Frazier's Investment Selection Process

David Frazier employs an in-depth, top-down approach to selecting ETFs for The ETF Strategist.

Every month, he reviews and analyzes more than 100 statistics on factors that affect consumer spending, business investments, exports, and government spending.

He also regularly analyzes data on investors' purchases and redemptions of mutual funds and data that reveal investors' perceptions of worldwide economic conditions.

In addition, he reviews information on demographic trends, geopolitical events, and new legislative proposals.

Frazier systematically uses all that information mentioned above to forecast the future direction of worldwide economic conditions and to determine the stage of the business cycle at which different countries around the world appear to be operating at any point in time.

These forecasts and determinations are integral components of his ETF selection process, because different asset classes and economic sectors tend to perform quite differently during different economic environments and during the different phases of a typical business cycle. Click here to learn about the business cycle and the typical performance of different asset classes and economic sectors during different phases of the business cycle.

The most important component of Frazier's ETF selection process is his Asset & Sector Allocation (ASA) Model, which he uses to forecast the direction of stock, commodity, and real estate prices and to determine the primary asset classes and economic sectors in which he advises subscribers to The ETF Strategist to allocate their investments at any point in time.

That model consists of 97 economic and financial variables, and 13 investor sentiment indicators.

The economic and financial variables that make up Frazier's ASA Model include worldwide statistics on economic activity, employment, inflation, interest rates, consumer debt, retail sales, corporate profits, productivity, manufacturing activity, and numerous other variables that reveal important economic and financial developments.

The model's investor sentiment indicators include the Association of Individual Investors' weekly polling of investors' attitudes about the financial markets, the spread between interest rates on high-grade corporate bonds and low-grade bonds, and several other indicators that reveal investors' attitudes and beliefs about the future direction of worldwide economies and financial asset prices.

The Forecasting Accuracy of Frazier's ASA Model

Frazier's ASA Model has accurately forecast, within two months of stock market lows and highs, every major turning point in the U.S. equities market since 1970.

For example, his ASA Model forecast in February 1975 that the 1973-1974 recession had ended and that a new bull market was underway. Over the next 14 months, the Dow Jones Industrial Average rallied 37 percent.

In September 1982, his ASA Model forecast that the 1980-1982 recession had ended and that a new bull market had begun. Over approximately the next five years, from Oct. 1982 to Aug. 25, 1987, the Dow advanced 1,826 points (204 percent) and the S&P 500 Index rose 180 percent.

Frazier's ASA Model also accurately forecast the beginning of both the 1991-2000 and the 2003-2007 bull market.

Most recently, his ASA Model forecast in July 2007 that worldwide economic conditions would deteriorate substantially, and that stock prices would fall sharply, during the ensuing months. Less than three months later, the U.S. economy entered its worst recession since 1982 and stock prices peaked. Over the next 14 months — from Oct.10, 2007, through Dec. 31, 2008 — the S&P 500 Index declined a whopping 40.6 percent (including dividends).

In contrast, Frazier's aggressive ETF recommendations appreciated 11.1 percent, on average, during that period, as he advised subscribers to The ETF Strategist to allocate a substantial portion of their investments to inverse-equity ETFs — ETFs that rise in value when stock prices in general decline.

Investor sentiment indicators are statistics that reveal investors' attitudes and beliefs about the future direction of the economy and stock prices. Examples included the Association of Individual Investors' weekly polling of investors' attitudes about the financial markets, the spread between interest rates on high-grade corporate bonds and low-grade bonds, and the trading volume on the New York Stock Exchange versus trading volume on the OTC Bulletin Board.

These indicators are primarily contrary indicators, meaning that when they rise to high levels, stock prices tend to decline. This apparently contradictory outcome is the result of the following: Whenever investors' attitudes are very positive about the future direction of the economy and stock prices, everyone that who interested in buying stocks already has bought and therefore no one is left to propel prices higher.

As a result, stock prices tend to peak once these contrary indicators reach high levels, as investors begin to take profits and the number of people interested in selling their stocks rises above the demand for stocks.

As mentioned above, Frazier uses a vast array of economic and financial variables, as well as several investor sentiment indicators, to forecast the direction of worldwide economic conditions and to determine which asset classes and economic sectors he expects to perform best during some specified period into the future.

In contrast, he uses a Relative Performance Model to reveal which economic sectors (and industries within those sectors) are actually performing the best at any point in time.

That model ranks the relative price performance of the 10 major economic sectors (and 130 industries within those sectors) over the most recent one-week, one-month, and three-month periods, and it reveals which sectors and industries improved and which ones deteriorated (in terms of their relative price performance) during the recent past.

In essence, Frazier's Relative Performance Model is a momentum model that attempts to determine which economic sectors (and industries within those sectors) will perform best approximately three months into the future. This model applies a theory first postulated by Sir Isaac Newton in his universal law of motion — an object in motion will remain in motion unless acted upon by an external force.

David uses his Relative Performance Model in a manner similar to the way in which someone would like to bet on a horse race. For example, most horse racing enthusiasts would welcome an opportunity to place their bets on a race during the final stretch of the race, rather than at the beginning of the race, by betting on a horse that ran the first half of the race in the middle of the pack, that gradually advanced its position during the third quarter of the race, and that then surged toward the front of the pack during the final stretch of the race.

In a manner similar to the example above, Frazier's Relative Performance Model helps him to identify the sectors and industries that demonstrate the fastest price momentum, at any point in time, and that will therefore likely outperform other sectors and industries during some specified period into the future. (The chart to the right shows the relative price performance, on average, of the 10 major economic sectors during the six-week period ended March 6, 2009).

Most importantly, however, Frazier primarily uses his Relative Performance Model to confirm (or disconfirm) the readings on his Asset & Sector Allocation Model.

For example, if Frazier's ASA Model had forecast stocks of companies that operate in the technology sector to be among the better-performing stocks during some specified period into the future, and his Relative Performance Model revealed that stocks of companies that operate in that sector were in fact the best-performing stocks during the recent past, he would feel secure that the readings on his ASA Model were correctly forecasting which economic sector would likely perform best approximately three months into the future. As a result of that analysis, David would likely advise subscribers to The ETF Strategist to invest a portion of their capital into ETFs comprised primarily of holdings in the technology sector.

In contrast, if Frazier's ASA Model had forecast stocks of companies in the consumer discretionary sector to perform best over the near term, but his Relative performance Model revealed that stocks of companies in that sector were deteriorating (in terms of their relative price performance), David would conduct more research before recommending ETFs comprised of holdings in that sector.

Once Frazier determines the asset classes and economic sectors that he expects to perform best during some specified period into the future, he compares every ETF in those sectors. For example, he examines their holdings, trading volume, and the ways in which those ETFs historically performed during different economic environments.

He also determines which of those ETFs are appropriate for conservative investors and which are appropriate for aggressive investors, based on the risk-reward characteristics of those ETFs.

Summary

Frazier obviously employs an in-depth investment selection process to determine the ETFs that he recommends to subscribers to The ETF Strategist.

Although that process is very complex, Frazier is confident that his investment recommendations will continue to outperform, on average, the vast majority of investments recommended by other investment newsletters, as well as the vast majority of investments recommended by most mutual fund managers and the so-called Wall Street experts.

He is also confident that his investment recommendations will help you to preserve the majority of your capital during difficult economic environments and to generate substantial investment returns during all other environments.

Click here to learn about the business cycle and the typical performance of different asset classes and economic sectors during the different phases of the business cycle.