Global Insight's sector rotation model recommends overweight positions in consumer staples and healthcare over the next year based on fundamental, technical, and credit indicators. Consumer staples has compelling valuation, consistent profit growth, and improving credit quality. Healthcare also has attractive valuation and robust earnings growth prospects. In contrast, energy and consumer discretionary warrant underweight positions as their earnings growth outlook is weaker than other sectors. Technical indicators also point to negative momentum for consumer discretionary.

1. Summary
• Global Insight's economic and financial forecasts reli-
ably advise sector rotation strategy in asset manage-
ment.
• The best sectors for investing in the U.S. stock market
over the next year will be consumer staples and health-
care. These warrant an overweight position in investors'
portfolios relative to their benchmarks.
• The consumer staples sector has the best attributes for
an overweight position:
• Compelling comparative valuation, consistent
growth in profits, and free cash flow;
• Improving credit quality and "defensive" nature in
a slowing economy;
• Technical conditions in line with the overall market.
• The worst sectors on a one-year-ahead basis are energy
and consumer discretionary. Prospects for future earn-
ings growth are worse here than expected for other sec-
tors. The technical indicator for the consumer
discretionary sector also gives a bad reading, as does a
negative trend in credit risk for the energy sector. These
point to an underweight position for these sectors.
The Issue
Global Insight's economic and financial views reliably
advise Sector Rotation Strategy in Asset Management. Our
macroeconomic and industry analyses and forecasts pro-
vide fundamental forward-looking metrics that are used
directly in security valuation-such as sector profits, CapEx,
and free cash flow.
The Stock Sector Rotation Model uses the analysis and
forecasts from Global Insight to calculate and rank the sec-
tors that have the highest potential for total return, and then
constructs the "optimal" portfolio that has the sector over-
and underweight positions set to "maximize" the total port-
folio return.
The Approach
Global Insight's framework for sector rotation strategy is
based on a rigorous combination of fundamental, technical,
and credit indicators that together measure the relative
investment conditions present in each sector.
Our investment framework is based on quantitative met-
rics. The process begins by measuring the current funda-
mental valuations for each sector. Expected returns for each
sector are then developed for a four-quarter-ahead "strate-
gic" perspective based on relative valuations, compared to
history and other sectors, as well as forward growth of
profits and free cash flow.
The four-quarter strategic perspective is complemented by
a one-quarter-ahead "tactical" perspective that is also based
on the same fundamental valuation metrics used in the
four-quarter view.
Next, we derive metrics of the technical and credit condi-
tions present in each sector. These are used as a "filter," or
overlay, against which the fundamental sector positions are
vetted. The technical and credit conditions are compared to
the fundamentally based indicators to see if there is a rea-
son for augmenting the recommendations for sector over-
or underweight positions.
(C) Copyright 2006. ALL RIGHTS RESERVED
Contacts:
Mark Killion, CFA, 610-490-2547, mark.killion@globalinsight.com
Natasha Muravytska, 610-490-2558, natasha.muravytska@globalinsight.com
Global Insight Web Site, http://www.globalinsight.com
WIS STOCK SECTOR
ROTATION MODEL
AUGUST 2006

2. WIS Stock Sector Rotation Model2
August 2006
Fundamental View
At the heart of Global Insight's Stock Sector Rotation
framework is an "APT-style" sector valuation model that is
used to develop fundamental valuation indicators for use in
advising sector rotation strategy among the 10 Economic
GICS® sectors (e.g., energy, basic materials, industrials,
consumer discretionary, consumer staples, healthcare,
financials, information technology, telecommunications,
and utilities).
The stock sector forecasting model is a practical forecasting
model created to provide a fundamental basis for quantita-
tive portfolio construction and asset allocation. Historical
simulations show this model-based framework can provide
significant "out performance" of the sector-optimized port-
folio relative to the total market performance. (For more
information on framework for modeling expected returns,
see www.globalinsight.com/WIS-Financial.)
Key attributes of our Stock Sector Rotation model:
• Connects macro views down to sector impacts, and
translates them into expected sector market
returns;
• Lead/Lag relationships – four of the seven factors
used to forecast returns are known historical data;
• A fundamental, quantitative framework for portfo-
lio management advisory, such as "overweighting"
or "underweighting" sectors relative to the portfolio
benchmark; and
• Includes technical and credit conditions to augment
fundamentals.
