a bear market there will be some “good” stocks to buy. In a bull market
the majority of stocks go up, although some to a greater degree than
others. Picking the right stock for market conditions, however, is far
too risky without a commensurate reward. By contrast, applying active
management to broader market indices increases an investor’s chances
of participating in the overall market trends, both up and down.
Certainly equities aren’t the only instruments for an active manage-

ment strategy. There are also approaches for fixed income such as the
Active Income Fund that Astor offers clients who are seeking low-risk
means to invest in the fixed-income markets.
Given the dominance of equities in most investor portfolios these days,

it is extremely important to recognize how active management can pro-
duce potentially significant returns that are at least commensurate with
the long-term, historical return associated with stocks of 12 percent to
15 percent over time. Active management carries less risk than buy-
ing and holding stocks since it eliminates exposure to equities during
market corrections. In addition, more aggressive investors can establish
short positions in equities to capitalize on market corrections.
Active management is in line with the basic investment concept of “buy

low, sell high.” After all, this is the fundamental way of making a profit.
The vital difference, however, is that active management does not use
arbitrary price targets or the fact that the market is up or down at a par-
ticular moment to trigger investment actions. Rather, it relies on pre-set
criteria—in the case of Astor, the stages of the economic cycle—to make
informed, intelligent investment decisions.
As recent bear market corrections have shown us, corrections in the

overall stock market can come at the worst time, taking away 50 per-
cent or more of an equity portfolio and wiping away years of gains.
Unfortunately, these corrections occur when investors have their largest
exposure to stocks, making the corrections feel even greater than their
percentages. If you lose 50 percent of your portfolio, you need a gain of
100 percent just to get you back to flat. Based on average returns, this
can take you eight to ten years! Therefore, avoiding drawdowns caused
by contractions can add years to your investment life.
2 Finding the Bull Inside the Bear

Active Management—Knowing When to Buy
and Sell
To actively manage an account or portfolio, you need criteria for when
to buy and when to sell. At Astor, we invest based on the current eco-
nomic conditions—not what we believe the economy will likely do a few
months from now. Over the years, we have found that economic reality
is far more powerful than a hypothetical forecast. I learned this lesson
when I started my career as an analyst at the Federal Reserve. Part of
my job was to compile economic data, dealing with tangibles such as
the rate of growth of GDP, weekly jobless claims, and the size of the
U.S. workforce.
When I moved to Wall Street, I took on a much more difficult job:

forecasting. The problem with forecasting was that I was wrong a lot.
It’s like the old joke that says economists were created to make weather
forecasters look good. Very quickly I returned to my analytical roots.
Rather than trying to predict what was going to happen, I preferred to
review and analyze economic data to determine what was happening at
the time. Specifically, I wanted to create criteria to determine the cur-
rent stage of the business cycle. Once the business cycle was identified,
an active management investment strategy could be implemented to
capitalize on a particular stage. Focusing on economic cycle identifica-
tion, rather than making investment decisions based on market timing
or predictions that typically have a low percentage of accuracy, is a
cornerstone of the Astor investment philosophy.
The Business Cycle

Determining the current phase of the business cycle is not without
its challenges. For one thing, economic signals can be mixed, and the
economy can grow or contract at different rates at different times. The
objective, therefore, is to look at specific economic data, which I will
review later in this chapter, and make a determination of where the
economy is at the moment.
At any given time, the economy is at one of our sequential phases of

the business cycle: expansion, peak, contraction, or trough. Repeated
over and over through the decades, the business cycle looks like the
sine wave in Figure 1.1, rising higher, peaking out, declining, hitting
Chapter One 3
FIGURE 1.1 Economic Sine Wave
bottom, and rising again. The overall direction of the wave is upward,
with higher peaks and higher bottoms, as the U.S. economy moves
steadily forward.
Let’s take a look at each of these four phases and the characteristics of
each.
• xpansion usually lasts the longest of all the economic stages and
E
produces the greatest amount of wealth. This phase is marked by
low unemployment and higher corporate profits, which usually
lead to stock market rallies. In simplest terms, when more people
are working, producing more things, and investing more money,
the economy is expanding.
• eak is the euphoria stage during which stock prices appreciate

P
sharply and consumer spending surges. This is also when com-
panies tend to overbuild, overbuy, and over-hire. Excesses build
up that are not healthy for the economy in the long run.
• ontraction may be an unpleasant stage, but it is a very neces-

C
sary one. As the economy slows down or slips into recession,
businesses begin to shed the excesses that resulted from expan-
sion and peak stages. Consumer spending and investment
decrease. Companies lay off workers and stock prices decline.

Contraction is the mirror opposite of expansion. In simplest
terms, it means fewer people working, less is being made, and
declining investments.
• rough is when the contraction hits bottom. Large numbers of

T
workers are laid off, and consumer spending declines. Although
the economy is still contracting during the trough, companies
that are leaner and more efficient start to make money again.
Lower labor costs and higher worker productivity (the result of
earlier layoffs) help boost corporate profits. This allows the econ-
omy to get healthy again and returns the cycle back to expansion.
Defining the Business Cycle in Real Time

The business cycle is easiest to identify in the rearview mirror. With
the passage of time, economists study not only the current economic
data, but also the latest numbers in the context of previous data. That’s
why the National Bureau of Economic Research (NBER) makes its
pronouncements on the beginning and the end of a recession months
after the fact.
From an active management standpoint, the challenge is determin-

ing how the economy is performing right now. Do the data indicate
an expanding economy or a contracting one? Are the data mixed,
indicating the next phase is not fully underway? Although there is a
plethora of data by which to analyze the economy—from durable goods
to vehicle sales to housing market statistics and reports from regional
Federal Reserve banks—at Astor we have broken it down to the ABCs
of economic analysis:
• GDP (Gross Domestic Product)

• Employment
• Investment money flows and stock price momentum
Using this data we determine if more people are working (as measured
by employment statistics) and making more products (as measured
by GDP), and investing more money (as measured by money flows
and stock price momentum). If so, then the economy is expanding.
Conversely, if fewer people are working, making fewer products and
investing less, then the economy is contracting.
Chapter One 5
Let’s take a closer look at each of these components of our economic
analysis.
GDP
Gross Domestic Product is one of the most comprehensive measures
of economic health, reflecting the physical output of businesses. To
get technical just for a moment, GDP reflects the sum of consumption,
investment, government spending, and exports, minus imports. Of
these components, the largest is consumption, accounting for about
two-thirds of the total. Little wonder then, that consumer spending is
so closely watched. Even though GDP is a lagging indicator that is sub-
ject to revision, it is a vitally important gauge of the U.S. economy that
is watched by everyone from the Federal Reserve Board of Governors
to traders on the floor of the stock exchange. Granted, GDP does have
some limitations. For example, it tends to understate the service and
technology sectors, and it subtracts from U.S. output the goods and
components imported into the U.S. by American multinationals from
their overseas operations. Nonetheless, since those limitations are con-
sistent quarter-to-quarter, GDP acts like an index, reflecting the relative
strength or weakness of the economy.
You don’t have to be an economist to decipher GDP or to understand

what’s happening in the economy. When a GDP report is released, the
first questions to be considered are:
• How is the economy performing compared to the previous quarter?
• How does the economy compare to a year ago?
• Is the GDP rate of growth increasing, which would indicate relative

improvement in the economy?
• Or, is the rate of growth declining, which shows that economic

growth has slowed?
Occasionally, GDP “goes negative,” showing a quarterly growth rate

such as -1.0 percent. Obviously, that doesn’t mean industrial plants
have kicked into reverse and are now “unmaking” goods. Rather, the
rate of production has declined in the most recent period from the
previous quarter. A negative GDP reading is a sure sign of a contract-

FIGURE 1.2
Percent Growth Gross Domestic Product
Year
Line graph shows fluctuations in GDP, from the strong economic growth of 2000 to the
contraction during the 2008 to 2009 recession when GDP “went negative.”
ing economy, as reflected by the 2009 reading in Figure 1.2. By classic

definition, a recession occurs when there are two sequential negative
GDP quarterly numbers. Increasing unemployment and declining stock
prices, which can be just as painful as a classic recession, also character-
ize economic contractions.
Another insight that can be gleaned from the GDP report is the level of
inventories. Inventories are not part of the GDP equation since goods
in the warehouse today were previously counted as output. However,
the report does make note of inventory levels, which can influence the
interpretation of the GDP number. For example, a strong GDP output
number looks less rosy if growth in output resulted in higher inven-
tories instead of increased consumer or end user sales. Furthermore,
when inventories decline because consumption has increased, it is a
sign that economic activity may be picking up soon.
Employment
Employment has broad impact beyond the immediate economic impli-
cations. Who has a job, who does not, and who is still looking are all
important and emotional considerations for the economy. People who
have lost their jobs or who are afraid of losing them are reluctant con-
Chapter One 7
sumers and far less likely to commit to any big-ticket purchases. Jobless
fears can also sour investor sentiment.
Employment is such an integral part of the economy that it is specifi-

cally mentioned by the Federal Reserve in its goals of monetary policy.
In addition, employment is tied directly to the business cycle. In a
contracting economy, growth in demand slows and inventories build.
Companies cut back production and lay off workers. This helps com-
panies to reduce their labor costs, become more efficient, and improve
profitability. During a recession, worker productivity (output per
employee) typically improves. As the economy recovers and demand
picks up, companies can benefit from lower labor costs for a time.
Eventually, however, demand will reach the point at which production
must be expanded and additional workers hired. Initially, productiv-
ity will decline. However, expansion in payrolls signals that economic
recovery is underway.
What’s most significant about productivity after an economic con-

traction is the degree to which the benefits linger. For example, let’s
say a company has 100 workers making 100 widgets a day. When the
economy contracts and demand slackens off, the company is forced to
lay off workers. At first, there are 70 workers making 70 widgets a day,
and then 50 workers making 60 widgets a day. This initial productivity
increase is to be expected, but it’s nothing to get excited about because
output is still down. When demand picks up, the company may be able
to produce 70 widgets with those 50 workers before it must start hiring
again. If the company has truly improved productivity, it will be able
to increase production at a faster rate than it must hire workers. For
example, if production eventually goes up to 150 widgets produced by
100 workers, perhaps through more efficient manufacturing processes
or better use of technology, that’s a significant productivity improve-
ment. Although contractions are painful, they can often result in better
and healthier economic growth in the long run.
To decipher what’s happening to the economy in terms of employment,

attention is focused on the monthly Employment Situation Report
(known unofficially as the unemployment report). When this report is
released, the statistic that gets the most attention is the unemployment
rate. The absolute statistic is not as important as the relative change
from one month to the next and over a longer period of time. Figure 1.3

FIGURE 1.3
Percent Unemployment
Year
Changes in unemployment, from 4 percent in 2000 to 9.6 percent in 2010.
shows the unemployment rate rising fairly steadily over the past decade.
But another key statistic is the size of payroll employment, which
reflects the rise or fall in the number of people working. Additionally,
the report shows the number of newly unemployed persons —those
who have been out of a job for less than five weeks.
The Employment Report is carefully tracked not only for what it reveals
about the current labor market, but also for indications of how well or
poorly the economy is performing. Increased joblessness, an increase
in the number of newly unemployed persons, and a shrinking payroll
number are all indications of poor or weakening economic conditions.
Similarly, an uptick in job creation, a decrease in the number of newly
unemployed people, and growth in the payroll number are signs of
economic improvement. Keep in mind that the economy needs to add
about one million jobs a year to keep growing, taking into account both
new entries and people leaving the workforce.
Investment Money Flows and Stock Price Momentum

Investment money flows and stock price momentum reveal the under-
lying belief of how well the economy is performing. Typically, inves-
tor sentiment improves in step with economic growth and a better
employment picture. The stock market, in fact, is one of the most
important indicators of economic activity, ref lecting the outlook
Chapter One 9
for growth in corporate output as well as the profitability and the
mood of investors.
When analyzing the stock market, we are not concerned at all about
price-to-earnings (P/E) ratios. Although some analysts use P/E to sug-
gest whether a stock is underpriced, fairly valued or overpriced, we don’t
put much credence in this ratio at all. Whether a stock is priced at $50
or $100 means little. Far more important is the relative change in stock
prices, particularly when looking at the broader market. That’s why we
focus on the direction of money flows and stock price momentum.
It is far more important to know if additional investor money is going

into equities and increasing the value of the stock market as reflected in
the major indices such as the Dow, S&P 500, or the Nasdaq Composite.
Or are investors pulling out of equities, causing stock prices to decline?
In some instances, the stock market’s behavior may be more telling
than the economic data, particularly when the economy is perceived to
be at or near a turning point in the trend—in other words at the peak
or the trough.
When studying economic data or stock market performance, it is

important to look beyond just a single report or a one-month time
frame. Trends develop over time, and it often takes several months for
a new trend to be identified and confirmed. With a longer-term per-
spective, the goal is to look for a consensus among the indicators, not
only to confirm the trend, but also to gauge its strength. For example,
when economic indicators show strong growth and the stock market
is exhibiting positive upward momentum, the conditions favor a sus-
tained economic expansion. Conversely, when economic indicators
worsen and the stock market turns downward, the stage is set for a
sustained contraction.
Participating in the Broad Market

Once the current business cycle is identified, an investment strategy can
be put in place. Although these strategies have many variations, depend-
ing upon factors from the age of the investor to his or her risk tolerance,
there are two basic investment premises that should be followed.
1. An expanding economy is favorable to equity markets and there-

fore owning stocks.

