Business cycle based investing : Who is it suitable for?

Just as nature undergoes seasonal changes, businesses also go through different cycles. Each sector or business follows its own cycle, and being able to recognize, adjust, and invest in the right theme or sector during the current cycle is essential for successful investing. A typical business cycle comprises four main phases: Recovery, Expansion, Recession, and Slump.

Recovery: This phase in the business cycle signals a turning point after a contraction or recession, where economic activity starts to rebound. In this phase key economic indicators, such as employment rates and consumer spending, show signs of improvement.

Expansion: In the expansion or growth phase, various key aspects come into play. Consumers and businesses gain confidence, factories operate at full capacity, businesses plan expansions, employees receive multiple job offers, experience salary hikes, and consumers engage in buying discretionary goods and planning vacations. This phase typically has a duration shorter than the recovery phase.

Slump: Conversely, during a slump phase, consumers and businesses become nervous and delay spending. Factories operate with idle capacity and reduced shifts, businesses implement cost-cutting measures and reduce capital expenditures, layoffs and salary freezes occur, and consumers opt for spending cuts. The duration of this phase varies but is generally shorter than the recession phase.

Recession: The recession phase is characterized by a substantial decline in economic activity across various sectors. Key economic indicators, including gross domestic product (GDP), employment rates, and consumer spending, undergo a significant contraction. This phase usually follows the peak in economic activity and precedes the recovery phase. On average, the recession phase lasts between 6 to 18 months historically.

Depending on the economic parameters, one can determine our current position within the four cycles. It is important to note that it is difficult to identity the exact time frame of each cycle as there are no typical patterns. External events such as policy adjustments, technological advancements, and global economic conditions also impact the duration and intensity of each phase.

What is business cycle investing?

The initial step in business cycle investing involves determining the current economic phase. This can be done by comprehensive analysis of four key parameters. Firstly, macroeconomic factors, including the interest rate scenario and fiscal deficit, provide crucial insights. Secondly, investment decisions, particularly capex investments indicate the ongoing cycle. Thirdly, evaluating the sentiments of businesses and consumers, as seen in the sales of discretionary products, offers valuable perspectives. Lastly, considering global factors, especially the growth in developing economies, contributes to a comprehensive understanding.

This comprehensive analysis helps in identifying the phase of the business cycle. It is essential to do this analysis for both domestic and international economy. Based on this analysis, one can identify the right investment theme for the current market scenario.

The next step is to allocate in the theme suitable for the current market scenario and adjusting investments from one sector to another based on the business cycle phase. For example, during times like 2011 and 2012 when the global scenario was weak and domestic markets experienced a slowdown, investors who made defensive choices like technology and pharmaceuticals stood to gain. Conversely, from 2013 onwards, as sentiments improved on an overall basis, and the domestic economy began to recover, shifting towards sectors like banks and auto could have been more fruitful. Hence, in business cycle investing, continuous rotation from one theme to another basis the change in economic cycle is crucial for generating alpha.

Additionally, unlike other investment strategies such as value or contrarian investing, business cycle investing adopts a top-down approach. In this approach, investments are typically made across market caps, themes, and sectors.

Who should invest in business cycle?

While business cycle investing can offer interesting opportunities, it is important to note that predicting market movements is inherently challenging, and equity investing always carries higher risks. Further, investing in business cycle requires a lot of patience. If you are someone who can wait for a long time and handle the ups and downs, you might gain from tactical allocation to get potential returns over a long period. Further, individuals with high risk appetite looking for a well-diversified portfolio may explore business cycle investing as it lets you spread your money across different types of businesses that do well in different economic situations.

(The author is Director, Wealthy Wallet Financial Services)