The metrics used in the WIS Stock Sector Rotation model
to generate expected returns are standard sector valuation
measures, such as the dividend yield, dividend payout
ratios, PEG ratio (sector P/E ratio divided by three-year
forward growth rates in same sector profits), free cash flow,
and the interest rate "yield curve."
Our model specification is closely aligned with the "Value"
and "GAARP" approaches to stock market investing:
• Buy at a low price and sell at a high price;
• Look for fast earnings growth in the context of a rea-
sonable price;
• Recognizing future returns will largely be determined
by the dividends you receive;
• Diversify the portfolio among different types of expo-
sure;
• Pay attention to management efficiency in the use of
capital and investments;
• Respect monetary conditions as shown by policy inter-
est rates and the yield curve;
• Minimize your transaction and investment costs; and
• Allow technical and credit conditions to guide the tim-
ing of entry/exit.
The sector rotation advisory from this model is made in the
context of a typical "portfolio policy statement," which
ensures the portfolio composition aligns with the typical
investor's goals, objectives, and tolerance for risk. The
"policy statement" guidelines form the basis for the con-
straints we place on the portfolio, and collectively define
the investment objectives and style.
Thus, we seek to derive the sector weights that maximize
the portfolio total return, subject to these "policy state-
ment" constraints:
• The benchmark to be used to judge the portfolio results
is the MSCI USA Index.
• This portfolio has stocks only, with no exposure to
bonds, cash, commodities, etc., and is always fully
invested.
• The portfolio is to be invested only in the compa-
nies/sectors that comprise the MSCI USA Index,
meaning it only has exposure to "large cap" U.S. com-
panies, with no international or small cap exposure.
• This is a "long only" portfolio; we prohibit any "short-
ing" of sectors.
• We avoid an over-concentration on a few sectors by
setting limits on the amount of over- or underweight-
ing (+50%/-50%) that is allowed for each sector rela-
tive to the benchmark.
• To ensure proper diversification, no combination of
any three sectors in the portfolio can account for over
70% of the portfolio.

3. WIS Stock Sector Rotation Model 3
Global Insight
The results of the portfolio optimization—which is subject
to the aforementioned constraints—are best interpreted as
fundamental, quantitatively based views on the best strate-
gic sector composition of portfolios.
Overlay of Technical and Credit Conditions
Fundamental metrics alone are not adequate for investment
strategy. Many studies that investigate the relative influ-
ence of technical conditions and fundamental factors on
investment performance conclude they both have "explana-
tory" information for future returns1, 2. As a result, invest-
ment approaches that consistently outperform market
benchmarks typically pay attention to, and respect, the
technical and credit conditions in the market, in addition to
equity fundamentals.
In our framework, the fundamental metrics provide the first
basis for sector investment strategy. However, the actual
over/under setting of sectors is augmented and tempered by
measures of the technical conditions in the market, in addi-
tion to measures of the direction of change in sector credit
quality. Our stock sector rotation framework ensures each
of these perspectives is incorporated into the sector invest-
ment strategy.
When all three of these perspectives (fundamental, techni-
cal, and credit) agree with each other, there is a strong basis
for over- or underweight of the sector. However, when the
technical and/or credit indicators give a result that dis-
agrees with, or even contradicts, the fundamental indica-
tors, there is a basis for more caution.
The technical indicators we use as overlay to fundamental
analysis capture the recent momentum of sector stock price.
They show the extent to which stock prices are moving up
or down in recent months relative to their one-year history,
and the extent to which the sector patterns are better or
worse than the pattern in the overall MSCI USA Index.
The risk direction indicators we use in the overlay are
drawn from Global Insight's Sector Risk Ratings, which
measure the credit and operating risks present in each sec-
tor. The Sector Risk Ratings show the current relative level
of credit and operating risk in each sector, and whether that
risk is getting better or worse over time.
The Sector Risk Ratings are built up from 40 individual risk
factors that reflect and predict changes in credit quality.