2. A contracting economy is unfavorable for equities, and therefore
stocks should be sold and/or short positions taken, and/or alloca-
tions to bonds and cash should be increased.
The best way to establish a long or short position in the equity market to
capitalize on the current economic condition using an active manage-
ment strategy is with the broad indices. The indices allow investors to
participate in the stock market’s moves, both bullish and bearish. These
indices, such as the S&P 500 and the Nasdaq 100, are better surrogates
for the U.S. economy than any one particular stock.
That is not to say that stocks do not have a place in an investor’s port-
folio. Many investors buy stocks that they like or that they purchase
because of potential growth in a particular sector of the economy.
When it comes to active management, however, I believe the best way
to capture the movements of the overall economy is with broad-based
indices such as the S&P 500 or Nasdaq 100. Keep in mind that active
management involves a portion of an investor’s portfolio, and may
account for 40 to 60 percent of an investor’s equity holdings. Depending
upon the portfolio mix, this may be as little as 20 or as much as 40 per-
cent of the overall portfolio.
It is also important to realize that the primary determinant of a stock’s

movement is the underlying direction and momentum of the broader
equity market. In fact, industry data show the market itself may account
for nearly 80 percent of a stock’s movement. Therefore, it is more effi-
cient and effective to participate in the broad market through a stock
index rather than an individual stock. An index, by definition, will
reflect a large sector of the economy. This cannot be accomplished with
any confidence by picking individual stocks. Even in a roaring bull
market, there is always the chance that the one stock an investor picks
is a laggard.
The Active Management Advantage

For the investment professional, active management strategies are valu-
able tools for delivering performance to clients, with fewer headaches
during the downturns. Further, when the downside risk during cor-
rections is limited (or potentially eliminated altogether), clients have a
stronger base on which to build compared with buy-and-hold.
Chapter One 11
STANDARD & POOR’S 500 (S&P 500) 1: A basket of 500 wide-
ly held stocks, weighted by market value and performance. The
index is designed to be representative of the stock market as
a whole. Company stocks are selected for the index based on
their market size, liquidity, and sector (such as financial, tech-
nology, etc.). The S&P 500 is widely used to judge overall U.S.
market performance and as a benchmark for performance used
by portfolio managers and investment professionals.
NASDAQ 100 2 : A weighted index of the top 100 non-financial

stocks traded on the Nasdaq Stock Market. The Nasdaq 100 is
a narrower index than the Nasdaq Composite, which reflects
the value of all the stocks traded on the Nasdaq. Dominated
by the leading, large-cap technology stocks, the Nasdaq 100 is
often used as a benchmark for technology-stock performance.
1 S&P 500 is a registered trademark of Standard and Poor's.

2 Nasdaq 100 is a registered trademark of The Nasdaq Stock Market, Inc.
The key to active management is that it offers strategies whereby inves-

tors can potentially avoid most of the drawdowns by getting out of
equities during adverse economic times, or even taking a short position
to capitalize on a declining market. Although investors will not catch
every up-move in the market as they switch from a short to a long posi-
tion when economic analysis dictates, they will not need to. Over time,
their losses will be smaller, and investors will be allowed to reap profits
from short positions during market corrections, while holding profit-
able long positions during market appreciation.
As part of economics-based active management, it is important to

let the analysis do the work it is supposed to do. In other words, you
cannot become so wedded to ideas or perceptions of what you think
is happening, or what you think should be happening, that you fail to
do the analysis or take it seriously. That does not mean you make an
investment decision based on every piece of new economic data. Rather,

you must always survey the economic landscape to determine what is
happening. When that picture is mixed or the data are unclear, do not
be afraid to sit on the sidelines until you can determine the economic
trend with more confidence. There is nothing wrong with being out of
the market and in cash until you feel more certain of what the economic
data and stock market performance are telling you.
When in doubt, get the heck out. That’s a good mantra for the active
investor and for professionals who advise them. No money was ever lost
by being in cash. If it turned out you sold too soon, then all you did was
forsake some potential profit. If you wait on the sidelines too long before
getting in, you can still make significant profits as the trend continues.
Consider what happened after the 1990 to 1991 recession. If you had
waited until late 1994 or early 1995 before taking a position in equities—
missing three years of the expansion—you still would have tripled your
money in the S&P 500 and made ten times your money in the Nasdaq.
That is, if you did one thing: sell when the expansion ended.
Investing Based on Economics

Taking an economics-based active management approach provides
firm rationale and a more precise strategy for making investment deci-
sions. The strategy relies upon underlying economic trends, not merely
the fact that a particular stock or sector looks good at the moment. If
the economy is expanding, it is a good time to be invested in equities,
including higher-risk issues that tend to perform best during these
times. When the economy is contracting, it is better to be out of equi-
ties and in defensive issues or, for a more aggressive approach, to have a
short position in equities.
During these overall trends, there will be countermoves. In every sus-
tained rally, there are periods of time when the market sells off, either
as a short-term reaction to news or as profits are taken. Nonetheless,
the market will follow the longer-term direction until a new trend
is established. For example, from 1995 through 2000, the U.S. saw a
period of strong economic growth, solid employment, and higher stock
prices. Taking a long position in equities during that time would have
yielded excellent results. During that time there were some pullbacks
and declines due to a variety of factors and events. Geopolitical and
economic upheaval, however, proved to be short-term bumps, and the
market found footing each time and continued to move higher.
Chapter One 13
Economic Expansion
GDP — Sequential quarterly growth starting at a rate of 3.75

percent or better.
Employment — Average monthly job growth of 125,000, or
sustained over a quarter.
Stock Market — Continual quarterly appreciation at a 9 to
10 percent annualized growth rate.
Economic Contraction
GDP — Average quarterly growth rate below 3 percent, or

sequential lower rates.
Employment — Job losses over three or more months.
Stock Market — Annualized growth rate below risk-free rate
of interest, for several quarters.
The challenge is always to discern the trend, despite outside forces, par-
ticularly at moments when the data are unclear or an economic change
has been detected. To do that, investment professionals should make
a habit of studying economic data—month-to-month and quarter-to-
quarter—in order to ascertain if the prevailing economic trend is still
intact, or if the trend is beginning to change. Here are some examples
from recent history to illustrate.
In early 2000, a roaring economy and long bull run in the stock market
made many people wonder if we would ever see a bear market again. By
the first quarter of 2000, however, there were signs of what was to come.
GDP, which had been up a whopping 7.3 percent in the fourth quarter
of 1999, dropped to a 5.5 percent gain in the first quarter of 2000.
Similarly, the stock market (as measured by the monthly close for the
Dow Jones Industrial Average) also began dropping, from a December
1999 close of 11,497.12 to the March 2000 close of 10,921.90. The writ-
ing was on the wall, but how many people paid attention? By the third
quarter of 2000, with GDP showing 2.2 percent and the stock market
continuing to drop, it was becoming apparent that the long expansion
of the 1990s was coming to a close.

A few years later, many investors would be surprised again when eco-
nomic expansion came to an end. Had they been looking for signs, how-
ever, they would have headed for cover. In the fourth quarter of 2007,
despite warnings of a housing market bubble, few people expected the
bloodbath that would occur amid the credit crunch that became a full-
blown financial crisis. Yet, once again, the economic statistics would
have been an early warning signal.
By the fourth quarter of 2007, GDP was slowing, up 0.6 percent. The
stock market closed the year at 13,264.82, down 4.5 percent from the
third quarter, but still 7.4 percent higher than the first quarter close.
By mid-2008, however, the statistics told a different story, as Table 1.1
illustrates. In the first quarter of 2008, GDP came in at 0.9 percent, fol-
lowed by a small reprieve as the economy gained of 2.8 percent in the
second quarter of 2008. The economy then fell sharply with readings of
0.5 percent in the third quarter of 2008 and -6.3 percent in the fourth
quarter. Two quarters of contraction as measured by GDP is the classic
definition of a recession.
The Employment Situation report, meanwhile, showed steep job losses,

which accelerated throughout 2008, as shown in Table 1.2. In the fourth
quarter of 2008 alone, job losses were 1,297,000.
No surprise then, that the stock market also declined sharply, falling to
a monthly close at the end of the fourth quarter of 8,776.39 as seen in
Table 1.3, a level that had not been seen since early 2003.
The economic contraction continued through mid-2009, as evidenced

by GDP numbers. The stock market reflected the deep concerns for the
economy, although as conditions seemed to improve from the depths
of carnage in the first quarter of 2009, the Dow did recover somewhat
from its lows. Job losses continued, although not at the magnitude of
early 2009.
By the third quarter of 2009, the economy was growing again. Job
losses continued throughout 2009, although growth in employment did
resume in 2010 (with some losses in the third quarter of 2010). As one
would expect, the stock market also recovered from its lows, ending
2009 above 10,000, and staying above that level for the majority of 2010.
Chapter One 15
TABLE 1-1 GDP by Quarters
TABLE 1-2 Employment Situation Change in Nonfarm Payroll
TABLE 1-3 Stock Market (as measured by the month close for the Dow)
Economics in Action
Economic statistics are dynamic. Not only do they change from month
to month and quarter to quarter, but they also ebb and flow with the
pulse of U.S. business and the market. You don’t have to be an econo-
mist to decipher economic statistics. Reading, understanding, and
tracking a few key statistics over a period of time will yield insights into
how the economy is performing, what the prevailing trend is, and if the
trend is changing. With this insight, investment professionals can help
their clients make better and more informed decisions, with greater
confidence, as part of an overall strategic plan.

Chapter 2
OUTLOOK 2012: IT’S ALL
ABOUT THE MONEY
A
t Astor Asset Management, we begin the New Year with a back-
ward look at where we’ve been in order to put into perspective
the events, forces, and other factors that will influence the next
twelve months. Following is a recap of how we view the economic land-
scape for 2011 and what lies ahead for 2012.
Without a doubt, 2011 was one of the most challenging years for port-
folio managers, and this manager for sure, given the extreme volatility
of the market. The Dow Jones Industrial Average frequently saw daily
moves of several hundred points in both directions, depending upon
the day and the headlines du jour. When you strip out those gyrations,
you can see that not much really happened. The S&P 500 ended the
year at 1257.60, just on the negative side of flat from where we started
the year.
I am proud of how well the Astor team identified the impact of econom-
ic events, even if some of our trade executions were sub-optimal. We
began 2011 with the economy expanding, albeit at a rate that was slower
than hoped for at the time. The fundamentals early in the year certainly
supported further economic growth and continued equity appreciation.
As we moved forward into the year, however, the markets appeared to
rally more robustly than perhaps could be justified by the fundamentals
in the third year of a recovery following the great recession of 2008. One
unforeseen event that struck the economy at a vulnerable time was the
tragic earthquake and tsunami that hit Japan late in the first quarter
17
of 2011, followed by a catastrophic nuclear accident. With the third
largest economy in the world and a major source of capital essentially
offline, it is no wonder that the global economy felt the blow. For the
U.S., the timing could not have been worse, as the domestic recovery
had finished its second year and was getting long in the tooth. The U.S.
economy needed fresh support, not new headwinds, for the recovery
to continue apace. By mid-year 2011, the economic data were waning,
with growth in GDP slowing to 1.3 percent in the second quarter and
unemployment persisting around the 9.0 percent mark. At mid-year,
we believed that the economy had hit the “stall speed”—meaning it was
growing, but at such a slow pace it put further growth into question and
raised the possibility of another economic recession.
Our decision was to take risk off the table and reduce equity exposure.
With the benefit of 20/20 hindsight we can see that we made the right
call regarding the economy. One of our investment choices, however,
was high-yield fixed income, based on our belief that corporate bal-
ance sheets were in better shape than government balance sheets.
Unfortunately, at the time, novice investors were drawn in by advertise-
ments from brokerage firms that touted high-dividend securities and
low broker loan rates as safe bets. Then came the Washington political
drama, with trumped up fears over the debt ceiling and a downgrade
of the U.S. federal government’s debt rating from Triple-A to double
A-plus. (In our view, the downgrade by S&P was ludicrous since the
ability of the U.S. to repay its debts had not changed one iota.)
The general public misunderstood the debt ceiling debate and panicked
over media projections of what could happen if the U.S. government
could not issue more debt to keep the wheels turning. In an atmosphere
of sell first and ask questions later, investors bailed out of everything.
Some fixed income assets lost more than their equity counterparts. Our
portfolios suffered slightly in this massacre, as well. Adding fuel to an
already hot fire was the European debt issue, with a multi-month Greek
drama as that country teetered on the brink of default several times
while the European Union hammered together a bailout plan.
Removing the political drama and the hype of projections, we can see
that the economy did start to stutter step at mid-year. It was clear that
GDP was going to come in at the lower end of the projected range, due
largely to reduced government spending (which is usually a 20+ percent

contributor to GDP) and lower prospects for exports to Europe. While
many money managers pointed to strong earnings and large profit
margins, which would eventually send markets higher, we believed that
these conditions were only supporting the market and keeping it from
crashing.
Corporate America has done a great job of repairing balance sheets,

raising cash, and becoming more efficient, but that has not been enough
to spur demand and create jobs. Therefore, in the second half of the
year, we became even more defensive and focused on reducing volatil-
ity. Again, our decision proved to be correct, because the fourth quarter
of 2011 saw even greater daily swings in the markets. Because of our
defensive positioning, volatility in our portfolios was a mere fraction of
what was experienced in the market. However, the timing of that deci-
sion locked in returns that did not show our proudest moment.
Most important, however, we stuck to our discipline and philosophy to

create our investment portfolio. We can’t worry about how we got here.
We began the fourth quarter of 2011 with the best portfolio for the
conditions at the time, with low volatility and reduced risk compared to
any competing portfolio to which we are compared for that period. As
2011 came to a close, it’s clear that there was a lot of noise for the past
12 months, but little to show otherwise, fundamentally and statistically
from a return standpoint. And as we look back on 2011 sans the politi-
cal drama, we are able to see clearly what we believe lies ahead.
2012 Outlook
The theme for 2012 is “it’s all about the money.” Never before have
we heard so much political rhetoric, both domestically and abroad,
centered on the economy and, more specifically, about money. Every
problem has a price tag associated it, one way or another. This costs too
much…Raise taxes…Lower taxes…Spend less… etc. You’d think that
money issues were the only ones in the U.S. or the world. Consider the
U.S. war in Iraq, which essentially came to an end with little fanfare
on either side, pro or con. What about global warming, food supplies,
homeland security, global terrorist threats, the need to improve educa-
tion domestically and around the world, and many other issues besides?
Chapter Two 19
Our current obsession with money has a lot to do with the great reces-
sion of 2008. The financial crisis that touched it off was caused by the
misuse of money and exacerbated by easy credit that spurred borrow-
ing. Then came overspending and excessive debt that accumulated over
several years. We can’t lay the blame on one over-extended consumer
group or bad mortgage practices or government spending programs.
Rather, as I will discuss shortly, the root of our ills is the consistent
misuse of personal balance sheets over an extended period of time.
To listen to the current rhetoric, however, one might think that money
is the cure for whatever ails us. If people and corporations simply earn
more (buy more, invest more) then we’ll be out of the woods and back
on easy street. Not so. Yet, our myopic thinking keeps us from seeing
anything except money—and more specifically jobs and money. (By
the way, what I see being done in the name of money indicates to me we
need to rethink our value system, but that’s another story.) And while
we’re at it, when did every politician become an economist and with
conviction to boot? Rather than relying on the best economic minds in
the country with a nonpartisan study and recommendations, lawmak-
ers have their own opinions, thank you very much, along with what
they think are all the answers to cure the current economic malaise.
The solution, however, is not more money; it’s less debt.
Regardless of what one’s opinion might be about the actions of the

central banks and the governments during the financial crisis and the
ensuing recession (the pros and cons of which we can debate forever), all
sides must agree on one thing: the result was to buy time. Some will say
the Fed and central bankers around the world merely “kicked the can
down the road” and that the day of reckoning will come, sooner or later.
Yet buying time is not a bad outcome given where we were and where
we are now, three years later. Yes, there were a lot of foreclosures and
job losses. Buying time, however, essentially allowed people to regroup
and repair. Of the three key sectors—public, private, and corporate—
the best use of that time was made by corporations. Corporate America
reduced payrolls, cut expenses, and shored up its balance sheets. Now,
corporations, in general, are sitting on a good deal of cash. Thus, I have
few worries about the financial health of U.S. corporations. Unlike the
shaky days of 2008, I don’t foresee another wave of large companies get-
ting into trouble and possibly going out of business.

