Getting Your Investment Strategies in Sync with Business Cycle Turns

This article is not about market timing, since I believe it is not possible to time the market or business cycles immaculately. Each business cycle is a consequence of complex and deeply interconnected corporate and government decisions. And neither comes with a manual or an instructional video. Thankfully, historic evidence offers some, though limited, insight into how investors can make informed adjustments to their portfolios.

A recovery is when the economy starts picking up the pace after either a slowdown or a recession. As it takes hold, investors who have reported profits from those periods have invested in cyclical stocks and commodities.

As the recovery hits an early upswing, further gaining momentum on increased consumer confidence, attractive investments are also commercial and residential properties. Of course, if there is an early upswing, there is bound to be a late upswing as well. This is when the boom — and, in some cases, bubble mentality — takes hold. If history is to teach us anything, it’s usually not a good idea to buy stocks when markets are peaking, and the same goes for commodities and real estate. However, it just might be the right time to buy bonds, since yields are increasing, as well as interest- rate sensitive stocks.

After the peak, it is typically the time for the economy to slow down a bit or a lot, or even go into a recession. In any event, the economy is likely to go into a perfectly natural decline, during which time bonds and interest-rate-sensitive stocks remain good investments, enjoying decreasing interest rates and the resulting high yields.

Sometimes an economic slowdown turns into a recession. Typically, monetary and fiscal policies will be eased. However, for any such measures intended to stimulate the economy to switch into a higher gear there could be a considerable time lag, which is something investors should bear in mind. And as the recession nears its end, commodities and stocks again are good investments to think about.

Now, as I’ve said at the beginning, I don’t believe that business cycle/market timing can be done with any reasonable amount of precision. Still, more or less belatedly and based on empirical evidence, investors can recognize the shifts in gears and act accordingly.

Some food for thought: the Federal Reserve might be done with cutting interest rates, yet it has pumped an unprecedented amount of money into the economy. Commodity prices are skyrocketing, while the greenback is spinning down the toilet. Job numbers are yo-yoing up and down, while manufacturing and durable goods orders are in a nosedive.

Then there are the serious concerns as to the exposure of financial institutions to subprime loans and their marking-to-market, while budget, current account and other deficits very much remain issues to worry about. In my humble opinion, although the signals are mixed at best, the U.S. economy is at least experiencing a worrisome slowdown.

As for Canadian investors, although things are not nearly as bad here as they are in the U.S., we cannot ignore the fact that our two countries occupy a heck of a lot of space on one continent. Although our respective economies are diverging one from another more and more, there are bound to be unpleasant aftershocks in Canada as well in the months to come.