These risk factors are derived from the standard credit risk
frameworks used in corporate lending and fixed-income
portfolios. They also show the effect of industry structure,
stage in lifecycle, and sovereign/macroeconomic environ-
ment on industry risk profiles. (For more information on
Sector Risk Ratings see www.globalinsight.com/WIS-Risk.)
To incorporate the risk perspective into our stock sector
rotation strategy framework, we calculate the indicator
called "Sector Risk Direction," which shows the direction
and relative magnitude of changes in the credit profile in
each of the stock market sectors.
The Findings
Figures 1 and 2 summarize the August 2006 recommenda-
tions for sector rotation strategy, shown here as overweight
and underweight positions relative to the MSCI USA Index
benchmark.
Figure 3 shows the current, neutral sector composition of
the MSCI USA benchmark—the amount, in percentage
terms, that each sector represents as compared to the total
MSCI USA Index. The "neutral" sector weights in the
benchmark are based on the size of market capitalization as
of July 2006.
Notice that in the benchmark the financials sector has the
largest share (21.8%), followed by information technology
(15.4%) and healthcare (12.1%). Since these three sectors
collectively represent almost 50% of the MSCI USA mar-
ket capitalization, most of the movement in the overall
index will be determined by these sectors.
The sector rotation model recommends that the consumer
staples and healthcare sectors be given an overweight posi-
tion relative to the MSCI USA benchmark for investing
over the next four quarters. By contrast, the energy, con-
sumer discretionary, and utilities sectors have relatively
poor fundamentals for investment.
Currently, the consumer staples sector has a sizeable over-
weight recommendation, helped in part by its "defensive"
nature in a slowing economy. The companies in this sector
1 James P. O'Shaughnessy, What Works On Wall Street, 2nd ed. (Columbus, OH:McGraw-Hill, 1998)
2 Bollinger, J. 2004, "Combining Technical and Fundamental Analysis", CFA Equity Topics: Highlights from the 2004 CFA Institute Annual Conference

4. WIS Stock Sector Rotation Model4
August 2006
often show consistent earnings growth over the course of
the business cycle from selling relatively "inelastic" prod-
ucts and services. This feature is reflected in lower meas-
ures of volatility in stock prices and earnings growth rates
than is typically seen in other sectors.
An attractive sector valuation also boosts the relative
prospects for total future return from consumer staples.
Despite seeing stock prices rise in line with those of the
overall market (as shown by the neutral momentum indica-
tor), the dividend yield from this sector is still compara-
tively high.
Appendix 1 shows the latest setting for the fundamental
factors for all sectors. In this table, consumer staples show
a good dividend and rising payout ratio. Further, while a
sector P/E for consumer staples of 19 is not particularly
low when compared to other sectors, it is lower than its
own history (consumer staples have a 10-year average P/E
of 23). Also, the forward growth of profits from this sector
is strong enough to lower the "PEG" ratio to an even more
historically attractive range, and to raise the free cash flow
"turning point" indicator well above one. In addition, the
improving fundamental indicators are a large factor in
determining an improving credit outlook for this sector.
The healthcare sector also merits an overweight recom-
mendation from both fundamental and risk perspectives.
Despite seeing its stock price momentum lag behind the
overall market during the past year (shown by a negative
reading on the momentum indicator), healthcare still sup-
ports a reasonable dividend yield on average. Furthermore,
the yield has been rising in recent years and now stands
some 6% above the sector's own historic average. Perhaps
the most attractive aspect of this sector is the robust
prospect for future earnings growth due to faster sales and
positive pricing power. Relatively fast profits growth rais-
es the FCF turning point indicator up to a very attractive
1.3, and lowers the PEG ratio down to a level that is less
than one-half the value seen historically in this sector.
Like healthcare and consumer staples, the industrials sector
is relatively undervalued, while the earnings trend remains
intact. However, industrials are usually more economically
sensitive than these other sectors. In recent years, this fea-
ture has supported the industrials sector, as shown by a pos-
itive reading in the momentum indicator. However, the
outlook now is for a slowing economy and a tough pricing
environment for industrial commodities and supplies.
Fortunately, the performance of the U.S. industrials sector
will be boosted by strong earnings from overseas, as a
weaker dollar and robust demand from Asia support a still-
healthy growth rate for sector profits. So, while the per-
formance of industrials remains very solid to date, a
worsening perspective for future credit quality tempers
what would otherwise be a solid overweight recommenda-
tion for the industrials sector.