Public debt in the U.S. also is not a major concern for me. Of course,
I am cognizant of what has happened in Europe, with the threat of
default on sovereign debt leaving governments between the rock of
austerity and the hard place of tax increases. Some local debt in the U.S.
is also problematic. However, I do not see widespread problems where
governmental debt in the U.S. is concerned. The U.S. is not Europe—
not even close—on so many levels, including a bigger base of earners.
Although some concerns are being voiced out there about U.S. debt as a
percentage of GDP, I am not ready to sound the alarm. If we do get into
dangerous territory, we will have plenty of time to avert a crisis.
The real problem, as the charts below will illustrate, is the private sec-
tor. Consumers ruined their personal balance sheets by essentially con-
suming ten years’ worth of stuff in five years. Consumer household debt
levels, which reached a peak of 130 percent in the third quarter of 2007,
have eased somewhat to 114 percent of after-tax income as of the first
quarter of 2011, but remain elevated. Housing has yet to recover, and 30
percent of U.S. homeowners owe more than their houses are worth, to
the tune of about 15 million borrowers and almost one trillion dollars
in mortgage debt. With consumer spending accounting for nearly 70
percent of GDP, this alone should make 2012 challenging. Now, as con-
sumers deleverage, the necessary reduction in spending will be another
drag on the economy, which is already on thin ice.
What’s the Problem? My Financial Picture,

That’s What!
The last decade has been challenging from an investment standpoint
as investors have experienced two separate recessions, first in 2002
and then in 2008, each accompanied by a peak-to-valley drawdown in
stocks of more than 50 percent. The last recession was accompanied by
an even more destructive economic force for consumers as home prices,
according to the Case‑Shiller Index, fell more than 30 percent from
their peak in 2006. This combination has made the recession of 2008
the worst economic downturn since the Great Depression, followed by a
difficult recovery. Yet, even with all these challenges, prudent and con-
sistent consumers had the opportunity to weather the storm and create
some value for themselves. While not spared the losses and effects of
this past recession, those who had stayed the course may have a far bet-
Chapter Two 21
ter investment portfolio and total wealth picture than they otherwise
would have had, as illustrated in Figure 2.1.
FIGURE 2.1 Total Wealth Chart
Assumptions for Figure 2.1

- $87,000 yearly income, grows annually in line with Consumer Price Index
- $200,000 home purchase value
- $160,000 mortgage
- $10,000 initial investment portfolio
- 2.5% savings/investment rate
- Investment portfolio split 70/30 between S&P 500 and Barclays Aggregate
Bond Index
Given the turmoil of the past six years, being prudent paid off for those
who stuck to a simple plan of no additional debt beyond a reasonable
mortgage (i.e., living within one’s means) and consistently contributing
to investment accounts for long-term goals. While home values have
fallen, which has reduced home equity, maintaining a consistent invest-
ment plan has resulted in a portfolio that is significantly higher, thanks
to regular contributions and investing at lower market levels. Although
this scenario is not ideal, and not having higher total wealth over a
seven-year period is not the typical investor plan, it is livable—particu-
larly when you consider the alternative.

Unfortunately, the overwhelming majority of us do not fit the profile
of being consistently prudent. Living “in the moment,” as opposed to
thinking longer term, affects decision making, as we all know. Thus,
in addition to declining home prices and a volatile stock market, many
consumers are feeling the effects of having increased their debt levels
over this period. Consumer debt-to-income ratios, while declining
from 2006 levels, still stand above 100 percent, which is considered very
high from a historical standpoint, as illustrated in Figure 2.2.
As illustrated, the trouble stemmed from consumers taking out loans

against their home equity, which either went back into improvement
projects or that were spent elsewhere, all of which negatively impacted
total wealth levels. Many people also reduced or stopped contributing
to long-term investment portfolios or changed investment amounts
and patterns, reduced exposure at unfavorable levels, and didn’t make
up their portfolio losses when the market rebounded (negative com-
pounding), or all of the above. The bottom line from this comparison is
clear: being prudent and consistent would have better served consumers
through this period.
What’s clear from this study is that the culprit for the loss of wealth
during the past decade has not been the stock market or even the hous-
FIGURE 2.2 Debt to Income
Chapter Two 23
ing market. The real problem is debt. Over the past decade, consumers
mismanaged their personal balance sheets, investing inappropriately,
taking on too much or too little risk, and borrowing from appreciating
assets to buy depreciating ones. In effect, they created an appreciating
liability on a depreciating asset.
In addition, for consumers in debt, it’s not just a matter of tightening

belts and cutting back expenses. The bitter pill of deleveraging carries
little satisfaction. Buying a shiny new car or taking the entire family on
a vacation carries with it a feel-good afterglow. But pay off a mortgage
and what do you have to show for your money? You already have the
“thing” that you spent the money on (car, boat, house, etc.). All you have
now is the pain without a commensurate gain—except for an incremen-
tally healthier balance sheet. After the spree, now it’s time to pay the
proverbial piper, and it’s not going to be cheap—or easy.
The Money “V”

In the aftermath of the financial crisis, much has been made about the
role of money in economic forecasting. During the early phases of the
economic recovery, increases in the Fed balance sheet were thought to
be inflationary, which sent investors rushing out to buy hard assets such
as gold. Then it was thought that the U.S. dollar would lose its promi-
nence, and investors fled the greenback. Neither of these trades has
been particularly promising. Nonetheless, there are those who forecast
the economy and outlook for many assets by looking at the velocity, or
“V”, of money. The velocity of money (no matter which matrix you use)
tells much of the story. It tells why inflation is low and likely to remain
low, perhaps even slipping to a deflationary environment temporarily.
In addition, it tells why growth is below trend and likely to remain so,
and why equity market appreciation will remain subpar as well. Once
the velocity of money expands, a sustainable expansion will follow.
When and why is a guess; it just doesn’t appear to be in 2012.
Currently, the V of money (as illustrated in Figures 2.3, 2.4, and 2.5)
is near historical lows—meaning money is not circulating very much
through the economy. In the good ol’ days, a dollar went through the
economy far more frequently than now. You earned a dollar, you bought
a skateboard, the guy who made and sold skateboards paid his rent, the

FIGURES 2.3, 2.4, 2.5
Money supply and money velocity charts show decline in the aftermath of the
financial crisis and recession.
Chapter Two 25
landlord bought a new snow blower, the hardware store purchased more
inventory, and so forth as money went through a growing economy.
More recently, however, money has not been circulating through the
system. The reason is simple: more dollars are being used to pay off debt
rather than to fuel new purchases. Dollars that are used to deleverage
are considered “retired.” Typically that would give banks more incen-
tive to initiate additional new loans. Instead, as deleveraging continues,
money is not being created at the same rate as it has historically. This,
to me, is a sign that economic growth will be subpar.
Stock Market–It’s About Valuations

At this point, let’s turn our attention to the stock market and what we
might see in 2012 from an investment perspective. As the New Year
begins, it is clear that companies with strong fundamentals and balance
sheets should weather the storm relatively well even as the economy
rolls over from modest expansion to contraction. In other words, this
is not 2008 all over again. It could get bumpy for equities in early 2012,
but the range of the past two years should hold up, at least on a monthly
closing basis. I expect that statement to hold true for upside as well as
downside projections. There is the risk that we could see a stock market
decline, but given the foreseeable circumstances, a 50 percent correc-
tion is highly unlikely.
If we do see some economic growth and/or market appreciation, we

believe it will be in the latter part of the year after election uncertainty
is removed, regardless of which party wins. Further, Fed policies and
investor behavior may start to pay some dividends by then—particu-
larly if the money locked in the banking system begins to expand as
the money multiplier or velocity reverts back to historical levels. This
will happen at some point and the global economy awash with frozen
liquidity will usher in a period of significant growth. It will most likely
surprise on the upside, so investors need to make sure they are not
chewed up by current adverse market behavior.
To that end, what is worth watching is a shift in the typical pattern

we’ve seen thus far. Equities have rallied on every shred of good news,
while bonds have gone lower. Conversely, negative news has hit equities
and boosted bonds, following the traditional risk on/risk off pattern.

If, at some point, bonds go lower for reasons other than “risk on” and
equities follow suit, I would suggest that this is a warning shot that
needs to be heeded. It could very well signal that there is perceived risk
in U.S. Treasuries, while a slowing economy is hampering stocks. I’m
not talking about the Dow being down 50 points and bonds being off a
quarter-point. The magnitude I’m referring to is a 300-plus point drop
in the Dow in one day and bonds falling by a point. A simultaneous
decline in stocks and bonds will be the warning sign that the next leg
of the contraction or bear market is upon us, and that the slowdown in
the economy is about to get more severe.
We are also about to enter into a climatic shift with regard to valua-
tions. Currently, the S&P 500 tends to trade somewhere between 12 and
20 times earnings. There are opinions out there that by the time the
recession or contraction is finally over, the multiple will be in the single
digits. This reasoning is not obvious, given the fact that corporations
have lots of cash and they are earning plenty of money. Therefore, the
idea that stock prices will likely go down when companies are earning
money seems contradictory. The answer, however, lies in the fact that
the value of stocks is a multiple of cash flow, a concept I always thought
was arbitrary to begin with. Why would a company be valued at $1 bil-
lion when it makes $100 million? I have never been able to rationalize
that relationship, and I’ve built a business that doesn’t need to know
those elements of valuation. Instead, I choose to focus on the direction
of the economy, which is much more logical and meaningful. When
the economy is expanding, stocks tend to appreciate regardless of their
multiples. Conversely, when the economy is contracting, stocks tend to
decline, even if they are already at lower multiples.
It appears now that the average multiple (stock price to

earnings) should be adjusted downward at least temporarily and per-
haps permanently, due to the reckless use of leverage over the last
several decades. Therefore, our outlook is for multiple compressions.
Stocks could hit their earnings targets, but still be worth less—but not
worthless, by any means.
Chapter Two 27
Fixed Income, Interest Rates, and Inflation
Traditionally, there has been a relationship between fixed income yields
and economic growth. Recently, that relationship has not been normal
due to the aggressive actions taken by the Fed to address the recession
and the need to stabilize the economy. Looking ahead, it is likely that
this relationship will “normalize,” thereby sending short-term rates
slightly higher.
To explain, there is a relationship between economic growth and inter-

est rates, with the two-year interest rate, on average, tending to equal
four quarters’ average GDP growth. When an interest rate slips to
negative, one would typically assume that GDP is also going to drop
into negative territory. Currently, with a slight tick up in inflation, real
yields are negative (nominal rate minus inflation equals the real yield).
However, even with my somewhat pessimistic view, I do not foresee
economic growth slipping to levels that equal the real rate.
The reason is that the relationship between fixed income yields and the
economy is not following normal patterns. While real rates have slipped
into negative territory, we think that indicates the economy is going to
slow down, but not to the point of going to a negative rate. Therefore,
for the relationship to normalize, rates need to be higher.
Meanwhile, although inflation did pick up in 2011, without widespread

employment gains and wage increases it would be difficult to support
sustained higher levels of inflation that would further make the real
yield lower as well. Thus, while I expect yields to normalize (read: be
slightly higher) even in the face of a weakening economy, I don’t expect
inflation to get out of hand.
Interestingly, the Fed recently announced that it is going to provide

clearer forecasts of where its rate policies are headed. As the Fed
becomes much more transparent to the point of telegraphing where
rates are going, I would listen more closely to those pronouncements.
This has been a significant change in Fed behavior and the days of try-
ing to discern the meaning of tersely worded statements. (Next thing
you know, the Fed governors will be on “The View” and making the
rounds to Letterman and Leno, as well.) Bottom line: when the Fed
speaks, listen.

