THE SOUTH AFRICAN INDEX INVESTOR |
“Greater rewards, lower costs” |
TOOL BOX |
Investment Philosophies, Theories and Practices (continued…)
Investment Opportunities in an Economic Cycle
Most of the time, financial markets attempt to predict the state of the economy, typically six months into the future. This means the market cycle (bull market, market top, bear market and market bottom) is usually well ahead of the economic cycle. For example, when the economy is in a deep recession, the market will look ahead at possible signs of recovery, and if it does find some evidence thereof stock prices will start to move up.
But important to remember: certain sectors of business profit more than others in certain stages of an economic cycle. Therefore, some investors and traders try specifically to invest in sectors which offer relative value to others in anticipating that those sectors will benefit from a specific stage of the economic cycle—otherwise known as sector rotation.
The following table describes the different stages and typical characteristics of the economic cycle. The diagram (next page) shows those business sectors that proved historically to be successful investments at certain stages of the economic cycle.
However, be warned: this is not a infallible method of investing; external factors or unforeseen events may play havoc with the eventual outcome of one’s bet on the performance of certain sectors.
|
Economic Cycles |
Full Recession |
Early Recovery |
Late Recovery |
Early Recession |
State of the Economy |
Consumer expectations have bottomed
Industrial production has bottomed
Interest rates are falling
Yield curve is normal
|
Consumer expectations are rising
Industrial production is growing
Interest rates have bottomed
Yield curve steeper |
Consumer expectations are beginning to decline
Industrial production is flattening out at the top
Interest rates are rising
Yield curve is flattening
|
Consumer expectations are at their worst
Industrial production is falling
Interest rates are at their highest
Yield curve is flat or inverted |