The financial sector is, by far, the largest sector in the mar-
ket, so sector rotation strategy must take a view on what
kind of exposure should be placed here. The recommenda-
tion for the financial sector as a whole is for a neutral set-
ting within the portfolio, but this is largely due to diverging
trends among several of the key sub-sectors within finan-
cials. For example, the prospects for the real estate sub-sec-
tor are very poor, with an underweight setting indicated by
both the fundamental and credit indicators. However, the
outlooks for the insurance and, to a lesser extent, banking
sub-sectors are positive on balance. If real estate were to be
excluded from the financials sector, the remaining compo-
nents would warrant an overweight recommendation in the
overall portfolio.
By contrast, the relative view of the energy and consumer
discretionary sectors is unambiguously negative for related
reasons. The energy sector's future prospects are in large
part a victim of the success of the recent past, having
enjoyed the biggest run-up in stock market prices over the
past few years, largely on the strength of steadily higher oil
prices. However, while high oil prices are expected to
remain in place for several years, supported by strong
demand from China and other fast-growing emerging mar-
kets, the prospects for further increases in prices are capped
by an expected slowdown in the U.S. economy and price-
induced attempts to lower demand.
The consumer discretionary sector is similarly sensitive to
the impact of a slowing U.S. consumer market. The dividend
yield for this sector is unattractive anyway, and the prospects
are further clouded by a negative reading in both the credit
risk indicator and the technical momentum indicator.
by Mark Killion, CFA, and Natasha Muravytska

5. WIS Stock Sector Rotation Model 5
Global Insight
FIGURE 1
Recommended Portfolio Weighting for 10 U.S. Stock Market Sectors over Next Four Quarters
(Over (+), equal (=), or under (-) weight setting relative to the portfolio benchmark)
Fundamental
Indicators1
Four-
Quarter
View
One-
Quarter
View
Technical
Indicator2
Risk
Direction3
Recommendation
Consumer
Staples
++ ++ = + Overweight
Healthcare ++ ++ - + Overweight
Industrials ++ - + - Small Overweight
Financials Excl.
Real Estate
= + = + Small Overweight
Real Estate - - + - Underweight
Telecomm.
Services
- + + + Equal Weight
Information
Technology
- = - = Underweight
Materials - - + - Underweight
Utilities - - = + Underweight
Consumer
Discretionary
-- -- - + Underweight
Energy -- -- + - Underweight
August 2006
1 Over/underweight setting from Global Insight WIS Stock Sector Rotation models.
2 July 2006 Sector Price Index divided by the average from the previous 12 months.

6. WIS Stock Sector Rotation Model6
August 2006
6Copyright ® 2005 Global Insight, Inc.
SSR Model Expected Returns Drive
the “Optimal” Sector Weights to
Maximize Total Return for Portfolio
Real Estate
1.8%
Financials
ex. RE
20.0%
Health Care
12.1%
Consum er
Staples
8.8%
Materials
2.9%
Industrials
11.3%
Cons.Disc-
retionary
11%
Utilities
3.4%
Energy
9.9%
IT
15.4%
Telecom s
3.4%
-5.5 -3.5 -1.5 0.5 2.5 4.5 6.5
Q3 2006, 1-q Model Forecast
Q2 2007, 4-q Model Forecast
Sector Over/Underweight Resulting from First-
Quarter-Ahead (Third-Quarter 2006) and Fourth-
Quarter-Ahead (Second-Quarter 2007) Portfolio
Optimization
(Forecast from August 2006)
Information Technology
Financials excl. Real Estate
Utilities
Telecoms
Materials
Energy
Consumer Staples
Consumer Discretionary
Health Care
Neutral Sector Weights, August 2006
Portfolio Sector Weights from Fourth- and First-Quarter SSR
Models (August 2006 View)
Industrials
Real Estate
FIGURE 2
Recommended Portfolio Weighting for U.S. Financial Industries over the Next Four Quarters
(Over (+), equal (=), or under (-) weight setting relative to the portfolio benchmark)
FIGURE 3
Fundamental
Indicators1
Four-Quarter View
Technical
Indicator2
Risk
Direction3 Recommendation
Financials Excl.