The Dollar, Commodities, and Energy
The U.S. dollar ended 2011 slightly higher from where it began.
Although that may not look monumental, consider that the widespread
view last year was for the dollar to fall on hard times. A year ago, we
said we expected the “underdog” dollar to continue to surprise on the
upside—and it did. As we look at 2012, we are more bullish than bearish
on the dollar, and do not expect the greenback to lose its status as the
preferred currency any time soon, with the objective of it being more
stable in the years ahead.
As for commodities, they gained a lot of attention over the past few
years. From corn to copper, commodities captured everyone’s eye. Now
they are on the back burner again, garnering much less attention. What
happens in energy, meanwhile, will be a function of global growth.
The solution for higher energy prices is, simply, higher energy prices.
When prices go higher, alternative supplies become more viable, which
increases supply. And, higher prices cut consumption, which decreases
demand. Higher supply and lower demand equal lower prices. With
the forecast for subpar growth, energy may trend higher, but I am not
overly concerned.
Real Estate and Housing

A big question mark hung over the housing market in 2011, although
there were certainly opportunities for private investors and those who
wished to buy real estate stocks. Our advice a year ago was to be certain
of what you’re buying before you make a move (which is good advice
for anything these days). In the residential market, a supply overhang
remains problematic, although things have been improving slowly.
We are not out of the woods yet with housing; we are still in the process
of putting in the trough. The good news, as we said last year, is that we
do not need housing to turn around for the economy to be okay. For
the economy to have a sustained, vibrant growth trajectory, yes, hous-
ing needs to strengthen. But the current level of housing, both prices
and transactions, can support a flat economy. Therefore, the housing
market as it now stands won’t be a problem. Over time, economics
will likely be the solution to the housing market as the population
Chapter Two 29
transitions from buying to renting. Then, at some point, the trend will
reverse, and the economic viability of buying versus renting will help
support housing prices.
Conclusion: The Year of Zero

It appears 2012 is setting up to be what I call an inside year; by that
I mean the close of the year will be somewhere in the range of 2011.
While we might breach the extremes of 2011 temporarily, it doesn’t
appear that any good news can sustain the upside, while even the head-
winds from high debt levels, weak demand, and global political drama
won’t be able to hold the valuations much lower than the 2011 lows.
The U.S. economy and the global economy were seriously damaged by
the 2008 financial crisis. The crisis itself was the result of behaviors
that over many years created a fragile economy that could not sustain
itself without serious adjustments. Although this is not the forum for
me to get on my soapbox about all the political, social, and economic
changes that need to be made, suffice it to say that adjustments are
needed. While these transitions are underway, the outlook for 2012
appears benign.
Specifically for the year, debt levels must be lower in both the private
and public sector. This will cause GDP to slow and job growth to mod-
erate. Earnings are still likely to grow, albeit at lower than last year’s
pace; however, multiples will contract, offsetting earnings growth.
Thus, 2012 is the year of the zero.
Over the last few decades we’ve seen increased volatility, including
in the housing market. Extreme gyrations (which create the left and
right tails on the normal distribution of price action over time) are not
typical. Therefore, one of the objectives of the Fed policies, it appears,
has been to take the tails out of it (meaning the extreme moves up and
down), which given the flat year of 2011, shows this thinking in action.
I would expect volatility to narrow so that investors have a much more

definable space for their investments (in other words, don’t expect to
make or lose 50 percent in any given market). Yes, stocks and bonds will
move and might move against you at times. But you won’t have to worry
about having your head handed to you. It’s also apparent that the Fed

has been concerned about a fixed-income bubble; thus some of its poli-
cies are aimed at shifting investors slowly away from those instruments.
This underscores our belief that 2012 will be the year of zero as the Fed
policies reduce risk. When risk is reduced, so is return.
Although 2012 as the year of the zero may sound boring or even disap-
pointing, we can’t deny that under the circumstances and compared
to where many people thought we would be three years ago this is not
so bad. Up five percent or down five percent is meaningless, not much
more than a rounding error compared to the cliff we were hanging
over just a few years ago. The good news is we didn’t fall. The initial
rebound was obvious; a dead cat bounces after all. The next leg up was
impressive as growth was weak and challenges abound globally. Staying
solvent and within a five percent point range on both sides of zero tells a
much bigger story than many have been hearing. We survived! Looking
at the data for 2012, I still see challenges ahead and market dislocations,
but we have a market and economy that still function. That is good
news, indeed. Everything else is actually moot.
Chapter Two 31
Chapter 3
RISK, REWARD, AND
TRUE DIVERSIFICATION
WITH ETFS
True diversification with active management focuses on the overall mar-

ket and the economy rather than individual stocks and bonds.
I
f you said the word “diversification” to most retail investors, what
would their response be? Most likely they would say that diver-
sification is achieved by holding a certain percentage of assets in
stocks and a certain percentage in fixed income. Or, they might take
it a step further and suggest that to diversify within an asset class,
such as stocks, you need to hold a variety of equities: large cap, mid
cap, small cap, growth, value, etc. Although these beliefs are widely
held among retail investors, they are not examples of true diversifica-
tion. To use a simple analogy, it’s like filling up a dish with a scoop
of vanilla, another of chocolate, a third of strawberry, and a fourth of
pistachio, and maybe a few scoops of rocky road and mint-chocolate
chip. It may look and taste different, but it’s still ice cream, and you
haven’t achieved a balanced diet just by mixing the colors and a few
flavors on your plate. And if you leave it out too long, it will all melt
into an indistinguishable mess.
Similarly, as investment professionals and savvy investors know all too

well, holding different kinds of stock will not provide true diversifica-
tion, particularly in market downturns. In a bear market, some stocks
will be quicker to fall than others. For example, the small cap growth
33
stocks may get hit first, while the more conservative large cap value
issues hold up a little better. But in time, most equities will go down.
The only variation is the degree to which they decline. So, if one type
of stock goes down 10 percent, another stock declines 25 percent, and
yet another drops 50 percent, is that diversification within equities? I
don’t think so.
Active management is a highly effective way to achieve true diversifica-

tion within equities, or any other asset class for that matter. With an
active management approach to equities, investors can buy (go long)
when economic indicators point to an expansion and the stock market
is rising. Conversely, investors can sell to exit long positions in equities
(or even go short) when economic indicators point to a contraction and
the stock market is falling.
Economics-Based Active Management

ECONOMIC EXPANSION: Favors buying equities (long).
ECONOMIC CONTRACTION: Favors selling equities (taking

profits or establishing short position), increasing cash and
fixed income.
LONG OR SHORT: Broad market exposure through exchange-

traded funds (ETFs) that replicate major indices such as S&P
500 and Nasdaq 100.
Understanding Active Management

True diversification is achieved through a long/short active manage-
ment strategy. Active management means taking a proactive approach
to investing by utilizing fundamental and/or technical analysis to create
value in a portfolio beyond buy-and-hold. In fact, active management is
the antithesis of buy-and-hold investing.
As stated previously, the economy has cycles (expansion, peak, con-

traction, and trough) just like a year has its seasons. Throughout the
economic cycles, the market goes up and goes down. The key is to

address these cycles and add value to a portfolio by providing strate-
gies that work in all market conditions. Given recent events in the mar-
ket, more investors than ever are looking for ways to mitigate losses in
adverse market conditions and even to create profitable opportunities
in bear markets.
At Astor, we have developed strategies that position client portfolios to

profit in both up and down markets, through all the aforementioned
cycles. Our programs work to diversify portfolios so that the draw-
downs that investors typically experience during down markets are not
as deep, while still helping accounts to grow during up markets.
For investors who want to achieve true diversification through bullish

and bearish cycles in the market, active management is the key. And
the instruments that can best help you to accomplish that are exchange-
traded funds (ETFs).
The Investment Process Using ETFs

When investors want to gain exposure to the stock market, often
they choose a mutual fund or a stock that they like. Any number of
criteria can trigger their decisions, from advertisements to something
they heard from someone else. I would argue that the best way to gain
exposure to the stock market is through a product called the exchange-
traded fund, or ETF. An ETF is a collection of securities that tracks, or
is intended to represent, the performance of either a broad or specific
segment of the market. For example, if you wanted exposure to the S&P
500, you could choose the SPDR S&P 500 ETF, nicknamed the “spider,”
which trades under the symbol SPY. For something more specialized
such as biotechnology, you could choose a more narrowly focused ETF,
such as the SPDR S&P Biotech (XBI) or PowerShares Dynamic Biotech
and Genome Portfolio (PBE). With ETFs, you can make an investment
in a broad index or a sector simply by buying shares, such as you would
in your favorite company.
Astor constructs portfolios using ETFs. These instruments are a pure

play on a specific index or sector. The transparency and low expenses of
ETFs make them ideal investment choices for Astor’s macroeconomic
approach. Further, there is a vast range of ETFs available, covering
multiple asset classes, sectors, and investment styles beyond the broad
Chapter Three 35
indexes such as the S&P 500, Nasdaq 100, and Dow Jones Industrial
Average. Using ETFs, portfolios can be constructed that offer true
diversification across various asset classes and in all types of market
conditions.
The ETF Advantage

LOW COST: ETFs typically have low management fees and
expense ratios because they require less active manage-
ment than mutual funds. Most ETFs are designed to track a
benchmark, which can mean fewer trades and lower portfolio
turnover.
TAX EFFICIENCY: Since ETFs are passively managed, they

usually realize fewer capital gains than actively managed funds.
This reduces the frequency of tax gain distributions.
TRANSPARENT: ETFs provide investors with the required

information to make informed investment decisions. Investors
have access to all securities held within an ETF on a daily basis.
ALL-DAY ACCESS: ETFs trade throughout the day, enabling

investors to lock in the market value of an ETF at any time dur-
ing the trading day. Investors can enter or exit a position when
they want, not just the end of the day, as with mutual funds.
VAST EXPOSURE: ETFs provide exposure to asset classes

which, until recently, were off-limits to the average investor.
Avoiding Catastrophe
At one time it was unfathomable: a well-established company that sud-
denly was trading for only a few dollars per share—or less. Consider
Ford Motor Company that dropped below $2.00 per share in 2009, after
trading around $30 in 2001. Or consider Bear Stearns, which in 2007
was trading above $150 a share and was sold in 2008 for $10 a share after
the firm nearly failed. When Lehman Brothers went bankrupt in the

fall of 2008, shareholders were wiped out. As these examples show, the
risk of being in the wrong stock at the wrong time is huge. With ETFs,
however, the risk of going to zero is nil. Yes, an ETF can see a downward
move of 20 percent or more, but the chance of going to zero is remote,
if not mathematically impossible. The reason is that ETFs are made up
of dozens, and sometimes even hundreds, of stocks. Therefore, even
if you have a few big losers in the index, the ETF will not go to zero.
During the financial crisis, for example, the Financial Select Sector
SPDR (XLF) was down 30 percent or so at one point, but was still a far
better investment than the likes of Lehman Brothers or Bear Stearns.
Granted, having an ETF lose a third of its value is painful, but it’s not a
complete washout.
There are numerous ETFs, from those that track metals and other com-
modities to others that offer exposure to emerging markets or fixed
income. There are even inverse ETFs that allow you to replicate a short
position in a particular index. Buying inverse instruments, which go
up in value when the underlying index goes down, allows you to hedge
your portfolio. An investor could even construct a no-risk portfolio of
longs and shorts using ETFs, with the security of knowing that posi-
tions could be liquidated at any time.
Praise for the ETF

I am on record as saying that the ETF is the greatest financial inno-
vation since the creation of the put! To understand why I feel so
strongly about these instruments, allow me to explain. Back in the
early days of options, there were only calls, which gave the buyer the
right, but not the obligation, to take a long position in the underly-
ing security. Calls worked great if you thought the market was going
up, but if you wanted a short position you were basically out of luck.
Writing calls (meaning to sell them) would have given you short
exposure, but with far too much risk exposure. With the creation of
the put, it became possible to establish a short position by buying an
option. When you buy a put, you have the opportunity, but not the
obligation, to be short the market, and the only thing you stand to
lose is the premium you paid.
ETFs, in my opinion, give investors the same flexibility: establishing

long and short positions easily by buying an instrument—and with-
Chapter Three 37
out the complexity of shorting a stock. In addition, specialized ETFs
allow investors to be long or short a particular sector or industry.
For Astor, using ETFs to construct our portfolios allows us to put our
economic strategy into action. As explained in Chapter 1, during an
economic expansion phase, the objective is to be long the broad market,
such as the S&P or the Dow, which can be easily accomplished using
ETFs. In addition, we may want to use specialized ETFs to gain expo-
sure to a particular sector that is doing well and outpacing the growth
of the overall economy. Whatever my investment hypothesis, there are
ETFs that allow me to put my ideas into action.
As I have stated, I do not believe stock picking is an efficient way to
invest, particularly for the average individual. The expertise I have
developed and honed over the years is analyzing the economy to
identify the current economic phase (expansion, peak, contraction, or
trough) and then to invest accordingly. I prefer a long-term horizon and
making investment decisions based on particular economic fundamen-
tals. Plus, taking a sector approach avoids the risk of being invested in
the wrong stock. Even if you correctly identify the market trend and
pick a strong sector, you could still choose the wrong stock, whether
it’s one that lags because of a poor performing business unit or other
fundamental problems. With an ETF, you gain sector exposure across
multiple stocks. Using ETFs to invest, however, does mean that you
won’t get the sky-high returns of the rare stock whose gains outpace all
other issues in a sector. But unless you are a professional stock analyst,
your chance of accomplishing that is akin to finding a diamond on the
beach. A far more prudent strategy is to use ETFs to gain exposure to
the broad market and specific sectors.
Whether the overall trend is bullish or bearish, it is important to dis-
tinguish between the broad market and individual sectors. Even during
2008, when the stock market’s performance was absolutely dismal,
there were a few bright spots; among them, transportation. The lesson
here is to look beyond your normal benchmarks such as the Dow when
you are building a portfolio. Even if the entire market is down that does
not mean there will not be sectors that are performing well, or that
when the market rallies some sectors will outperform the rest.
Investing with ETFs allows you to think like an economist, instead of
trying to be a stock picker. Your investment decisions are based on what

you see happening in the economy and in particular sectors. This is a
good approach no matter which way the wind blows in the future.
Active Management Scenarios

