Dear Mr. Market:
It’s clear that nobody has a crystal ball but there are a few simple tools and “rules of the road” which can help manage your unpredictable and volatile behavior. For those of us who are visual learners this simple graphic is quite helpful in knowing where you may want to allocate your stock positions relative to where we are in the economic cycle.
There are two curves laid over each other on this graph. Simply explained, the red curve shows you where the stock market is and the green curve shows you what stage we’re at in the current economic/business cycle. Aside from some possible ability to optimally allocate stocks within the most opportune sectors in the economy, the real impact this visual shows you is that the stock market is essentially a leading indicator. In general, the stock market is a forward-looking gauge of what investor expectations are of the economy and interest rates.
There are certain economic sectors that typically outperform others depending on where we are in the stock market business cycle. Every stock market environment is unique and believe it or not every business cycle also presents us with a few differences from the last. As a basic rule of thumb here’s how the 10 sectors typically outperform the broader markets:
Stage 1: (Early Bull Market)
Stage 2: (Mid to Late Bull Market)
Stage 3: (Bear Market or Defensive sectors)
Some of this may seem fairly intuitive to you. Again, keep in mind that every market presents a different wrinkle to this scenario and there are also many instances where there are overlaps or some sort of outlier that drives a sector to potentially behave much differently than expected.
That being said we will briefly turn our focus on the three sectors we favor the most as we head into the last four months of 2014:
The world obviously needs energy and one could argue that this sector is one of those you should always maintain a healthy exposure to. This sector can be a tricky one, however, as recent geopolitical situations make investing here potentially more volatile than normal. Ironically enough, if some of these geopolitical concerns escalate you will undoubtedly see higher oil prices.
A conversation around energy rarely ensues without China coming into the discussion. Both the US and Chinese economies are the big drivers in this sector and on the whole their respective economies are gradually improving. Developing economies will continue to require energy for infrastructure as well as to support improving economies. Lastly, while investors need to be selective in this sector, there are some decent valuations in certain energy companies especially relative to rest of the stock market.
Again, stock selection is often the key in a sector like this but on the whole businesses are spending here and that’s what will drive technology to do well in the near-term. So many companies and their respective CFO’s have been overly conservative with spending as nobody seems to trust this economic recovery. The one thing about technology is that it’s always advancing which amplifies the reality of and the need to spend in order not to become obsolete.
One area to focus on in this sector are companies that have large cash balances on hand. This goes both ways as many are looking to acquire other companies which can of course strengthen the existing company but also be a huge boost to the firm being purchased.
Some may argue (in reference to cyclical charts such as the one we used) that technology stocks may not be where you want to be positioned towards the latter stages of a bull market. While this can be true, consider what type of market we’re in. Is it behaving in textbook fashion?
Similar to Technology, companies that have larger than normal cash balances are beginning to spend. This will take time, however, as many areas of the world are still licking their wounds from the last recession. A case in point is with regard to Europe. European economies are not “out of the woods” yet so investing in industrial sector related companies in this region will take patience.
The bottom line in this sector is that as credit and lending continues to “dethaw” a bit, the Industrial sector will benefit. If you’re hunting for a company in this sector we suggest sticking to some of the larger names as those will have greater access to liquidity and the ability to actually pull the trigger on capital spending projects.
Lastly, notice that the three economic sectors that we currently favor still fall within “early” to “mid and late” stage bull market sectors. This market is clearly due to take a breather but we’re not of the mindset that it’s time to shift into defensive sectors at all. That time will come but just “enjoy” the upcoming stock market correction and consider these three sectors as you establish and pick your “shopping list”.
If you have specific questions on any of these sectors or want to know which individual stocks we like within these three sectors, you can reach us using the Contact Form below: