1. Fundamental Analysis

The financial markets are discounting mechanisms, anticipating events that will not take place for several months. Forecasting the markets is therefore a two-staged affair. In the first stage, we determine what is going to happen in the future and in the second, we determine how much of that future has already been discounted (i.e. factored in) by the financial markets. The first tool, namely Fundamental Analysis, is the first stage of this process. The other four tools are the second.

Fundamental Analysis involves the study of a range of indicators to determine the outlook for economic growth and inflation - the two principal factors that drive the financial markets. Some of the key variables that we follow are: capacity utilisation, interest rates, liquidity, currency movements and commodity prices (particularly the oil price).

2. Valuation Analysis

Saying that an asset is expensive is akin to saying that it is priced for perfection. In other words, an asset that is expensive has already discounted all the good news and its price is likely to fall almost irrespective of what happens in the future. The question is: how do we determine when any particular asset is expensive? The value inherent in bonds is determined by comparing their yields to a number of yardsticks including current inflation, our in-house estimate of inflationary expectations and real short-term interest rates. The process for equities is a little more complex and involves the regression of historical P/E (price-earnings) ratios against a number of key variables including bond yields, inflation and the slope of the yield curve. Valuation Analysis has less relevance for currencies, at least over the short to medium-term, but we monitor various measures of purchasing power parity (including the Economist magazine's Big Mac index) to identify when a currency is significantly out of line with its true' value.

3. Sentiment Analysis

Markets tend to bottom when all the news is bad and most investors are negative. There is logic behind this apparently perverse behaviour. When most investors are negative, the likelihood is that everyone that wants to sell has already done so. This means that when the first opportunistic buyers start to buy there is a dearth of supply and the investment's price can rise quite sharply. It is therefore important to keep an eye out for those situations when investors become too negative or too optimistic. There are several ways in which this is done. Firstly, we monitor sentiment surveys that tell us precisely what percentage of investors interviewed expressed a positive view towards a given investment. Secondly, we monitor commitment of traders' reports to see how speculators are positioned in the futures markets. Thirdly, we assess the consensus view simply by listening to the views being expressed by analysts and by observing the headlines in the financial press.

4. Technical Analysis

There are many that believe that the only way to forecast the markets is to analyse their behaviour in the past. Although we are not quite as fanatical about technical analysis as some, we do believe that it has an important role to play both in terms of identifying buy and sell opportunities as well as fine-tuning the timing of investment decisions. As far as our 'top-down' strategy is concerned, we prefer to buy on dips and to sell into strength and hence we employ technical analysis techniques that are consistent with this approach. One that we use is Elliott Wave analysis, which is based on the principle that price trends unfold in five waves: three impulsive (with the direction of trend) and two corrective. In turn, each impulsive wave subdivides into five smaller waves and each corrective wave subdivides into three smaller waves. Although it may sound a little off the wall, Elliott Wave analysis has proven to be a great way of anticipating market turning points. Our in-house risk models, which identify when trends are due for a breather, perform a very similar function.

5. Inter-Market Analysis

There are many different types of analysis that come under this one heading. It can involve comparing current market trends with historical experience or perhaps comparing the performance of different asset classes to see if they are behaving in a consistent manner. Examples in the past have included using previous bubble' patterns to forecast the NASDAQ and monitoring the close relationship between bond yields and commodities to confirm what is really happening in the real economy.