Now, let’s review a few scenarios in which active management plays a
part. At Astor, our goal is to use true diversification to achieve less volatile
long-term capital appreciation and lower drawdowns, thereby attempting
to generate a more stable risk/return curve than our benchmark.
First, I want to emphasize that it is not the role of the asset manager,
the professional who is actively managing a portfolio, to determine an
individual’s risk tolerance and market exposure. That decision is best
made by the client, with input from his or her investment advisor, based
on factors such as the investor’s age, investment time horizon, earnings
power, overall holdings, and risk tolerance. For example, if a client has
no appetite for risk, as evidenced by a large percentage of holdings in
fixed-income assets, this individual is not a good candidate for active
management. If equities were a small percentage of the person’s overall
portfolio, then the active management portion of those holdings would
be similarly confined to a small percentage.
If someone has moderate risk tolerance, with roughly half of his or

her portfolio in equities and half in fixed income, then at least half of
the person’s equity assets (or 25 percent of the overall portfolio) would
be invested in an active management program. This approach signifi-
cantly reduces the risk of the long-only equity approach of the portfolio
during market downturns. Moreover, this approach also increases the
potential return over time.
To illustrate this point, consider this scenario: An investor holds 100

percent of her portfolio in equities. If the market declines by 10 percent
over time, the equity holdings would also be down about 10 percent,
plus or minus a few percentage points, depending upon the perfor-
mance of the individual stocks in her portfolio. However, if half of the
portfolio were invested using an active management approach, then
sometime during the market’s decline, the investor would have at least
exited the market. Or, if her risk tolerance allowed it, she would be
short the market with half of her overall equity holdings. Thus, during
the downturn, her losses would be at least cut in half compared to what
Chapter Three 39
they would be if she continued to hold her entire equity portfolio. With
a short position, she could reap profits during a downturn that would
offset losses on her equities, possibly to the extent that she broke even
or made a small profit. In the worst-case scenario, she would have a
smaller drawdown than with a full equity exposure and in the best case
she would realize a modest profit.
Now, when the market turns and begins to recover, the investor can
fully invest in equities again. But instead of having to make up for a 10
percent decline in her entire portfolio, she is starting off with a small
loss, a breakeven position, or a small profit. When the expanding mar-
ket increases the value of the stocks in her portfolio, the investor reaps a
larger return over time—and, more important, with reduced risk.
Model Portfolios
With this understanding, let’s take a look at some hypothetical inves-
tor scenarios, and how active management could be used to reduce risk
and enhance returns. In each instance, the risk tolerance determination
from a portfolio management perspective is based on the percentage of
equities held in an individual investor’s portfolio.
Jonathan, a 36-year-old professional, is an aggressive investor whose

portfolio is 90 percent invested in equities with ten percent held in
lower risk fixed income. Given his equity exposure and risk tolerance,
Jonathan hopes to make large gains during a bull market. During mar-
ket downturns, however, Jonathan stands potentially to lose a signifi-
cant portion of his portfolio value. This is the underlying problem with
equity portfolios. The inevitable downturns in the stock market often
occur when an equity-based portfolio is at the peak of its worth.
For Jonathan, the investment recommendation would be for about half

of his equity holdings to be actively managed. Specifically, I would
recommend about half of his equity holdings to be managed with a
long/short strategy. The essence of the long/short strategy is to be long
equities when the economic indicators confirm an expansion, and to
be short equities during a contraction. Let’s take a look at Jonathan’s
portfolio during each stage of the economic or business cycle:

Expansion Mode: Jonathan
During economic expansion—as evidenced by GDP growth, relatively
low unemployment, and an appreciating stock market—Jonathan will
be heavily invested in equities. In keeping with his risk tolerance and
investment temperament, during an expansion Jonathan’s holdings will
be 90 percent equities, but in a very specific mix:
Jonathan’s Model Portfolio: Expansion
Total Equity Holdings Total Fixed-Income and Cash Equivalents

90% 10%
45% - Individual Stocks
45% - Active Management Equity (Indices) Holdings
To reap the benefits of broad exposure to the stock market during an

economic expansion, 45 percent of his equity holdings will be actively
managed using ETFs that replicate exposure to stock indices; specifi-
cally, the S&P 500 and Nasdaq 100.
Although Jonathan is an aggressive investor with 90 percent of his

overall holdings in equities, we would not recommend more than 50 to
60 percent of those holdings being actively managed. The prime con-
sideration is to use active management as a strategy to meaningfully
diversify a portfolio, not to dominate or overwhelm it. Through active
management, his equity holdings can be enhanced, while offering profit
protection and opportunities to reap further gains during market con-
tractions.
For an aggressive investor such as Jonathan, another component of

active management may also be included. A portion of his actively
managed investment will be deployed in a momentum and trend-
following system. This active entry/exit strategy would allow Jonathan
to benefit from opportunities—both short and long—that arise during
the prevailing trend.
The objective of the active entry/exit strategy is to buy and sell, depend-
ing upon momentum and trend indicators, to take advantage of rela-
tively short-term market moves. Several indicators can be used as part
of the active entry/exit strategy. By capturing these moves, which occur
Chapter Three 41
frequently within a longer-term trend, returns can be further enhanced
and risk can be reduced.
The most important consideration is to be disciplined in this approach,

and to use only a portion of the actively managed assets. That way, even
if a short-term directional move is missed, the majority of the assets
that are actively managed remain invested according to the longer-term
economic trend.
To illustrate how the positioning of Jonathan’s portfolio would work,

let’s assume that now the economy starts to deteriorate. Long positions
in the actively managed portion of his equity portfolio would be exited.
If the market were down 50+ percent, active management could limit
Jonathan's loss; for example, to 10 to 15 percent. When the market
rebounds and Jonathan re-enters his stock positions, it will take far less
of an up move to get him back to flat; for example, a 7.5 percent stock
market rise would erase about a 13 to 15 percent portfolio decline.
In contrast, a buy-and-hold investor would have been down significant-

ly more at the bottom of the market’s decline, and even after a partial
rebound would still be down considerably. Not only does Jonathan end
up with a better performance, compared with a loss for the buy-and-
hold investor, but he also does so with fewer of what I call “ulcer points.”
In other words, by actively managing his portfolio, he can reduce his
risk in adverse market conditions easily and efficiently, while reaping
the rewards of following the market trends, as defined by economic
data. Similar results can also be achieved by actively managing assets
in other markets as well, including fixed income, from both a short and
long perspective.
Contraction Mode: Jonathan

During an economic contraction—as evidenced by a decline in the GDP
rate, increasing unemployment, and a decline in the stock market—
active management would seek to protect Jonathan’s gains that were
reaped during the expansion phase. Beyond taking profits and selling
a portion of his equity holdings, active management would also seek to
profit through short positions during the contraction. This is achieved
by establishing outright short positions replicated using inverse ETFs.

Outside of the actively managed portion of the portfolio, Jonathan
and his investment advisor could also decide to sell some individual
stocks and increase his fixed-income and cash-equivalent holdings. For
the sake of this illustration, we will assume that Jonathan decides to
reduce his individual stock holdings and increase his fixed income/cash
equivalents as shown. His actively managed portion, however, remains
approximately 45 percent of his previous overall equity holdings.
Jonathan’s Model Portfolio: Contraction
Total Equity Holdings Total Fixed Income and Cash Equivalents

90% (before adjustment) 10%
25% - Individual Stocks 30%
45% - Active Management Equity Holdings
The actively managed portion of his equity holdings would utilize

inverse ETFs to establish a short position in the indices. (Remember, the
value of an inverse ETF increases when the underlying index declines.)
The objective of active management during the contraction is two-fold.
First, it lessens Jonathan’s long equity exposure during the unfavorable
market conditions associated with a contraction. Second, it seeks to
reap profits from the falling market, which could at least offset losses
Jonathan incurs elsewhere in his portfolio. Potentially, if his short posi-
tion is sizeable enough and the market decline is significant, Jonathan
could make a net profit on his overall holdings.
In addition, the active entry/exit strategy would be utilized to capitalize

on short-term momentum and trend opportunities. Again, this would
involve about 20 percent of Jonathan’s actively managed holdings. The
objective would be to look for opportunities to buy the market to take
advantage of short-term, upward countertrend moves that occur during
contractions and to sell when the move is over.
Throughout the management of Jonathan’s holdings, the strategies

deployed match his investment objectives, time frame, and risk toler-
ance. This is far better than determining an individual’s holdings based
upon age alone, which assumes that every 30-year-old, 50-year-old, or
70-year-old has the same risk tolerance and time frame. There could
be risk-averse 30-year-olds for whom active management should be
deployed conservatively, if at all. Or, there could be highly risk tolerant
Chapter Three 43
70-year-olds for whom active management would be an ideal strategy.
Once again, it is the role of the investment advisor, who knows the cli-
ents best, to advise them.
Expansion Mode: Monica

Monica is a 59-year-old widow with two grown children. A moderate-
risk investor, she has roughly half of her holdings in equities and half
in fixed income or cash equivalents. Her investment objective is to pre-
serve capital while also growing her portfolio steadily over time. Active
management within her equity holdings will help further these goals.
During economic expansion, Monica’s overall holdings will reflect her

50/50 split. However, the equity portion will be divided between individ-
ual stocks and active management holdings, using a long/short strategy.
Monica’s Model Portfolio: Expansion

50% 50%
As in the previous example, the actively managed portion will uti-

lize ETFs to replicate long exposure to the S&P 500 and Nasdaq 100.
Although Monica is a moderate-risk investor, we would not recom-
mend less than 50 percent of her equity holdings be deployed using
active management, representing 25 percent of her overall portfolio. If
a smaller percentage were committed to active management, the overall
diversification effect would be greatly diluted.
Using the long/short strategy, Monica would have long exposure to the
major indices when the economic data indicated that expansion was
continuing. Because of her overall moderate risk tolerance and her need
for capital preservation, the more aggressive, active entry/exit strategy
would not be deployed.
Contraction Mode: Monica

During economic contraction, Monica’s equity position could remain
at 50 percent of her portfolio or at a slightly smaller percentage if she

and her investment advisor decide to sell some individual stocks in her
portfolio. Nonetheless, 25 percent of her portfolio would continue to
be actively managed. In this scenario, a slight adjustment to her equity
holdings is assumed.
Monica’s Model Portfolio: Contraction

45% 55%
In keeping with the long/short strategy deployed for her actively man-
aged holdings, short positions would be established using ETFs as soon
as an economic contraction was detected and confirmed. Throughout
the economic contraction, this portion of her portfolio would remain
short to capitalize on the overall downtrend. The goal would be to offset
losses incurred from her other equity holdings, thus preserving capital
and providing a better foundation for the future when the economy
turned and expansion resumed.
Although active management can be deployed to reduce risk and poten-

tially improve returns, it is not for every investor. For example, Donald
and Sylvia are in their mid-50s. Their portfolio is held mostly in 401(k)
and other retirement holdings. They are conservative investors with
about 70 percent of their holdings in fixed income and cash equivalents
and 30 percent in equities, mostly mutual funds. Given their low risk
tolerance, active management would not be an appropriate strategy for
them. In fact, an investment professional who knows this couple and
their risk tolerance would not even present active management to them.
As these model portfolios illustrate, true asset diversification can maxi-

mize returns and minimize overall risk, by taking advantage of oppor-
tunities presented in rising and falling markets. Most important, the
strategies must be tailored to the individual’s investment objectives and
risk tolerance. In fact, that is the beauty of active management. When
the optimal portion of a portfolio is committed to an active manage-
ment strategy, an investor can protect against adverse market moves
without putting too much of his or her holdings at risk. Active manage-
ment is a powerful strategy that belongs in many investors’ portfolios.
Chapter Three 45
The key is for investors to work with their advisors to determine the
right portfolio mix to match their risk profile, while pursuing their
objectives for growth and capital preservation.

Chapter 4
ACTIVE MANAGEMENT
A VALUE PROPOSITION
Getting the economic direction correct is not only a good predictor for
market performance over months or years, but it also makes it much
easier to predict the outcome from surprise events.
O
ver the long-term, the average annual return from owning
stocks historically has been just under 10 percent. (According
to Jeremy Siegel, author of Stocks for the Long Run, between
1886 and 2001, historic returns averaged about 9.76 percent per year.)
That is not a bad annual return if you can realize it, but most funds
underperform their benchmark indexes on a regular basis. Moreover,
even if you were able to achieve an average annual return of 9.76 per-
cent, buy-and-hold has an inherent problem as a stand-alone strategy.
On your way to achieving that target return, you could see your capital
decline by 30 to 60 percent at times—and typically when you have the
largest exposure to the markets. Further, as fate would have it, your
portfolio could very well decline when you need your money most.
We are, by nature, emotional beings, and sitting through these stom-

ach-churning market episodes is very difficult to do. In fact, most
investors end up selling near the bottom and do not get back in until
the market is well past the previous exit point on the way back up. With
that action alone, you miss a significant portion of the market’s return
and need to work even harder to get it back. In other words, you have
to sit through a 30 to 60 percent pullback only to achieve a long-term
average return of less than 10 percent (if you did, indeed, sit through it).
47
Keep in mind that 9.76 percent is a simple arithmetic average return.
Actual returns, geometrically stated (taking into account compound-
ing), could be significantly less.
Some investors do hold through the ups and downs, attempting to

weather the storm, because they have a longer time horizon for their
financial needs. But what would happen if one of those financial needs
occurred sooner than expected, or something came up and you needed
money now? If that need arose in the middle or, worse yet, at the bottom
of the drawdown (see years seven or eight in Figure 4.1), how devastat-
ing could that be? Aside from the financial need to make up a greater
portion of those assets, it also reduces the capital base from which to
compound your returns during the next positive period.
FIGURE 4.1 Buy-and-Hold

$100,000 invested
Year
What is missing in most investment portfolios is a strategy that

smoothes out the impact of adverse market conditions. There is, how-
ever, a value-added strategy that can limit your drawdowns without
sacrificing your upside potential. This value-added strategy is called
active management, as illustrated in the hypothetical example shown
in Figure 4.2. In this scenario, you would have a much easier time (and
less worry) meeting financial demands in years seven and eight. The
bottom line is that active management allows you to make financial
decisions on your own terms, not the market’s terms.

