Economic Cycles – The Basics

Economic cycles - the basics photo

Economic cycles and what they mean for your investments.

The investment industry has long sold the idea that you need to invest for the long term rather than try to time the market. You might have even heard ‘it’s time in the market and not timing the market’ that matters. However, while it is more difficult to choose the optimum time to invest your money, it’s not impossible. There are better times than others to invest in certain types of investment and understanding economic cycles and how they work can help. 

What are economic cycles? 

An economic cycle is the overall state of an economy as it runs through a repetitive series of: 

  1. Recession 
  2. Early recovery 
  3. Peak 
  4. Early recession
  5. Back to recession  

 The stock market normally leads the economic cycle, and you will see a change in the stock market before you see a complete change in the economic cycle – partly due to the fact that economic data is always backwards looking. 

 

How the stock market influences economic cycles 

The stock market is full of companies that sell ‘things’. In a recession, those companies don’t sell as much as they normally would because the people who would normally buy their products might have been made redundant, working less or interest rates are higher, meaning they have less free money to spend and borrowing more money isn’t easy.  

However, companies that sell the things we all need, are the ones that may do better in a recession (including tobacco and alcohol companies as people will always smoke and drink). Tech companies, motor companies and builders may not do so well. People will adjust their spending to get through the recession, many will close investments and the stock market overall will go down. 

With consumers spending less, prices may fall to entice buyers back again, interest rates will start to fall to encourage borrowing again and sales will increase along with some new companies starting up to add competition to the market. With increased spending and new hiring, more people back in work means more wages earned, that in turn will be spent, boosting the economy further. 

With money going back into the economy, the stock market will do better again and once that happens, the economy will start to recover. Now more people have jobs once again, they might start spending on things like new phones and computers, meaning tech companies start to do well early on in an economic recovery. Housebuilders start to do better too as people want to move home. From here, transport, energy, oil and travel companies pick up as people look to enjoy life comfortably once again. 

All these companies that are now doing well again, will start employing more people which continues to baluster that early recovery. But being human, we overdo it and the companies selling ‘things’ increase their prices which means people eventually stop buying. Or it is simply the fact that everyone who was going to buy a new product and could afford it, has bought one or everyone who was going to buy a new home has done so. 

Naturally, when people again start spending less, it is bad for companies who then cut their workforce. This means we start heading back towards an early recession.  

This economic cycle has been repeating itself for the last 200 years. It’s perfectly natural and typically, an economic and stock market cycle can last between eight and twelve years. 

 

A bull vs bear market 

You might have heard these terms in the news or in press articles. A bull market is simply when things start to get better and the economy is expanding meaning the stock market is gaining value. A bear market is the opposite and is when the economy is shrinking, heading towards a recession and share prices are heading down. 

 

When to buy and sell during the economic cycle 

We have already said that while it is difficult to time the market, if there are better times than others to be investing and the economic and market cycle is a big driver in getting this right. Being in it for the long term simply isn’t enough. 

For example, if you invested in an average UK FT100 tracker fund in January 2000, you would have made a grand total of 8.4% in 21 years if you still had that tracker fund today, we would consider that ‘long term’ and on its own being in the market a long time is clearly not enough of an investing strategy.  

Therefore, the theory that investing for the long term is the best way, is simply not true. During those 21 years, if you had been aware of economic and stock market cycles and your investment manager could position investments correctly dependent on where we were in the cycle, your returns could have been much better. 

 

Common mistakes with investing 

The worst thing for an investor to do (and a mistake that many people make) is to buy at a peak in the stock market cycle believing it will just keep going up. If you invest at peak times and the market corrects, it might be five to six years before the cycle comes to a bottom and eight to 12 years before you break even again.  

 While remaining invested isn’t a bad strategy, it depends on the time you have and how long you want to wait before you start making money.  

 

Timing the market isn’t about trading 

You need an investment manager who knows and understands where we are in the economic cycle, as they can set realistic expectations around the money you can make and will invest your money in the right place.  

 Timing the market isn’t about trading. It’s about seeing where we are in the current economic cycle and where we are in the current stock market cycle. This changes all the time, and your Investment Manager should position your investments in the best place for where we are right now. Don’t be surprised if your portfolio changes three or four times completely over 12 years.  

 

What to invest in and when 

As a general rule, you should be investing when the market is at its most fearful and taking profits when confidence abounds. The belief that a rising stock market will just keep rising has been the downfall of many investors. When the market peaks you should think about lowering your risk and moving more to a fixed interest and bond strategy rather than continuing exclusively with equities. 

 

Effects of the pandemic on the economic cycle  

The pandemic has upset the current economic cycle because by February 2020 we were moving into an early recession phase. We then had an accelerated fall, which caused us to go straight into a recession. This happened all within two months rather than the expected two to four years. However, we also accelerated into an early recovery, which seems to suggest we could be in a mini cycle within a bigger cycle.  

The questions is, is this just temporary and are we going to carry on into a recession or has the pandemic saved us and now put us into an early recovery phase?  

Facts and figures state, we are in early recovery but there is a question mark over if this recovery has happened too fast. If the government comes through with infrastructure spending, people will return to work, jobs will be created and people will start spending more, meaning we should remain in this early recovery phase. If this is the case, investors could look to move money out of cash and into good investments to capitalise on the growth to come. However, they do need to be cautious. 

 A good mix at this stage could be:  

60-70% invested in the stock market and good quality funds or equities 

30-40% in cash and fixed interest investments 

 

Inflation is key 

 Inflation is bad for the stock market as it puts prices of goods up lowering the profit a company makes. Inflation is something you get at the peak of an economic cycle just before people stop spending. While all our ducks are nearly in a row for a recovery and a good period in the stock market, inflation could upset that. 

 

 Choosing an Investment Manager 

When you consider investing, you should always make sure your investment manager discusses where they feel we are in the current economic and stock market cycles, so your money is allocated properly in order to maximise your returns.  

If your Investment Manager can’t or doesn’t want to discuss the economic and stock market cycles with you, then you should perhaps question if they are the right Investment Manager for you or if they have your best interests at heart.  

At Middleton Private Capital, we will never charge our clients an annual management fee if we don’t achieve a net return of 2.25% above the Bank of England base rate. (See our website terms and conditions for more details). 

If you are thinking about investing or would like help managing your investments in the future, we would be delighted to discuss what we do and how we do it.  

Click here for more information. 

Middleton Private Capital Ltd is authorised and regulated by the Financial Conduct Authority, No. 804197. All investments contain risk, the value of investments can go down as well as up and investors should be aware they may not get back the full amount invested. 

 

 

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