Business Cycle Funds Try To Time Regimes Not Stocks

The 2020s have been markedly different from the 2010s in many ways. Today, we choose between electric and combustion engines when buying cars. We work partly from home. Television has been replaced by streaming platforms. Sustainability or climate consciousness influence are everyday choices and Artificial Intelligence is widening its reach in our lives. Digital payments have started to replace cash, and groceries and cabs arrive at our doorstep with a few clicks. Each of these shifts has required us to adapt and respond to a changing environment.

In much the same way, investing in equity markets today looks very different from the previous decade. Several underlying factors have evolved, requiring equity investors to reassess assumptions, adapt strategies to a new market reality. One strategy that aligns well with this changing environment is business cycle investing. Business cycle investing dynamically aligns portfolios with different phases of the economic cycle, namely, recovery, expansion, slowdown, and contraction, by adapting sector and stock exposures as market leadership shifts.

Business cycles in previous decades were driven by low inflation, low interest rates, relatively stable geopolitics, and easy liquidity, thus supporting equities and lower volatility. However, today, inflation is higher due to pandemic induced supply chain realignments such as near shoring and diversification of supply chains, elevating fiscal spending and the transition to green energy have all pushed costs higher. Also, climate related disruptions have started influencing commodity prices more regularly.

Due to higher inflation, central banks have less room to keep interest rates low. As interest rates are used to discount equity cash flows, higher interest rates put downward pressure on equity valuations. Inflation makes consumers prioritise essentials over discretionary spending, makes borrowing more expensive, impacting corporate revenues. As costs of various inputs go up, there is pressure on corporate margins raising uncertainty around earnings and valuations. From a business cycle perspective, such conditions typically lead to bigger performance differences in stocks and sectors, rather than broad-based rallies

Further, geopolitical tensions have added to these uncertainties. Geopolitical tensions also cause sharp moves in commodity, energy and food prices which affect inflation expectations, corporate margins, and central bank policy. These events influence investor risk taking and hurt market sentiments, making market rallies and corrections sharper and more frequent.

Such an environment increases the importance of business cycle investing. Different phases of the cycle favour different sectors. Early recovery phases often benefit cyclical and capital intensive industries as demand improves. As growth matures and inflation rises, leadership may shift toward commodities, energy, metals, and businesses with pricing power. During slowdowns or periods of heightened uncertainty, defensive sectors, companies with strong balance sheets, and domestically oriented businesses tend to offer relative resilience. Business cycle mutual funds apply this approach systematically, rotating sectors and stocks based on macro data, market signals, and earnings trends, tilting toward real assets and way from rate sensitive businesses in inflationary periods. Or during geopolitical stress, these funds could shift into defensive sectors, or businesses with strong balance sheets or domestically-oriented businesses which are less exposed to global disruptions.

Thus, in an environment shaped by structurally higher inflation, tighter monetary conditions, and elevated geopolitical risk, business cycle mutual funds offer an adaptive rather than static investment approach. By aligning portfolios with evolving economic phases, they tend to navigate volatility more effectively while capturing opportunities across market cycles.

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