FIGURE 4.2
$100,000 invested Active Management
Year
When the economy is doing well, you can make money by investing in
almost any sector. But that is not where the real value of active manage-
ment lies. When the economy is doing poorly, however, you can lose
money in almost any sector. An active management strategy responds
to changes in the economy and positions you to limit the losses. Now
that is value!
To further illustrate the purpose of using active management to achieve

true diversification, we created a hypothetical portfolio containing just
stocks and bonds. We then compared that to what the same portfolio
may have looked like had you used an active management approach,
such as Astor’s, in your portfolio during that same time period.
Figure 4.3 shows the results of a hypothetical, moderately conservative

buy-and-hold portfolio (the lighter line), which contained a 60 per-
cent allocation to the S&P 500 (an unmanaged composite of 500 large
capitalization companies) and a 40 percent allocation to the Barclays
Capital Aggregate Bond Index (a composite return of a diverse range
of U.S. debt instruments, previously known as the Lehman Brothers
Aggregate Bond Index). The active management model (the darker
line) was comprised of 100 percent equities (S&P 500) during economic
expansion and 100 percent fixed income (Barclays bond index) during
economic contractions or recession.
During the period of economic growth from 2005 to 2007, the active
management model portfolio produced returns that closely tracked
the hypothetical buy-and-hold 60/40 investor portfolio. During the
Chapter Four 49
2008 to 2009 recession (the darker shade on the timeline), however, the
divergence between the two portfolios shows the real value-added of
active management. A defensive position of 100 percent fixed income
during the recession stabilized the active management portfolio and
established a higher base from which to grow after the recession ended
and the economy began expanding again.
The active management model was able to significantly outperform the

straight buy-and-hold, as it was able to sidestep the decline and position
the portfolio to garner returns during the economic contraction. As you
can imagine, a more aggressive buy-and-hold portfolio (one containing
higher beta stocks with less fixed income) would have seen more pro-
nounced drawdowns, particularly during 2008 to 2009.
FIGURE 4.3 Buy-and-Hold Portfolio
Value of $100K -
Value
w/100%Fl during
recessions
Value of $100k
- 60/40
Year
Comparison of a conservative buy-and-hold portfolio of 60 percent equities and 40

percent bonds (lighter line) with active management model (darker line). The real value
of the active management approach is clearly visible during and after the 2008 to 2009
economic contraction and recession.

Risk and Reward
The greater the risk investors are willing to take, the greater the poten-
tial reward they are going to require in return for that risk. Standard
deviation is one measure of risk or volatility of a certain asset. (Treasury
yields are labeled as risk-free assets because the risk of default or non-
payment on the coupon and principal is minimal.) Generally speaking,
in order to reduce risk, you end up sacrificing return. However, active
management has the unique ability to diminish overall risk without
reducing long-term returns, as you can see in Figure 4.4.
Figure 4.4 Risk/Return
Comparison of buy-and-hold portfolio (60 percent equities and 40 percent fixed

income) with an active management mix. Half of the mix portfolio is invested in S&P
500 (60 percent) and half in Barclays Capital Aggregate Bond Index (40 percent).
The other half of the mixed portfolio is invested with 100 percent equities (S&P 500)
during economic expansion and 100 percent fixed income (Barclays index) during
contractions. As Figure 4.4 shows, the mixed portfolio has a higher return-to-risk ratio
compared to buy-and-hold.
Why You Should Worry About Drawdowns

One of the most important considerations when choosing an invest-
ment is the amount of drawdown you will likely experience and how
long it would take to recover.
• Drawdown: The total decrease (percentage or dollars) that your

account falls from the highest peak value achieved in the account.
• Recovery: How long it takes from the low value in the drawdown
to get back to new highs.
The results in Figure 4.5 show the drawdown and recovery during a
classic example: the period of 2001 to 2003. The results illustrate the
importance of reducing drawdowns, which shortens recovery time.
Chapter Four 51
FIGURE 4.5 Drawdown/Recovery Analysis
Look at how the addition of active management reduced the overall loss of the portfolio,
thus turning to profitability sooner than buy-and-hold.
If we have failed to drive the idea home at this point, consider the fol-
lowing: hypothetically, if you invested your money during the second
quarter of 2000 (the worst possible time within the historic snapshot
shown in Figure 4.5) you would have realized the following cumulative
gains/losses during the corresponding quarters. Your buy-and-hold
portfolio, if mixed with active management, would have lost no more
than $9,200, compared with a loss of $46,000 in an S&P 500 buy-and-
hold position. Additionally, the active mix portfolio would have already
recovered and posted a gain of more than $8,500 while the buy-and-
hold portfolio was still down $25,000, even with a 30 percent-plus
return in 2003.
The Case Study

Figure 4.6 depicts a more aggressive, all-equity buy-and-hold portfo-
lio (the lighter line on the chart) that correlated 100 percent with the
S&P 500 for the time period shown. When the economic contraction
and recession of 2008 to 2009 hit (the shaded area on the timeline) the
buy-and-hold portfolio suffered significant losses. Recovery from these
losses will take a considerable amount of time and percentage gains.
In contrast, the active management model (the darker line) switches to
a defensive position of fixed income-only during the contraction and
recession, thus guarding against losses and positioning the portfolio for
growth when the economy begins expanding again.

As Figure 4.6 shows, the major benefit of active management occurs
during uncertain or changing market conditions. With a significant
reduction in volatility in the value of your assets, you can feel more
comfortable making important financial decisions, and have a larger
asset base to compound during positive market environments.
FIGURE 4.6 All Equity Buy-and-Hold vs. Active Management
Value of $100K -
Value
w/100%Fl during
recessions
Value of $100k -
S&P 500
Year
Comparison of buy-and-hold/equity-only portfolio with an active management model,

which switches to a 100 percent fixed income position during economic contractions
or recession.
Conclusion
The deeper the declines in your portfolio, the greater the returns you
will need in subsequent periods to restore the initial value of your
portfolio. If a portfolio of $100,000 declines by 50 percent to $50,000,
you will need a 100 percent return from that point to recover the initial
value. If you are able to cut that loss to 25 percent to a lowest portfolio
Chapter Four 53
value of $75,000, that portfolio will need only a 33 percent return from
that point to recover the initial value. All else being equal, the 33 per-
cent return should take significantly less time to achieve than the 100
percent, based on the laws of positive compounding (which are much
more effective following limited drawdowns). We all know that time is
one of the most important factors in investing that we can have on our
side.
The points made in the case study are clear in Figure 4.7. The addi-
tion of active management created a much more desirable effect in the
long term. Through active management, the portfolio drawdown was
smaller, the recovery time was shorter, and, as a result, overall returns
were greater with much less risk.
Figure 4.7 Less Losses
Comparison of buy-and-hold portfolio with the active management model mix.

Although the active mix does post a larger yearly return during the period 2000 to 2010,
the more important data point is the lowest value of the account during the period.
Active management lost less than $2,000, while the buy-and-hold portfolio declined
by more than $18,000.
Summary: Strategies for Tomorrow’s Markets

Market corrections of the past have taught us an important albeit pain-
ful lesson, one that we at Astor have been teaching clients for years.
Rather than putting their hopes (and money) on buy-and-hold, inves-
tors must recognize the need to take a more active approach to invest-
ing. To meet the needs of these sophisticated investors, investment
professionals should offer more than just the mutual fund flavor of the
month or hot stock pick. Savvy investors are looking for strategies that
will serve them not only in today’s market conditions, but tomorrow’s
as well.

To meet the needs of their clients, investment professionals must under-
stand the advantages of active management, which allows investment
decisions to be made based on specific market conditions and other cri-
teria, such as Astor’s strategy of economics-based active management.
Through active management, investors have the potential to improve

returns and reduce risk. Moreover, they can bring true diversification
to their portfolios to guard against downturns and improve returns in
favorable conditions. This is vitally important in today’s new invest-
ment climate of shorter, less defined cycles.
Bullish or bearish, economic expansion or contraction, the cycles will

continue. Savvy investors and the investment professionals who advise
them should not be afraid when the cycles change. Through active man-
agement, they will be empowered to make bolder decisions which, over
time, can improve returns while reducing unfavorable market exposure.
Chapter Four 55
ABOUT ASTOR ASSET
MANAGEMENT
▲ ▲ ▲ ▲ ▲ ▲
Astor Asset Management is an SEC-registered investment firm

and subsidiary of Knight Capital Group, Inc. (NYSE Euronext: KCG).
Founded in 2001 by Rob Stein, Astor offers actively-managed portfolios
of ETFs to protect and grow capital over time by pursuing an attractive
absolute compounded return without the performance fees and lock-up
periods associated with hedge funds.
Astor manages over $1.2 billion in assets and its portfolios are available
through most financial brokerage firms in both separately managed
accounts and mutual funds. The firm uses a proprietary macroeco-
nomic model and tactical strategies to create a diversified portfolio of
non-correlating ETFs within all asset classes (equities, fixed income,
commodities, currencies, REITs).
The Astor Advantage

Astor seeks to generate positive returns in both up and down markets
(an absolute return approach). During market expansions, it utilizes
diversified, non-correlating long equity ETF positions. During eco-
nomic contractions, the portfolios will utilize defensive positioning,
which can range from overweighting cash and fixed income to using
ETFs with inverse exposure to broad market averages. The goal is to
create a positively-sloped return curve that will benefit from the direc-
tion of the economic trend.
Astor Asset Management believes that long-term financial goals for

investors are capital appreciation, limited volatility, and quick recov-
57
ery time from market losses. The firm’s view is that these goals can be
achieved by diversifying investments among various asset classes and
employing the use of low-cost investment products within an overall
portfolio. Astor seeks to limit drawdowns and generate profits in virtu-
ally all market environments. The basis of our philosophy is identify-
ing the recurring economic cycles of expansion, peak, contraction, and
trough, and actively rebalancing when the cycles change.
Astor’s proprietary macroeconomic model analyzes economic data

such as GDP, inflation, employment, money flows, and overall mar-
ket conditions to determine the current phase of the business cycle
(expansion, peak, contraction, or trough). Once the current phase of
the business cycle is identified, Astor, through active management,
rebalances its portfolios. Active rebalancing occurs only when the
economic cycle changes.
By analyzing macroeconomic factors, our goal is to achieve a less

volatile return and higher return-to-risk-ratio than our benchmark.
Tactical asset allocation is utilized to create exposure to a variety of
market sectors, capitalizations, and styles. Our objective is to produce
positive returns, not necessarily to outperform a benchmark. For
more information about Astor, or to contact Robert N. Stein, Senior
Managing Director, please see the Astor Asset Management web site at
www.astorllc.com.
About Knight
Knight Capital Group (NYSE Euronext: KCG) is a global financial
services firm that provides access to the capital markets across multiple
asset classes to a broad network of clients, including buy- and sell-side
firms and corporations. Knight is headquartered in Jersey City, New
Jersey, with a growing global presence across the Americas, Europe, and
the Asia Pacific region.

ABOUT THE AUTHOR
▲ ▲ ▲ ▲ ▲ ▲
Robert Stein is the Senior Managing

Director and Head of Global Asset
Management for Astor Asset Management
and Knight Capital Group, Inc. He also
serves as the Senior Portfolio Manager
of Astor’s separately managed account
programs and the Astor Long/Short ETF.
Rob started his career in 1983 as a project
analyst for the Federal Reserve under the chairmanship of Paul Volcker.
He then held senior trading or portfolio management positions with
Bank of America New York, Harris Bank Chicago, and Continental
Bank Chicago, which was acquired by Bank of America. In 1991, Rob
became the Managing Director of Proprietary Trading at Barclay’s
Bank PLC, New York.
Returning to Chicago in 1994, he formed Astor Financial Inc. and later

established Astor Asset Management, which provides investment advi-
sory services to clients. Rob is also the author of The Bull Inside the
Bear: Finding New Investment Opportunities in Today’s Fast-Changing
Economy and Inside Greenspan’s Briefcase: Investment Strategies for
Profiting from Reports and Data. He is regularly featured in print
and broadcast media for the financial world, including the Wall Street
Journal, Bloomberg BusinessWeek, Investor’s Business Daily, ABC,
FOX News, Bloomberg, and CNBC. Rob is the founder and president of
the Dream of Jeanne Foundation and is the vice chairman of the board
of trustees of Glenkirk, both of which help mentally challenged people
participate in community life. Rob graduated from the University of
Michigan and holds Series 3, 7, and 65 licenses.
59
GLOSSARY OF ECONOMIC
TERMS
▲ ▲ ▲ ▲ ▲ ▲
There are a variety of indicators that reflect at least one aspect of the
U.S. economy. Some of the indicators are broad measurements, such as
Gross Domestic Product (GDP), which gauges the output of U.S. busi-
ness. Others, such as Vehicle Sales, have a far more limited scope. Taken
together, these indicators provide in-depth information about how the
economy has been performing and a hint of what is likely to come.
At Astor Asset Management, our economics-based approach to active

management requires that we closely monitor economic data. While we
give more weight to some indicators (such as GDP and the Employment
Situation) over others, each report offers some insight. The best way to
make informed investment decisions is with a thorough understanding
of the current state of the economy (expansion, peak, contraction, or
trough) and the strength or weakness of that prevailing trend. We also
believe that investment professionals and their savvy clientele should
be familiar with economic reports and indicators, to understand their
meaning and discern their relative importance.
Following is a glossary of economic reports, with a brief description

of each.
61
Agricultural Prices
Released at the end of each month
This report from the U.S. Department of Agriculture includes the

prices received by farmers for crops, livestock, and livestock products.
Data are derived from surveys of mills and elevators (grain); packers,
stockyards, auctions, dealers, and other sources (livestock); and sample
surveys and market check data (fruits and vegetable prices).
Beige Book
Released eight times per year
Commonly known as the Beige Book, the Federal Reserve’s “Summary

of Commentary on Current Economic Conditions” is published eight
times a year. Each Federal Reserve Bank gathers anecdotal information
on current economic conditions in its district through reports from
bank and branch directors and interviews with key business people,
economists, market experts, and other sources. The Beige Book sum-
marizes this information by district and sector. The Beige Book does
not represent the views of the Federal Reserve Board or the Federal
Reserve Banks, but summarizes comments from businesses and con-
tacts outside of the Federal Reserve System.
Business Inventories
Released the middle of each month
This report from the Bureau of Census includes three components.

Monthly Retail Trade presents data on dollar-value of retail sales and
sales for selected establishment, as well as a sub-sample of firms pro-
viding data on end-of-month inventories. Monthly Wholesale Trade
includes data on dollar values of merchant wholesalers’ sales and end-
of-month inventories. Manufacturers report current production levels
and future production commitments, as well as the value of shipments,
new orders net of cancellations, month-end total inventory, materials
and supplies, work-in-process, and finished goods inventories.

