Rotate Sectors With The Cycle Not The Noise

In the years post-COVID, there have been phases of boom, bust and flat movements. During this period, there have been factors such as geopolitical escalations, supply chain disruptions, central bank actions, trade tariff impositions and selling from foreign investors and AI-related job disruptions that have impacted markets.

Presently, while India’s fundamentals are in a reasonably healthy position, global headwinds are weighing on markets, with the rupee in a downward trajectory with FPIs selling relentlessly, even as any resolution to US penal trade tariffs doesn’t seem near. Economies and industries (sectors/companies) go through their own cycles.

From an investing perspective, making the connect between macros and business cycles can be rewarding over the long term. Such an approach is at the core of business cycle investing, by identifying the right sectors and churning them based on macro data movements.

Growth, recession, slump and recovery are generally the four phases of a business cycle.

Making cycles work

It is important to know which phase is prevalent at any point in time to be able to identify the right sectors.

Some examples from the past could serve as guideposts. In 2003-2004, global growth was strong, while domestically, India was in a recovery phase. Banks and capital goods thrived in that environment. During 2008-2009, in the aftermath of the global financial crisis, global growth was weak, while domestic growth was in a strong recovery phase. It was time for domestic cyclicals, including autos, to flourish. From 2018 to 2020, India was in a recessionary phase, even as global growth was strong. Technology, pharma and FMCG rallied well in such an environment. In 2021, domestic growth also bounced back to the recovery phase, and so banks and capital goods staged a rally.

Some key parameters are used for identifying the phase of a cycle.

Macro parameters include current account deficit, fiscal deficit, IIP growth, interest rates, inflation, credit growth, etc. Investment indicators are CapEx investments, new projects cleared, etc. Business and consumer sentiment factors are purchasing manager index (PMI), business confidence index, sales figures of discretionary goods such as air conditioners, two and four wheelers, white goods, etc. Global factors are developed economies’ growth outlook and policy stances, China’s growth and policy outlook, cross-currency movements, etc.

Portfolio construction

Taking the right approach for business cycle investing is critical for making it a success.

It starts with a top-down analysis of various macro indicators mentioned earlier, the prevalent cycle is identified. Subsequently, at a broad level, the most suited sectors or themes for any prevalent phase of a cycle at a given time are chosen.

After selecting the sectors or themes, the stocks within these segments are chosen based on various financial parameters and their track record to make the most within a phase of the cycle.

Investments must be made across market capitalisations – large, mid and small – with no capping or any minimum requirements. There must also be no limits or capping on the allocation to individual sectors or themes within the portfolio. The holdings must be managed dynamically by churning the sectors smartly based on evolving macro data and rebalanced suitably.

Business cycle funds would help retail investors benefit from macro-driven sector churning suited to various phases of the economy/industry. The fund manager uses internal models to decide which sectors to increase or reduce exposure to at the right time, making the process simpler and more effective for retail investors.

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