Why Business Cycle Investing Matters Today

Economies move through different phases of growth, and each phase tends to influence market segments and sectors differently. Some parts of the market perform better than others at specific stages of the economic cycle. Business cycle investing involves designing a portfolio that is positioned to perform well across these changing phases of the economy.

It first starts with identifying the prevailing business cycle. A business cycle in the growth phase is typically marked by high consumer and business confidence. Factories run at full capacity, companies plan expansion, the job market is buoyant, and discretionary spending is strong. On the other hand, a slump phase is marked by delayed spending and idle factory capacity. Companies cut capital expenditure, job markets weaken, and consumer demand remains low. During the recovery and early expansion phases, sectors such as financials, consumer discretionary, and metals tend to do well. In contrast, defensives like pharmaceuticals, IT, and consumer staples may underperform in the recovery phase and deliver more moderate returns during periods of expansion.

Why is business cycle investing more relevant now? There has been a significant change in the factors that influenced business cycles in the last few decades. Business cycles were driven by more supportive factors such as disinflation (low inflation and low interest rates), de-escalation (lower geopolitical tensions) and monetisation (easy liquidity conditions). However, macro factors are likely to be more dynamic now as the global environment has changed. From disinflation, the world has moved into a phase where inflation is now an integral part. From de-escalation, the geopolitical tensions have escalated to an all-time high. From easy monetary policies, there has been a tightening.

As macroeconomic conditions change rapidly, investment strategies need to remain nimble. Portfolios must shift across sectors swiftly to manage risk and reduce volatility.

Business cycle investing offers another advantage in the form of diversification across sectors, themes, market capitalisations and investment styles. Since investments are aligned with prevailing economic phases, portfolios can shift across market segments as the business cycle evolves.

The process of identifying business cycles involves tracking multiple economic indicators. These include macro parameters such as the current account deficit, fiscal deficit, interest rates, credit growth, inflation, and the Index of Industrial Production. Investment indicators include capex investments and new projects approvals, among other things. Business and consumer sentiment are gauged by tracking Purchasing Managers’ Index, Business Confidence Index, sales of various consumer discretionary products, etc. Global factors such as developed markets growth outlook, emerging markets growth outlook, are also considered.

If the business cycle is strong both domestically and globally, portfolios may tilt towards cyclical sectors. These include metals, mining, oil, consumer durables, financials, automobiles, capital goods, and infrastructure. On the other hand, if the domestic and global business cycle is in a weak phase, sectors such as consumer staples, power and utilities may get favoured. The stocks in each of these sectors are then identified based on their business fundamentals. Business cycle investing may also entail keeping some cash in the portfolio to take advantage of emerging investment opportunities as the macro conditions evolve.

For long-term investors, business cycle investing provides a disciplined framework to respond to changing conditions. By focusing on broader economic trends and sector dynamics, it helps improve risk-adjusted returns over time. Business cycle funds translate this approach into a professionally managed, dynamic allocation strategy.

Disclaimer: Sharath Ferdinand Mascarenhas is Founder and CEO of MishMash Finserve. The views expressed are his own. This is partner content and not an Outlook Money editorial feature. Outlook Money does not provide investment advice or endorse any products or services mentioned.

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