Chain Store Sales
(see ICSC-Goldman Sachs Chain Store Sales Trends)
Challenger Report
Released during the first week of each month
The Challenger Report is a monthly job outlook report from outplace-

ment firm Challenger, Gray & Christmas.
Chicago Fed National Activity Index

The Chicago Fed National Activity Index, released monthly by the

Chicago Federal Reserve Board, is a coincident indicator of broad eco-
nomic activity. An index reading of “zero” indicates that the economy
is growing at its long-run potential growth rate. A value above zero
indicates that the economy is growing above potential, while a nega-
tive value indicates that the economy is growing below potential. The
index is a weighted average of 85 indicators of national economic activ-
ity. These indicators are drawn from five broad categories of data: (1)
production and income; (2) employment, unemployment, and hours
worked; (3) personal consumption and housing; (4) manufacturing and
trade sales; (5) inventories and orders.
Chicago Purchasing Managers Chicago

Business Barometer
Released on the last business day of each month
This report provides a regional view of the national economy, sum-

marizing current business activity. The report is also known as the
Chicago Purchasing Manager Index or Chicago PMI.
Conference Board Consumer Confidence Index

The Conference Board Consumer Confidence Index measures the level

of confidence that individual households have in the performance of
Glossary 63
the economy. Survey questionnaires are mailed to a nationwide rep-
resentative sample of households, which are asked five questions to
rate the current business conditions in the household’s area: business
conditions six months into the future, job availability in the area, job
availability in six months, and family income in six months. Responses
are seasonally adjusted. An index is constructed for each response and
then a composite index is fashioned based on the responses. Two other
indices—one to assess the present situation and one for expectations
about the future—are also constructed. Expectations account for 60
percent of the index, while the current situation is responsible for the
remaining 40 percent.
Conference Board Employment Trends Index

Released on the Monday following the Friday release of the Employment
Situation Report
The Employment Trends Index combines eight labor-market indica-

tors. This index includes: percentage of respondents who report jobs are
hard to get; initial claims for unemployment insurance; percentage of
firms with positions they are unable to fill now; number of employees
hired by temporary help industry; workers with part-time jobs due to
economic reasons; job openings; industrial production; and manufac-
turing and trade sales.
Conference Board Help Wanted OnLine Data Series

The Conference Board Help Wanted OnLine Data Series measures

the number of new, first-time online jobs and jobs reposted from
the previous month on more than 1,200 major Internet job sites and
smaller job sites that serve niche markets and smaller geographic areas.
The new online series is not a direct measure of job vacancies. The level
of ads in print and online can change for reasons not related to overall
job demand.

Conference Board Leading Economic Index
Released mid-month each month
This index is designed to signal peaks and troughs in the business cycle.
The leading, coincident, and lagging economic indexes are essentially
composite averages of several individual leading, coincident, or lagging
indicators. They are constructed to summarize and reveal common
turning point patterns in economic data in a clearer and more convinc-
ing manner than any individual component—primarily because they
smooth out some of the volatility of individual components.
Conference Board Measure of CEO Confidence

Released quarterly, during the first week after each quarter closes
The Conference Board Measure of CEO Confidence assesses CEO

views of economic conditions. The report includes assessments of cur-
rent conditions as well as the outlook for improvement and/or decline.
Construction Spending
Released on the first day of each month
Construction Spending, from the Bureau of Census, reports the dollar

value of newly completed structures. Individual data series are available
for several residential building types; nonresidential private building
types; public buildings, and other public and private structures, such as
roads and utility lines. Both current dollar and inflation-adjusted esti-
mates are available. This release is used directly to estimate the invest-
ment in the structures component of the expenditures estimate of GDP.
Since a building is not recorded in the data series until it is completed,
this series is a lagging indicator of construction activity.
Consumer Confidence Survey

(See Conference Board’s Consumer Confidence Survey)
Glossary 65
Consumer Credit
Released on the fifth business day of each month
Consumer Credit, from the Federal Reserve Board, represents loans for
households for financing consumer purchases of goods and services
and for refinancing existing consumer debt. Secured and unsecured
loans are included except those secured with real estate (mortgages,
home equity loans and lines, etc). Securitized consumer loans, loans
made by finance companies, banks, and retailers that are sold as securi-
ties are included. The two categories of consumer credit are revolving
and non-revolving debt. Revolving debt covers credit card use whether
for purchases or for cash advances, store charge accounts, and check
credit plans that allow overdrafts up to certain amounts on personal
accounts.
Consumer Price Index (CPI)

Released on the fifteenth of each month
The Consumer Price Index (CPI) is a measure of the average change

over time in the prices paid by urban consumers for a fixed market
basket of consumer goods and services. The CPI report, released by
the Bureau of Labor Statistics, provides a way for consumers to com-
pare what the market basket of goods and services costs this month
with what the same market basket cost a month or a year ago. The CPI
reports price changes in over 200 categories, arranged into eight major
groups. The CPI includes various user fees such as water and sewerage
charges, auto registration fees, vehicle tolls, and so forth. Taxes that are
directly associated with the prices of specific goods and services (such
as sales and excise taxes) are also included.
Consumer Sentiment Survey

(See Thomson Reuters/University of Michigan Survey of Consumers)

Current Account Deficit Report
Released quarterly, mid-month
The Current Account report from the Bureau of Economic Analysis

reflects the movement of non-capital items in the balance of payments
account. The report breaks out the balance on goods, services, and
income. Changes in the current account balance are a useful barometer
for the state of U.S. foreign trade as well as the flow of investment to
and from the United States. A widening deficit on the current account
is typical when the United States is purchasing excessive imports. The
current account also provides a good measure of the performance of the
United States in the international markets.
Durable Goods
Durable Goods from the Bureau of the Census is the advance release
of overall factory orders and shipments. Durable goods are indus-
trial products with an expected life of one year or more. They include
intermediate goods, such as steel, lumber, and electronic components;
finished industrial machinery and equipment; and finished consumer
durable goods, such as furniture, autos, and TVs. Data are reported for
seven different industry groupings, plus the total. New orders are the
dollar volume of orders for new products received by domestic manu-
facturers from any source, domestic or foreign.
ECRI Weekly Leading Index

Released each Friday
The Economic Cycle Research Institute’s (ECRI) Weekly Leading Index

is a weighted average of seven key economic data designed to predict
economic conditions in the near term. Meant to be clearly cyclical, the
index is designed to turn down before a recession and turn up before
an expansion.
Glossary 67
Employment Cost Index
Released quarterly on the last Thursday of the reporting month
The Employment Cost Index (ECI) from the Bureau of Labor Statistics
is based on a survey of employer payrolls. The index measures the
change in the cost of labor, free from the influence of employment shifts
among occupations and industries.
Employment Situation
Released on the first Friday of each month
Payroll figures are reported each month by the Bureau of Labor

Statistics in its Employment Situation Report. Payroll employment is a
measure of the number of jobs in more than 500 industries, except for
farming, in all states and 255 metropolitan areas. The employment esti-
mates are based on a survey of larger businesses. The report also pro-
vides information on average weekly hours worked and average hourly
earnings, which are important indicators of the tightness of labor mar-
kets. An index of aggregate weekly hours worked is also included in the
release, which gives an important early indication of production before
the quarterly GDP numbers come out.
Existing Home Sales

Released around the twenty-fifth of each month
Each month the National Association of Realtors (NAR) Research

Division receives data on existing single-family home sales from over
650 boards and associations of realtors and multiple listing systems
across the country. This data is included in the Existing Home Sales
Report.
Factory Orders
The Factory Orders report from the Bureau of the Census includes the
dollar volume of new orders, shipments, unfilled orders, and invento-
ries reported by domestic manufacturers. Data are reported for numer-
ous industry groupings, plus the total and specialized aggregates. New

orders are a good measure of demand for each industry and in aggre-
gate, and shipments are a good measure of supply. Unfilled orders are
the backlog of orders that have been received by domestic manufactur-
ers, but not yet shipped. Unfilled orders are one indication of the bal-
ance between demand and supply, most often used to indicate an excess
of demand relative to supply.
Federal Open Market Committee (FOMC) Meeting

Meets eight times per year
The Federal Open Market Committee of the Federal Reserve Board

(FOMC) meets approximately every six weeks to consider whether any
changes need to be made to monetary policy. The FOMC is comprised
of the seven Federal Reserve Board members, including the current
chairman, and five Federal Reserve District Bank presidents.
FOMC Minutes
Minutes of regularly scheduled meetings are released three weeks after
the date of the FOMC meeting
The Federal Open Market Committee (FOMC) holds eight regularly

scheduled meetings during the year and other meetings as needed.
Gross Domestic Product (GDP)

Released on the last Friday of each month
Gross Domestic Product (GDP) is a measure of the total production

and consumption of goods and services in the United States. The
report, released by the Bureau of Economic Analysis, includes two
complementary measures of GDP, one based on income and one based
on expenditures. GDP is measured one way by adding up the labor,
capital, and tax costs of producing the output. On the consumption
side, GDP is measured by adding up expenditures by households, busi-
nesses, government, and net foreign purchases. Theoretically, these two
measures should be equal. However, due to problems collecting the
data, there is often a discrepancy between the two measures. The GDP
price deflator is used to convert output measured at current prices into
constant-dollar GDP.
Glossary 69
ICSC-Goldman Sachs (ICSC-GS) Chain-Store Sales Index
Released each Tuesday
The index measures nominal same-store or comparable-store sales

excluding restaurant and vehicle demand. The weekly index statisti-
cally represents industry sales. The standard period used for the index
is Sunday through Saturday. The weekly sales index is presented on an
adjusted basis to account for normal seasonality and to counter other
data anomalies.
Import and Export Prices

Every month, the Bureau of Labor Statistics collects net transaction

prices for more than 20,000 products from over 6,000 companies and
secondary sources to formulate the Import and Export Prices report.
The overall import price index measures the price change of products
purchased from other countries by U.S. residents. The overall export
price index measures the change in the prices of domestically produced
U.S. goods shipped to other countries.
Industrial Production/Capacity Utilization

Released around the fifteenth of each month
The Industrial Production index, released by the Federal Reserve

Board, measures the change in output in U.S. manufacturing, mining,
and electric and gas utilities. Output refers to the physical quantity of
items produced. The index covers the production of goods and power
for domestic sales in the United States and for export. It excludes pro-
duction in the agriculture, construction, transportation, communica-
tion, trade, finance, and service industries; government output, and
imports. Each component is weighted according to its relative impor-
tance in the base period. The report also includes Capacity Utilization,
which gauges how much available capacity exists. The greater the
capacity utilization, the higher the production level, which could indi-
cate inflation (typically a measurement over 85 percent). Conversely,
a low capacity number indicates economic weakness as industries are
producing below their potential.

International Trade
Released around the ninth to the thirteenth of each month
The International Trade report from the Department of Commerce

reflects the balance of trade, or the difference between exports and
imports of goods and services. Merchandise data are provided for U.S.
total foreign trade with all nations, with detail for trade with particular
nations and regions of the world, as well as for individual commodi-
ties. Using the report, the importance of one country’s economy may
be analyzed in terms of U.S. trade. The report can further reveal to
what extent overseas growth is contributing to the U.S. economic per-
formance.
ISM Report
(See Manufacturing ISM Report on Business)
ISM Non-Manufacturing Index

(See Non-Manufacturing ISM Report on Business)
Jobless Claims
(See Unemployment Insurance Weekly Claims Report)
Job Opening and Labor Turnover

Released around the tenth of each month
The Job Openings and Labor Turnover Survey (JOLTS) is released by

the Bureau of Labor Statistics (BLS). Data in the survey are collected
and compiled monthly from a sample of business establishments. Data
are collected for total employment, job openings, hiring, employees
quitting, layoffs and discharges, and other separations.
Kansas City Fed Manufacturing Survey

Released on the last Thursday of each month
The Federal Reserve Bank of Kansas City surveys roughly 300 manu-
facturing plants that are representative of the district’s industrial and
Glossary 71
geographic makeup. Indices are calculated by subtracting the percent-
age of total respondents reporting decreases in a given indicator from
the percentage of those reporting increases. The indices, which can
range from 100 to -100, reveal the general direction of the indicators
by showing how, or if, the number of plants with improving conditions
offset those with worsening conditions. Index values greater than zero
generally suggest expansion, while values less than zero indicate con-
traction.
Manufacturing ISM Report on Business

Released on the first business day of each month
This report is based on data compiled from purchasing and supply

executives nationwide across multiple industries. According to ISM, a
reading above 50 percent indicates expansion in manufacturing, while
a reading below 50 percent indicates a general decline.
Manufacturing and Trade Inventories and Sales Report

Released around the fifteenth of each month
This U.S. Census Bureau report includes distributive trade sales and
manufacturers’ shipments (sales); manufacturers’ and trade inventories
(inventories); and total business inventories/sales ratio. Estimates are
based on data from three surveys: the Monthly Retail Trade Survey, the
Monthly Wholesale Trade Survey, and the Manufacturers’ Shipments,
Inventories, and Orders Survey.
Monster.com Employment Index

The Monster.com Employment Index is a comprehensive monthly

analysis of online job demand from Monster Worldwide, Inc. This
index provides a snapshot of online recruitment nationwide.

Monthly Mass Layoffs
Released around the twentieth to the twenty-third of each month
Mass layoff statistics are compiled by the Bureau of Labor Statistics

from initial unemployment insurance claims. Each month, states report
on establishments that have at least 50 initial unemployment insur-
ance claims filed against them during a consecutive five-week period,
regardless of duration. These establishments then are contacted by the
state agency to determine whether these separations lasted 31 days or
longer, and, if so, other information concerning the layoff is collected.
Quarterly mass layoff reports include additional information. The
report lists how many layoff events occurred and how many people
who are eligible to receive unemployment compensation were affected.
Layoff events are segmented by state and industry.
Monthly Retail Trade and Food Services

Released around the twelfth of each month
This report from the U.S. Census Bureau provides an early estimate of
monthly sales for retail and food service in the U.S. The survey is based
on questionnaires sent to approximately 5,000 firms.
Monthly Treasury Statement

The U.S. Department of Treasury budget is a monthly account of the

surplus or deficit of the U.S. government. Detailed information is pro-
vided on receipts and outlays of the federal government. The informa-
tion is provided on a monthly and fiscal year-to-date basis.
Mortgage Bankers Association’s Weekly Mortgage

Applications Survey
Released each Wednesday
The Mortgage Bankers Association’s (MBA) Weekly Applications

Survey analyzes mortgage application activity. The survey is used as an
indicator of housing and mortgage finance activity.
Glossary 73
NAHB/Wells Fargo Housing Market Index
This index is based on a monthly survey of National Association of

Home Builders (NAHB) members on the single-family housing market.
The survey asks respondents to rate current market conditions for the
sale of new homes and conditions in the next six months, as well as the
traffic of prospective buyers.
New Home Sales

Released around the twenty-third to the twenty-fifth of each month
The Bureau of the Census compiles data for this report from sample
surveys. The report includes sales figures and median prices of housing.
New Residential Construction

Released on the third Thursday of each month
New Residential Construction, released by the Bureau of the Census,

provides statistics on the construction of new privately owned residen-
tial structures in the United States. Data include the number of new
housing units authorized by building permits; the number of housing
units authorized to be built, but not yet started; the number of housing
units started; the number of housing units under construction; and the
number of housing units completed.
Non-Manufacturing ISM Report on Business

Released on the third business day of each month
This index is based on data compiled from purchasing and supply

executives nationwide. The index based on four indicators: business
activity, new orders, employment, and supplier deliveries. According
to ISM, an index reading above 50 percent indicates that the non-
manufacturing economy in that index is generally expanding; below 50
percent indicates that it is generally declining. For supplier deliveries, a
reading above 50 percent indicates slower deliveries and below 50 per-
cent indicates faster deliveries.

