Business Cycle Investing A Tactical Edge in Market Volatility

After a relentless run for 3-4 years post the COVID-19 pandemic, the markets have seen deep correction over the past five months. As FPIs hit the exit button, corporate earnings decelerate, domestic growth slows, US trade tariffs hit several countries, and liquidity tightens, a turn of cycles is apparent, necessitating a new approach to making investment choices.

Business cycle investing, which involves smart juggling of sectors based on the phase of a business/economic cycle in operation domestically and globally by considering several factors, may help navigate choppy markets.

Both businesses and economies go through cycles. There are four phases of any business cycle – growth, recession, slump and recovery.

Over the better part of the previous two decades, global interest rates were benign as inflation was low, liquidity was abundant as monetary policy was highly accommodative and geopolitical tensions were minimal. This mix of factors was highly positive for equity as an asset class.

However, the situation has now turned and presents structural challenges for the coming years . From disinflation, we have move to a generally inflationary environment, high interest rates, tight liquidity and heightened geopolitical tensions in recent years. This phenomenon may well continue for the foreseeable future.

Thus market volatility may be high. Positioning your portfolio smartly to move between sectors and being nimble enough to make quick decisions relating to shuffling of segments becomes important to keep this volatility to moderate levels.

That is precisely what business cycle investing seeks to achieve.

Juggling sectors judiciously

For business cycle investing to work, it is important to make sure which phase of the cycle we are in at any point in time. This is judged with a set of factors.

Macro parameters include current account deficit, interest rates, inflation, fiscal deficit, IIP (index of industrial production) figures and credit growth.Investment indicators are factors such as capex investments and new projects cleared and so on.

Business and consumer sentiments are gauged via purchasing manager index (PMI), business confidence index and sales figures of various consumer discretionary products such as cars and two-wheelers.

Global factors include monetary policies of developed economies, their growth outlook, China’s growth and policy stance etc.

Based on various global and local scenarios, portfolio positioning can be done smartly via business cycle investing.

Now, when there is strong domestic growth and robust global growth, the portfolio can have a mix of domestic cyclicals (banking, auto, capital goods, consumer durables and infrastructure) and global cyclicals (metals, mining, oil etc.)

If there is weak global growth and dull domestic growth, exposure to domestic defensives would be the key. So, telecom, power, utilities and FMCG would figure prominently in the portfolio.

With weak global growth and strong domestic growth, domestic cyclicals would take precedence as key sectors while investing.

When there is strong global growth and weak domestic growth, a combination of global cyclicals, export-oriented sectors (Software, pharmaceuticals, auto ancillaries etc) and domestic defensives should find increased focus in the portfolio. A top-down approach is required to identify the business cycle phase and choose the appropriate sectors for investing.

Executing business cycle investing is challenging due to the difficulty of identifying economic phases on time and swiftly adjusting portfolios, as delays can lead to underperformance. This strategy requires deep sector knowledge, making it hard for lay investors. Therefore, investing through professionally managed mutual funds focused on business cycle investing is ideal.

Disclaimer: This article is not part of the Outlook Money editorial feature. The views expressed are personal and do not necessarily reflect those of Outlook Money. Readers are advised to do their own research or seek professional advice before making any investment decisions.

Mutual fund investments are subject to market risks. Read all scheme-related documents carefully before investing. Past performance is not indicative of future results.

Disclaimer: The Views are Personal and not a part of the Outlook Money Editorial Feature