Dating back to 1854, it has been proven that certain sectors of business profit more in certain stages of an economic cycle. The arrangement of stages provides sound investment strategies that involve the movement of money from one industry sector to another, in an attempt to beat the market. Market cycles predict the state of the economy one to two quarters in advance ahead of the economic cycle. Watching for telltale signs of which companies will be successful in the coming stages of an economic cycle can give great insight into which stage the economy is in. As the economy is in the pits of a recession, the market begins to look ahead to a recovery, and opportunities arise to acquire undervalued stocks at steep discounts and bonds with high coupons.
THE MARKET CYCLE
MARKET BOTTOM - represented by diving prices, culminating in a long-term low.
BULL MARKET - begins as the market rallies from the market bottom, nowhere to go but up.
MARKET TOP - hits the top, the ceiling of the bull market, which begins to flatten out.
BEAR MARKET - Down we go again to the next market bottom.
THE ECONOMIC CYCLE
FULL RECESSION - GDP has been retracting for 2 straight quarters, unemployment is high, interest rates are falling, consumer expectations have bottomed, and the yield curve is normal. Sectors that profit most in this stage include:
Cyclicals and transports (near the beginning) - those that produce durable goods such as raw materials and heavy equipment, airlines
Technology - the manufacturing of electronics, creation of software, computers, the latest IT services, and upgraded database systems
Industrials (near the end) – producers of goods used in construction and manufacturing, aerospace and defense, industrial machinery, tools, lumber production, construction, cement and metal fabrication. Closely follows the S&P 500.
EARLY RECOVERY - This is when things start to pick up, GDP has been expanding for 2 straight quarters, consumer expectations are rising, industrial production is growing, interest rates have bottomed and the yield curve is beginning to get steeper. Sectors that profit most in this stage include:
Industrials (near the beginning)
Materials - supplies materials for construction, the mining and refining of metals, chemical producers, and forestry products.
Energy (near the end) – Exploration and development of oil/gas reserves, oil/gas drilling, or integrated power firms. Very sensitive to political events.
LATE RECOVERY - Interest rates rise rapidly, with a flattening yield curve. Unemployment is low, however consumer expectations are beginning to decline and industrial production is flat. Sectors that profit most in this stage include:
Services (near the end) – Intangibles, 2/3 of overall US economic activity, consisting primarily of truck transportation, messenger services and warehousing, information sector services, financial investment services; rental and leasing services, professional, scientific & technical services, administrative and support services; waste management and remediation, health care and social assistance, arts, entertainment and recreation services.
Energy (near the beginning)
Noncyclicals and Staples - food, beverages, tobacco and household items, goods that people are unwilling to cut out of their budgets regardless of their financial situation.
EARLY RECESSION - This is where things start to go bad for the overall economy. Consumer expectations are at their worst, industrial production is falling, interest rates are at their highest, and the yield curve is flat or inverted. Sectors that profit most in this stage include:
Services (near the beginning)
Utilities – contains electric, gas and water companies and their integrated providers. As interest rates fall, the debt-loaded utility companies will increase debt repayments significantly.
Cyclicals and transports (near the end)
Important Reports and Leading Indicators
Weekly jobless Claims – is a 4 week U.S. unemployment moving average, doesn’t include self-employment, part-time employment, or independent contractors.
Housing Starts – picks up during early recovery (expansion) phase of the economic cycle, ignores home sizes & prices.
Existing Home Sales – focuses on home demand, has a two month backlog due to it taking two months on average to close on a home.
Consumer Confidence Index – predicts consumer spending, which accounts for 70% of the economy.
Purchasing Managers Index – collects information from 400 purchasing managers around the country, is usually a good indicator of growth in GDP.
Durable Goods Report – provides data from more than 4000 manufacturers in 85 industries of new orders of higher-priced capital goods with a useful (income-producing) life of three years or more.
FED Beige Book – is published eight times a year by the Federal Reserve Board, 4 weeks in advance of the meeting of the Federal Open Market Committee, who are in charge of injecting liquidity into the US markets by buying and selling U.S. Treasury securities, as well as setting the federal funds rate - the rate that commercial banks charge between themselves for overnight loans.