NY Fed Empire State Manufacturing Survey
This report is based on a monthly survey of manufacturers in New York

State conducted by the Federal Reserve Bank of New York.
Personal Income
Released around the first or last business day of each month
The Personal Income report from the Bureau of Economic Analysis

mainly measures the income received by households from employment,
self-employment, investments, and transfer payments. It also includes
small amounts for expenses of nonprofit organizations and income of
certain fiduciary activities. The largest component of personal income
is wages and salaries from employment. Personal income is released
after the employment report and thus can be estimated by the payroll
and earnings data for the employment report. Disposable income refers
to personal income after the payment of income, estate, certain other
taxes, and payments to governments.
Philadelphia Fed Business Outlook Survey

Every month, the Federal Reserve Bank of Philadelphia surveys respon-

dents to assess general business conditions as well as company busi-
ness conditions. Answers are given based in the current month versus
the previous month, and the outlook for six months from the current
month. An indicator is presented for a decrease, no change, an increase,
and a diffusion index.
Producer Price Index (PPI)

Released during the third week of each month
The Producer Price Index (PPI) from the Bureau of Labor Statistics
is a family of indices that measures average changes in selling prices
received by domestic producers for their output. The PPI tracks changes
in prices for nearly every goods-producing industry in the domestic
economy, including agriculture, electricity and natural gas, forestry,
fisheries, manufacturing, and mining.
Glossary 75
Productivity and Costs
Released quarterly, at the beginning of the month
Productivity and associated costs, compiled by the Bureau of Labor

Statistics, reflects the relationship between real output and the labor
and capital inputs involved in production. This shows changes over
time in the amount of goods and services produced per unit of input.
Retail Sales
(See Monthly Retail Trade and Food Services)
Richmond Fed Survey of Manufacturing Activity

The Federal Reserve Bank of Richmond surveys manufacturing plants

that are representative of the district’s industrial and geographic make-
up. The indices are calculated by subtracting the percentage of total
respondents reporting decreases in a given indicator from the percent-
age of those reporting increases. The indices, which can range from
100 to -100, reveal the general direction of the indicators by showing
how the number of plants with improving conditions offset those with
worsening conditions. Index values greater than zero generally suggest
expansion, while values less than zero indicate contraction.
Semiconductor Book-to-Bill Ratio

Released around the fifteenth to the twentieth of each month
Semiconductor Equipment and Materials International releases the

results of a survey of U.S. manufacturers on a monthly basis. The
3-month moving average of shipments and new orders plus their ratio,
named the book-to-bill ratio, are all included.
Semiconductor Billing
First of last day of the month
The Semiconductor Industry Association reports the global dollar

volume of integrated circuit sales on a three-month moving average on

a monthly basis. All types of semiconductor chips are included in the
totals: microprocessors, memory, and others. The sales are reported
individually for four regions: North America, Asia-Pacific, Japan, and
Europe. The data are compiled from a survey of the largest global chip
manufacturers.
Thomson Reuters/University of Michigan Survey of

Consumers
Released on the first or last day of each month
The Thomson Reuters/University of Michigan Consumer Sentiment

Survey is based upon a nationally representative sample of consumer
households. It reports an index of consumer sentiment and an index of
consumer expectations.
Treasury Budget
(see Monthly Treasury Statement)
Unemployment Insurance Weekly Claims Report

Released each Thursday
This weekly report from the Department of Labor measures the num-
ber of applicants filing for state jobless benefits. The report is important
as an indicator of employment and, therefore, economic trends. An
increase in jobless claims, for example, shows that job prospects are
worsening (or at least have not improved), while a decrease in claims
indicates job growth. On a week-to-week basis, the claims number
can be volatile. Therefore, looking at jobless claims over a longer time
period (such as month-to-month) may be more meaningful.
Unemployment Rate
Released on the first Friday of each month
The unemployment rate is released by the Bureau of Labor Statistics,

and represents the number unemployed as a percent of the labor force.
Persons are classified as unemployed if they do not have a job, have
actively looked for work in the prior four weeks, and are currently
Glossary 77
available for work. Actively looking for work may consist of any of the
following activities: networking, contacting an employer directly, or
having a job interview with public or private employment agency; con-
tacting a school or university employment center; sending out resumes
or filling out applications; placing or answering advertisements; check-
ing union or professional registers; or some other means of active job
search. People are counted as employed if they did any work at all for
pay or profit during the survey week. This includes all part-time and
temporary work, as well as regular full-time year-round employment.
Persons also are counted as employed if they have a job at which they
did not work during the survey week because they were on vacation,
experiencing child-care problems, taking care of some other family
or personal obligation, on maternity or paternity leave; involved in an
industrial dispute; or prevented from working by bad weather.
Vehicle Sales
Auto companies report vehicle sales each month. Light vehicle sales
are divided between cars and light trucks (sport utility vehicles, pickup
trucks, and vans). Light vehicle sales include both sales of vehicles
assembled in North America that are sold in the United States and sales
of imported vehicles sold in the United States.
Weekly Natural Gas Storage Report

Released each Thursday
This report from the U.S. Energy Information Administration provides

data on working gas in underground storage in the lower 48 states,
including current storage and historic comparisons.

Wells Fargo/Gallup Investor and Retirement
Optimism Index
Released quarterly
The index draws from investors randomly selected from across the
country. An investor is defined as a person who is head of a house-
hold or a spouse in a household with total savings and investments of
$10,000 or more. The sample size is comprised of roughly two-thirds
non-retired people and one-third retirees.
Wholesale Trade
Released around the tenth of each month
Companies provide data to the Bureau of Census on dollar-values of

merchant wholesale sales, end-of-month inventories, and methods of
inventory valuation. Monthly wholesale trade, sales, and inventories
reports are released six weeks after the close of the reference month.
They contain preliminary current month figures and final figures for
the previous month. Statistics include sales, inventories, and stock or
sale ratios. Data are collected from selected wholesale firms. The sample
is updated every quarter to add new businesses and eliminate those who
are no longer active wholesalers.
Glossary 79
ECONOMIC CALENDAR
Monday Tuesday Wednesday Thursday Friday
1 2 3 4
Semiconductor Vehicle Sales - Chain Store Sales Employment
Billings AutoData 3 Situation
1 1 Monster Employ 5
ment Index
Challenger
MBA Mortgage 2 ECRI Weekly
Report
Applications Jobless Claims Leading Index
2
Survey 4 1
Construction 1
Productivity and
Spending Costs
2 Conference 3
Board Measure
Manufacturing Factory Orders
of CEO confi-
ISM Index 2
dence
3 2 Non-Mfg. ISM
Index
ICSC - Goldman 4
Sachs chain
Oil and Gas
store sales
Inventories
2
2
Personal Income Weekly Natural Gas
3 Storage Report
2
7 8 9 10 11
Consumer Credit Chain Store MBA Mortgage Jobless Claims ECRI Weekly
1 Sales ICSC Applications 4 Leading Index
Goldman Sachs Survey 1
2 2
Conference Import and
Board Export Prices
Employment Job Openings 2
Trends Index and Labor
2 Turnover Survey
2 Weekly Natural
Gas Storage
Report
Wholesale Trade 2
(MWTR)
3
Treasury
Budget
Oil and Gas 3
Inventories
2
Scale: 1 – Least Significant; 3 – Signficant; 5 – Highly Signficant
Economic Calendar 81
14 15 16 17 18
Retail Sales ICSC GOldman MBA Mortgage Jobless Claims Current Account
(MARTS) Sachs Chain Applications 4 3
3 Store Sales Survey
Snapshot 2
The Conference ECRI Weekly
2
International Board Leading Leading Index
Trade Consumer Price Industrial Indicators 1
2 Index Production 1
3 2
Producer Price
Business Weekly Natural Index
Inventories Oil and Gas Gas Storage 3
(MTIS) Inventories Report
2 2 2
NY Empire State
Manufacturing Beige Book Philadelphia Fed
Survey 4 Survey
2 2
NAHB Wells
Fargo Housing
SEMI Book-to-
Market Index
Bill Ratio
2
2
Manufacturing
and Trade
Inventories and New Residential
sales Construction
2 1
21 22 23 24 25
ICSC Goldman MBA Mortgage Jobless Claims GDP
Sachs Chain Applications 4 5
Store Sales Survey
Durable Goods
2 2
3 Existing Home
Sales
Monthly Mass The Conference 2
Layoffs Board Help
3 Wanted
2 ECRI Weekly
Leading Index
Oil and Gas New Home Sales 1
Inventories 2
2 Weekly Natural
Gas Storage
Report
2
Kansas City Fed
Manufacturing
Survey
2

28 29 30
Personal Income ISCS Goldman MBA Mortgage
3 Sachs Chain Applications
Store Sales Survey
2 2
Wells Fargo/
Gallup Investor
Optimism and The Conference Chicago Fed
Retirement Board Consumer National Activity
1 Confidence Index
3 2
Richmond Fed
Manufacturing Agricultural Chicago PMI
Survey Prices 2
2 2
Oil and Gas
Inventories
2
Thomson
Reuters/
University of
Michigan Survey
of Consumers
3
RATINGS EXPLANATION
1 and 2 — This data is marked as the "least significant" because data
release has little (if any) impact on the markets and is not a key mea-
surement of the U.S. economy. Data marked with 1 or 2 has no role in
Astor’s economic model.
3 — Data given the "significant" rating indicates that the data release
has a limited impact on the markets, but may represent a key area of
our economy. Data marked as 3 do not have a direct impact on Astor’s
economic model, but are closely monitored.
4 and 5 — A "highly significant" rating indicates that the data is the

most important to the market and represents a key component of the
economy. Data that has a rating of 4 or 5 have a large influence on
Astor’s economic model.
Economic Calendar 83
This book, and
other great products,
are available at significantly
discounted prices. They make
great gifts for your customers, clients,
and staff. For more information on these
long-lasting, cost-effective premiums,
please call (800) 272-2855, or email us
at sales@traderslibrary.com.
Marketplace Books®
www.marketplacebooks.com
ISBN: 978-1-59280-559-4

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Bull

Published by Marketplace Books Inc.

All rights reserved.

This publication is designed to provide accurate and authoritative

From a Declaration of Principles jointly adopted by a Committee of

Of course support outside of business is also very important in completing

vi Finding the Bull Inside the Bear

From the start of my career as an intern at the Federal Reserve, when

Active management is a general term and may encompass a variety of

There are other, similar examples throughout the 1990s: currency

A more recent example is the European debt problem, which resur-

viii Finding the Bull Inside the Bear

As we review recent economic history, there were significant events

Regardless of these changes, the longer-term direction of the markets

Responding to a New Investment Climate with

Active management means taking a proactive approach to investing

The most important issue is for investors to dedicate a portion of their

At Astor Asset Management, our economics-based approach to active

x Finding the Bull Inside the Bear

Being vigilant and flexible—ready to switch from a partially long to a

Active management is the new investment paradigm for today’s eco-

My purpose in writing this book is to explain the benefits of active man-

xii Finding the Bull Inside the Bear

The challenge we see is convincing investors to pay attention to what is

At Astor, active management means using economic analysis to deter-

We believe that investing in the broader indices is a far more effective

Certainly equities aren’t the only instruments for an active manage-

Given the dominance of equities in most investor portfolios these days,

Active management is in line with the basic investment concept of “buy

As recent bear market corrections have shown us, corrections in the

2 Finding the Bull Inside the Bear

When I moved to Wall Street, I took on a much more difficult job:

The Business Cycle

At any given time, the economy is at one of our sequential phases of

•  eak is the euphoria stage during which stock prices appreciate

•  ontraction may be an unpleasant stage, but it is a very neces-

4 Finding the Bull Inside the Bear

•  rough is when the contraction hits bottom. Large numbers of

Defining the Business Cycle in Real Time

From an active management standpoint, the challenge is determin-

• GDP (Gross Domestic Product)

You don’t have to be an economist to decipher GDP or to understand

• How is the economy performing compared to the previous quarter?

• How does the economy compare to a year ago?

• Is the GDP rate of growth increasing, which would indicate relative

• Or, is the rate of growth declining, which shows that economic

Occasionally, GDP “goes negative,” showing a quarterly growth rate

6 Finding the Bull Inside the Bear

ing economy, as reflected by the 2009 reading in Figure 1.2. By classic

Employment is such an integral part of the economy that it is specifi-

What’s most significant about productivity after an economic con-

To decipher what’s happening to the economy in terms of employment,

8 Finding the Bull Inside the Bear

Changes in unemployment, from 4 percent in 2000 to 9.6 percent in 2010.

Investment Money Flows and Stock Price Momentum

It is far more important to know if additional investor money is going

When studying economic data or stock market performance, it is

Participating in the Broad Market

1. An expanding economy is favorable to equity markets and there-

• eak is the euphoria stage during which stock prices appreciate

• ontraction may be an unpleasant stage, but it is a very neces-

• rough is when the contraction hits bottom. Large numbers of