Real Estate
++ = + Overweight
Real Estate - + - Underweight
Insurance ++ - + Overweight
Banks + = + Overweight
Diversified
Financials
= = + Neutral Weight
August 2006
1 Over/underweight setting from Global Insight WIS Stock Sector Rotation models.
2 July 2006 Sector Price Index divided by the average from the previous 12 months.

7. WIS Stock Sector Rotation Model 7
Global Insight
APPENDIX 1
Stock Sector Model Factor Matrix
(Data available in August 2006)
Fincls.
Cons. Cons. Health Excl. Real Real
Sector/Q2 2006 Energy Materials Indus. Discr. Staples -care Fincls. Estate Estate Tech. Telecoms Utilities
Dividend Yield (%) 1.41 2.24 2.02 1.12 2.28 1.60 2.70 2.60 3.57 0.73 3.18 3.40
Dividend Yield Divided by Historical Average3 0.58 0.96 1.21 1.08 1.10 1.06 1.21 1.21 0.76 1.89 1.16 0.80
Payout Ratio 0.13 0.53 0.33 0.22 0.38 0.30 0.37 0.31 0.87 0.12 0.59 0.70
Payout Ratio Divided by Historical Average3 0.29 3.06 0.55 0.72 1.01 0.51 1.04 0.79** 0.40 0.74 1.33 1.41
Payout Ratio Turning Point4 0.59 0.70 0.94 1.05 1.06 0.96 1.07 1.05 0.96 1.01 1.03 0.93
P/E Ratio 12.67 15.81 17.53 20.76 18.99 20.04 14.28 13.55 42.93 21.35 21.14 16.15
P/E Divided by Historical Average3 0.63 0.65 0.79 0.66 0.84 0.73 0.88 0.82 1.02 0.42 1.01 0.97
Three-Year-Forward Growth of Profits, (2006-09) 3.88 2.72 7.73 8.02 3.09 11.63 3.55 9.03 0.39 10.38 7.65 4.62
Three-Year-Forward (2006-09) Profit Growth Divided
by Historical (1998-2005) Compound Growth Rate 0.13 0.79 1.33 3.51 0.92 1.51 0.20 1.59 -0.56 2.69 1.61 1.25
PEG (P/E Divided by Three-Year-Forward Profits
Growth) 3.26 5.81 2.27 2.59 6.15 1.72 4.02 1.50 109.53 2.06 2.76 3.49
PEG Divided by Historical Average1 0.61 0.50 0.57 0.03 0.55 0.46 1.01 0.64 7.19 0.16 0.57 0.33
One-Year-Forward Free Cash Flow Growth in
First-Quarter 2006 (2006-07) -8.19 4.22 8.59 8.68 4.09 26.15 -9.75 17.26 -29.83 8.66 15.38 5.17
Three-Year-Forward (2006-09) FCF Growth Divided by
Historical (1998-2005) Compound Growth Rate 0.01 0.51 1.06 2.43 0.71 1.72 0.44 1.42 -2.51 1.17 0.62 2.49
Free Cash Flow (FCF) Turning Point5 1.97 1.27 1.22 1.14 1.07 1.27 1.08 1.23 0.98 1.30 1.09 1.22
3 Historical Average Calculated over first-quarter 1995 through first-quarter 2006.
4 Payout Ratio Turning Point Calculated as the latest annual sector observation divided by a three-year moving average of the previous data observations.
5 Free Cash Flow Turning Point is calculated as the sum of the combination of the latest and forward annual sector observation divided by a 3-year moving average
of the previous data observations.
Macro Drivers for Stock Sector Rotation
(July 2006)
Q2 2004 Q3 2004 Q4 2004 Q1 2005 Q2 2005 Q3 2005 Q4 2005 Q1 2006 Q2 2006
Three-Month T-Bill Rate 1.01 1.43 1.95 2.47 2.94 3.46 3.98 4.46 4.91
10-Year T- Bill 4.60 4.30 4.17 4.30 4.16 4.21 4.49 4.57 5.07
Yield Slope 4.55 3.00 2.14 1.74 1.41 1.22 1.13 1.03 1.03