Don’t try to ride a trendy SUPERCYCLE – it’s incredibly risky… especially now

When the going gets tough, we often hear about the investment cycle – a way of describing how when the economy expands, contracts, and then expands again, it often impacts the value of our investments.

Some investors use this cycle to determine when to buy and sell – and to decide which sectors and companies to choose.

“Trying to time cycles can be dangerous, but also hugely profitable,” says James Yardley, senior research analyst at Chelsea Financial Services.

On a bike: If you think economies go in cycles, it follows that bad times eventually turn into good ones and vice versa

He says the UK economy typically oscillates between ‘boom’ and ‘bust’ – and the stock market tends to do the same, often ahead of the economy’s own performance. “Our animal spirit causes us to become both overly exuberant in good times and overly pessimistic in bad times,” he adds.

If you think that economies move in cycles, it follows that bad times eventually turn into good ones and vice versa, and that different investment styles can also fall in favor and out of favor.

It’s a belief that can help investors choose winning strategies before sentiment changes. That is, provided they have time on their side and heed expert warnings, not leaning too heavily on any particular sector or asset class.

Understand how cycles really work

The first step is to understand how the business cycle works. Ryan Hughes, head of investment partnerships at wealth manager AJ Bell, explains that there are four distinct phases: ‘downturn’, ‘contraction’, ‘recovery’ and ‘expand’.

He adds: “You can use it to predict which types of investments should prosper, allowing you to modify your investment strategy as the economy moves through the four phases.”

According to Chelsea’s Yardley, another key ‘cycle’ worth considering is the cycle between two different types of investment: growth and value.

Yardley explains, “Growth stocks are those that are expected to grow faster than average. They are often in sectors such as technology and their stocks can look expensive when valued using traditional methods such as earnings.

“In contrast, value stocks tend to be slower growing companies – often more stable and predictable – but they generally look cheaper than growth stocks when using traditional valuation methods.”

Another cycle is the “supercycle”, defined as a period of sustained expansion of a type of asset or item, driven by demand. Commodities are currently in a supercycle.

What part of the cycle are we in now?

With bad economic news coming daily, experts say we are in the final phase of the economic cycle slowdown, with more bad news to come. Hughes says: “With the country’s GDP set to fall, we could soon enter the contraction phase, where we would expect to see corporate valuations [share prices] fall as business and social confidence declines.

Kyle Caldwell, investment fund specialist at wealth management platform Interactive Investor, agrees the UK is in the “late downturn” phase, before a recession hits.

In terms of growth versus value, Chelsea’s Yardley says the cycle “has now started to reverse” in favor of value stocks. “We’ve seen the value start to outperform again,” he adds.

Finally, many have spoken of a supercycle of raw materials due to the energy transition and the increased demand for the metals needed to manufacture electric cars and solar panels.

James Luke, commodities specialist at investment bank Schroders, says the current high prices are sustainable due to limited supply. Marcus Phayre Mudge, director of investment trust TR Property, believes there is the possibility of a ‘green building’ super cycle due to the need for materials that will allow homes and businesses to become carbon neutral, including building materials for home insulation.

How do investors align their portfolios?

There are steps investors can take to bring their portfolios in line with the cycles — and Interactive’s Caldwell says now is the time to act.

He says: “At the moment, we are just before a recession occurs. Now is a good time for investors to review their portfolios and consider adding recession protection.

Gareth Witcomb, manager of JPMorgan MultiAsset Growth & Income investment trust, agrees it is wise for investors to take less risk with their investments. He says: “As financial conditions tighten, we as fund managers will increase exposure to cash and face lower levels of risk overall.

Simon Edelsten, who runs the Mid Wynd investment trust and the Artemis Global Select fund, picks companies that will do better in increasingly tough economic conditions.

He says: “For the cautious investor, the industries that tend to weather recessions better are those that supply items you can’t live without – like healthcare, consumer staples and perhaps- even be the cosmetics.”

Although Edelsten suggests changing your portfolio in terms of exposure to specific sectors, he thinks focusing on the US is still the best way forward.

He says: “As long as U.S. interest rates continue to rise and the U.S. economy remains less troubled than others, maintaining a healthy amount of dollar-priced equity investment remains, for us, the key to coping with a difficult second half of the year.’

The inclination towards value investing

If you also keep an eye on the “value vs. growth” cycle, Edelsten warns that while value stocks may seem like a good bet for a recession, that’s not always the case – so you need to choose carefully.

He says: “The value universe can include many ‘cyclical’ stocks – from non-food retailers to home builders and banks. Recessions are generally not happy times for these sectors, especially if they also see wages or input prices rise significantly.

As for the ‘supercycle’, most experts are warning investors to steer clear. “Supercycle should be a term reserved only for describing a high-end bicycle,” says Bruce Stout, director of investment trust Murray International. “It should not be applied to an industry that currently has a particularly profitable purple patch.

“Historically, the term is usually applied to a sector or industry at exactly the time of peak excessive market valuation in a futile attempt to justify the unjustifiable.”

Funds for now… and for the future

Investors looking for funds that perform well at this stage of the economic cycle should adopt a defensive attitude.

Interactive’s Kyle Caldwell recommends three trusts that invest conservatively: Capital Gearing, Ruffer and Personal Assets.

These generated three-year returns of 20%, 38% and 18% respectively.

He adds: “The trio has a low equity weighting and is invested in many defensive arsenals, such as inflation-linked bonds and gold.”

He also suggests Vanguard LifeStrategy 60 – a multi-asset fund with 40% invested in bonds and the balance in stocks.

“Due to their higher levels of diversification through investments in various asset classes, these funds should be better equipped to weather a market storm than equity funds that invest globally or focus on a particular region,” he said. Meanwhile, Chelsea’s James Yardley says it may be time for Britain’s beleaguered small businesses to have their day, at least in the year to come.

“Small businesses have always been more successful when markets anticipate improving economic conditions as they emerge from recession,” he adds.

Suitable investment funds include Marlborough UK Microcap Growth, Jupiter European Smaller Companies and Global Smaller Companies.

These funds have struggled in recent years, with global small businesses posting 18.5% year-over-year losses.

The equivalent returns of Jupiter European Smaller Companies and Marlborough UK Microcap Growth are even worse, with losses of 32% and 35% respectively.

Words of Caution for “Cycling” Investors

Trying to time market cycles is fine, but it’s always worth making sure your portfolio is prepared for any eventuality.

Stout, of investment fund Murray International, warns that not all businesses will operate in line with the economic cycle.

“For commodities, energy, steel and manufacturing this may be the case, but for other businesses new products, greater distribution or changing technology may be much more important,” he said.

Meanwhile, Caldwell warns that it’s notoriously difficult for investors to get the market timing right. He says: “A more conservative approach is to put together a diversified portfolio that will perform well over the long term – a mix of both offensive and defensive investments.

Yardley, in Chelsea, also warns against putting all your eggs in the ‘growth’ or ‘value’ basket. “It’s a dangerous cycle. The danger is that you end up with all your stocks or all your funds pointing in one direction. This can be disastrous, as high-growth investors have found out the hard way this year.

For example, the Scottish Mortgage investment trust has made a lot of money for investors by investing in growing companies.

But this year, as interest rates rose and economic growth stumbled, its stock price fell 44%.

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