What is Business Cycle-based Investing?

Just like life, businesses too have their ups and downs. Different factors such as interest rates, employment scenarios, and monetary policies drive businesses' profits. Generally, businesses tend to grow when the economy grows and fall when it contracts. However, this might not always be the case. When the economy contracts, some sectors perform better than others. Is there a way to take advantage of the business cycles?

Business Cycle-Based Investing helps investors take advantage of the different stages of the business cycle. Phases of Business Cycles: A business cycle consists of four main stages: recovery, expansion, recession, and slump.

Recovery: Recovery is when the economy grows, companies produce more, and employment rises. As a new business cycle starts after the last cycle has hit rock bottom, in this stage, investors and traders start to buy securities as they believe that the worst is over. During this stage, the technology sector performs well as the demand for innovative products and services increases. Moreover, as there is confidence that the economy will grow, consumer spending on discretionary (non-essential items) increases. The industrial and infrastructure sectors also get a boost.

Expansion: As the name suggests, expansion is when the economy expands and reaches its peak. The key economic indicators are at their highest. Employees have multiple job offers, and factories are running on all three shifts. Financials, consumer discretionary, energy, and metals are the sectors that tend to outperform other sectors. This stage is marked by rising inflation, low unemployment, and optimistic investors.

Recession: The contraction phase or recession comes next. In this phase, there is a decline in economic activity, production starts to go down, unemployment rises, and individual spending falls. Central banks might begin to tighten their monetary policies because of high inflation. This, in turn, makes it hard for people and businesses to borrow money, which paves the way for the next stage. It is also essential to understand that external factors such as geopolitical events and natural disasters can also lead to a recession as the investor sentiment is generally down in such a scenario.

Slump: Slump is the last phase of recession, where economic activity and employment are at their lowest. GDP, corporate profits, sales, and other economic activities are also down. Borrowing money is tough for people and businesses. Moreover, companies tend to lay off employees, pause salary hikes and promotions, and halt expansion programs. As a result, discretionary spending goes down, and people tend to buy things that they will need, irrespective of the economy's performance. Hence, in this stage, companies related to healthcare, consumer staples, and utilities tend to perform well.

Business Cycle Based Investing
We have seen that different sectors of companies tend to perform differently at different stages of the business cycle. In the case of business cycle-based investing, investors have to make investment decisions based on the changes in the business cycles.

Investors use macro parameters, investment indicators, business and consumer sentiment, and global factors to ascertain the business cycle phase and strategise their investment moves. Macro parameters include Current Account Deficit, Fiscal Deficit, Interest Rates, Credit Growth, and Growth, while capex investments and new projects indicate the current investment scene. Sales of various consumer discretionary products help to figure out the sentiment.

Business Cycle Investing includes buying and selling certain stocks for maximum gains based on the business cycle. However, investing, rebalancing, and exiting investments at the right time is difficult. If you want to take advantage of the business cycle but don't have the time or expertise to do it manually, you can look at business cycle funds.

Business Cycle Funds are mutual funds that aim to take advantage of the changes in the business cycles by investing in sectors and stocks at different stages of business cycles. These funds invest by identifying macroeconomic trends and investing in the sectors and themes likely to outperform at a specific stage of the business cycle. Most of these funds invest across sectors and market caps, which makes the investment process extremely flexible. When investing in such a fund, investors should have an investment horizon of atleast five years and more.

By Pratik Desai,Founder & Managing Director,Shrinathji Investment