Introduction

There are two distinctive money management objectives that Butler, Lanz & Wagler engages in - growth and income. Clients will desire one or both of these objectives but each is different in both the type of securities employed and the systems that drive the results. The philosophy behind both objectives, however, is similar. The following is a brief explanation of the investment philosophy that drives our money management style. This philosophy can be broken down into three basic components:

1. The utilization of mechanical systems to generate buy/hold/sell decisions.
2. Timing the market (whether the bond market, stock market, commodity market, etc.).
3. Incorporating business cycle dynamics.

What follows is a more detailed explanation of each of these components.

Mechanical Systems

Investment decisions are typically made in one of three ways:

1. Anecdotal or irrational analysis
2. Reasoned analysis
3. Mechanical means

The first of these - anecdotal or irrational analysis - is when an investment is made for spurious reasons. Perhaps a neighbor or family member recommends an investment, and after no independent research of our own, we buy the investment. For obvious reasons, this is not a serious approach to investing and we will therefore disregard it.

One seemingly acceptable means of arriving at investment decisions is by reasoned analysis. The reasoned analysis approach involves gathering relevant data, analyzing it, and making a decision based on that analysis. This is obviously a rational approach. The problem is that rarely will that "rational" analysis completely avoid human emotion. The burgeoning field of behavioral finance has identified several analytical biases of humans (including professional investors) that result in incorrect conclusions about investments and the economy. These errors are likely to occur in the analytical phase of investment decision-making. However, even if we assume the analysis to be correct, the same biases may prohibit or impair the ability to actually act on it. Again, human emotion inhibits the ability to reach investment objectives.

For this reason, we prefer the third method of investment decision-making - a purely mechanical approach. In this way, we may escape almost all of the bias that would be present if we took each decision to require an individual analysis. All the analysis of what drives market behavior has been done beforehand to yield a decision of the type: if x, then y. More realistically, our systems are of the form: if v, w, and x, then y. In other words, to trigger an action, either buying or selling a security, we generally require more than one market condition to be present. Historically, those conditions have proven to be profitable in taking the action under consideration - buying or selling.

Timing the Market

If an investor were to ask all stockbrokers and financial planners whether investors can profitably time the stock market, 95% or more would respond with a resounding "NO!" Suppose, however, that you rephrased the question slightly. "Are there certain market conditions that have proved more profitable for stocks than others?" Or, conversely, "Have there been certain market conditions that have proven more treacherous for stock investing than others?" If these market professionals are being honest, they would certainly have to respond with a "yes."

Perhaps, then, a definition of the phrase "market timing" is in order. Butler, Lanz & Wagler views market timing as simply identifying market conditions as "historically favorable," or "historically unfavorable" to the asset being timed. We analyze current market conditions and weigh them against historical precedent. Our mechanical system will then generate an action based on the current market environment.

It should then become apparent that we utilize mechanical systems to "time the market." But we should be clear that for us, "timing the market" is really just assessing the risks in any given asset class at a particular point in time.

Incorporating Business Cycle Dynamics

Our investment philosophy depends crucially on this premise: the price behavior of all assets - stocks, bonds, commodities, gold, foreign securities, and currencies - are determined by the forces of supply and demand. Further, these forces are governed by the business cycle. For example, have you ever noticed that gas prices (or the price of oil) rarely skyrockets when we are in a recession? That's because demand for oil and gas needed for transportation and production has decreased with the rest of the economy. The implication is that oil and gas companies are poor candidates for purchase when the economy is contracting. However, when the economy is expanding, all other things held constant, demand for oil and gas should increase.

The same assessment can be made for all assets. That is, what are the behavioral tendencies of a particular asset class (such as precious metals) in each phase of the business cycle? These tendencies are the result of influential supply and demand factors changing as the economy moves cyclically through expansion and contraction.

In summary, we use mechanical systems to time the market, and these systems are based on what we know about the behavior of asset classes in different phases of the business cycle.