Cycli­cal cycli­cal

Finweek English Edition - - INVESTMENT -

Un­der­stand­ing and po­si­tion­ing a port­fo­lio for cycli­cal, non-cycli­cal and counter-cycli­cal stocks is per­haps one of the most ne­glected parts of in­vest­ing. Broadly, the think­ing here is that the prof­itabil­ity of cycli­cal stocks is very much aligned with the gen­eral econ­omy – counter-cycli­cal stocks do bet­ter in tough eco­nomic t i mes, while non- cycli­cal stocks pretty much make profit re­gard­less.

A ‘ buy and hold’ in­vest­ment strat­egy should re­ally only fo­cus on the non­cycli­cal stocks. Those that make money re­gard­less of what the econ­omy is do­ing – sure, in tough times prof­its may weaken but im­por­tantly they still make a profit. Ex­am­ples of th­ese would be food retailers, health, ed­u­ca­tion and to a de­gree sin stocks (beer and cig­a­rettes). Re­gard­less of how the econ­omy is do­ing or how we’re do­ing at an in­di­vid­ual level we have to eat, look af­ter our health, ed­u­cate our chil­dren and if we can, squeeze in a drink or three to help cope with the tough times. In some in­stances th­ese would be con­sid­ered de­fen­sive stocks in that they sur­vive the tough times much bet­ter than most busi­nesses. Th­ese stocks fit per­fectly into a straight ‘ buy and hold’ strat­egy, the price may weaken at times but the longer term trend is up­ward for the strong ones.

With cycli­cal stocks, we need to time our buy­ing and sell­ing, try­ing to get in around the bot­tom of the price moves and ex­it­ing around the top. Two ex­am­ples of sec­tors in this space are min­ing and con­struc­tion; they boom when the econ­omy booms but they se­ri­ously strug­gle when the econ­omy strug­gles. Small-cap stocks will of­ten also be cycli­cal as they are typ­i­cally very closely tied to the coun­try’s econ­omy as they tend to only re­ally op­er­ate within one coun­try (in our case this would be South Africa).

The prob­lem with cycli­cal stocks is the tim­ing. Buy­ing a non-cycli­cal is easy – when it is cheap, jump on board and pretty much hold it for as long as that com­pany is the dom­i­nant player in its space. Cycli­cal is a whole lot harder, as tim­ing the bot­tom is prac­ti­cally im­pos­si­ble. So the best case here is that you buy too early and prices go nowhere for a cou­ple of years as you wait for the re­cov­ery. The worst-case sce­nario is that you buy while it’s still fall­ing and by the time the stock reaches bot­tom you’re al­ready markedly un­der wa­ter. The other prob­lem with cycli­cal is the sell­ing – you have to sell when the stocks are boom­ing and again. We sel­dom time that right. Ei­ther we sell far too early or we are un­able to sell at the top (be­cause of all the good news f low­ing) and so we miss the exit and find our­selves hold­ing when the stocks are halfway down again.

For me per­son­ally it is sim­ple – non-cycli­cal stocks are for long-term in­vest­ment port­fo­lios, the clas­sic ‘ buy and hold’. Cycli­cal stocks are more for a trad­ing port­fo­lio and sure, the po­si­tion may be held for many years and the en­try and exit is much harder, and, as such, I have very lit­tle ex­po­sure to cycli­cal stocks in my port­fo­lios.

Counter-cycli­cal are those that do well in tough eco­nomic times and less so when the econ­omy is strong. The ob­vi­ous one here would be debt col­lec­tion. Dur­ing tough times more peo­ple de­fault on loans so the debt col­lec­tion com­pa­nies see in­creased busi­ness. The ben­e­fit for the share­holder is that while much of a port­fo­lio may be strug­gling dur­ing the tough times, th­ese counter-cycli­cal stocks will be do­ing great. The trick here is find­ing th­ese counter-cycli­cal in­dus­tries and they are very few and no listed com­pa­nies spring to mind as be­ing counter-cycli­cal.

Si­mon Brown is a Fin­week con­trib­u­tor and heads ju­s­, a free re­source of fi­nan­cial in­for­ma­tion and in­vest­ment ed­u­ca­tion.

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