For students of investing, one of the first principles taught is that commerce occurs in cycles, much like the ebbs and flows of waves in nature. The demarcations of these business cycles are typically recessionary periods, a time for consolidation and regrouping in order to recover and begin the next positive wave. No matter what the prevailing trend might be in the cycle, various market sectors are known to historically perform better than others, providing opportunities in both bear and bull market periods. Understanding these business “seasons” and how to recognize related investment opportunities is commonly referred to as seasonal investing.
The key point is that whether you are in a down market or one in recovery, there are specific sectors that traditionally offer better returns than others. The following diagram portrays the relationship between sector performance in the stock market cycle and the peak and trough activity of the economic cycle:
The positioning of various sectors is based on a study of years of historical data and should not be construed to mean that this representation will always hold. Past performance is never a guarantee of future results, but from a pure probability perspective, there is enough consistency in the above pattern that “seasonal” investors have taken advantage of these relationships and profited in the process.
The first “takeaway” from the diagram is that the stock market generally precedes actual results in the business cycle. Analysts have estimated that the markets anticipate results six months down the road and factor those results into today’s valuations. On the chart, this timing difference is represented by the difference between the “Top” of the “blue” stock market cycle and the “Peak” of the “gold” business cycle.
The current recession ended last year, but the “trough” has been extended while a mild recovery has gradually developed. However, there has been a mild bull market for the past seven months, driven primarily by government stimulus programs. There is still doubt if our recovery will stabilize once the Fed discontinues its Quantitative Easing program in June, but currently, the market appears to be optimistic.
As mild as our recovery has been, initial attention last year focused on UPS and Fed-Ex. Transportation stocks signal that commerce is moving again. Increases in transactions are confirmation that favorable trends are imminent. Banking stocks typically move early also, reflecting more financial support for business growth, but in the current case, banks are more the exception than the rule due to persisting problems with foreclosures in the real estate industry. Technology and basic industry are next in line and have shown appreciation in the recent run-up in stock values.
Seasonal investors need not focus only on domestic offerings. Today’s investor must be global in perspective since much of the growth in global commerce has been in emerging market countries. Overseas investing does involve more risk, as anyone engaged in forex trading would advise. Gains in a foreign company can be wiped out if the Dollar appreciated materially versus the other company’s currency. A forex broker can provide hedging tools, but hedging is not for the inexperienced.
The best way to invest “seasonally” and in markets overseas is by way of the many exchange-traded fund offerings on the market. One can easily construct a well-diversified portfolio of shares from a variety of funds devoted to investing in specific market sectors. If an individual stock appeals to you, then that can also be added to the mix.
Seasonal investing benefits from the business cycle’s “rollercoaster” ride. Use these principles to get the most out of your ride.