Cycli­cal na­ture

Finweek English Edition - - INVESTMENT -

The world moves in cy­cles: sports teams go through tough pe­ri­ods, re­la­tion­ships have their ups and downs and of course economies and com­pa­nies have their boom and bust pe­ri­ods. We can­not deny the cycli­cal na­ture of mar­kets, com­pa­nies and economies, with the 2008/09 global fi­nan­cial cri­sis be­ing such an ex­am­ple. How­ever, we also have to cau­tion against cog­ni­tive bias whereby the brain likes to ‘see’ pat­terns where none may ex­ist.

Fur­ther, cy­cles are easy to spot in hind­sight, but a whole lot harder to call when we’re liv­ing them. The 2008/09 cri­sis is now a no-brainer to spot and even in the lead-up to it, some were fore­cast­ing a global cri­sis, but tim­ing is al­ways the hard part. An even larger num­ber of an­a­lysts had been fore­cast­ing dis­as­ter since just af­ter the dot-com bust in 2000/01.

It was with this in mind that I did some re­search on some­thing called the Kress Cy­cles that a reader had asked about. For­mu­lated by Sa­muel Kress, of the SineS­cope ad­vi­sory, this se­ries of cy­cles starts with a gi­ant 120year cy­cle, which is then bro­ken down into shorter 60-, 40-, 24-, 12- and six-year cy­cles. Us­ing th­ese self-named Kress Cy­cles, his pre­dic­tion is an ex­pected bot­tom­ing-out in 2014, with the re­sult be­ing po­ten­tial wars and mas­sive eco­nomic de­pres­sion. The ques­tions are sim­ple, is he right and should we be con­cerned? My an­swer is equally sim­ple: he may be right, but a 120-year cy­cle is not some­thing I am go­ing to put much stock in and I am cer­tainly not go­ing to base any in­vest­ment de­ci­sions on a 120year cy­cle even if it is bro­ken down into smaller more man­age­able pe­ri­ods.

The big­ger pic­ture is that there is al­ways some­body (in fact nu­mer­ous some­bod­ies) with a the­ory that makes for com­pelling read­ing and some­times they may even be right, but how do we spot those who’ll be right ver­sus those who will be hor­ri­bly wrong, in ad­vance? My method is to al­ways keep it sim­ple − the more com­plex a the­ory, the less likely it is to be ac­cu­rate, as com­plex­ity can hide re­al­i­ties but also of­fers far too many ar­eas for er­ror. That said, things are look­ing rough for emerg­ing mar­kets right now, but we don’t need a 120-year cy­cle to tell us that.

Stay­ing with cy­cles, one of the lessons that I have learnt in in­vest­ing is to largely stay away from cycli­cal stocks – the con­struc­tion sec­tor is an ex­cel­lent ex­am­ple. The very na­ture of con­struc­tion is boom and bust and right now we’re in the bust phase. Will it change and re­vert back to a boom? You bet it will – but when? Tak­ing the cycli­cal na­ture of the sec­tor into con­sid­er­a­tion, I bought con­struc­tion stocks in 2010, fig­ur­ing that we had to see the cy­cle turn up sooner or later. I have long since sold my con­struc­tion stocks for pretty much the price that they still trade at and when the cycli­cal turns, I will watch from the more com­fort­able side­lines be­cause the other prob­lem is that we for­get to sell when the cy­cle gets all frothy.

Back in 2007 when con­struc­tion stocks were all boom­ing and Mur­ray & Roberts was trad­ing above R100 and on a his­toric P/E of over 30 times, no­body was warn­ing of the im­pend­ing bust, which for a cycli­cal sec­tor, had to be com­ing. That is the prob­lem − share­hold­ers get caught up in the hype and don’t ac­tu­ally exit at the top. This re­sults in badly-timed en­tries and even worse-timed ex­its in­ter­spersed with long pe­ri­ods of noth­ing re­sult­ing in sub-par re­turns over the cy­cle. So I avoid those and in­stead in­vest pre­dom­i­nantly into non-cycli­cal stocks. That said, ev­ery­thing does move in cy­cles; but fi­nan­cial stocks, re­tail­ers and the like tend to have weaker booms and busts, hence pro­duc­ing smoother su­pe­rior re­turns. Si­mon Brown heads ju­s­tonelap.com, a free re­source of fi­nan­cial in­for­ma­tion and in­vest­ment ed­u­ca­tion.

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