Financial and economic

Late cycle investing: where to put your money at the tail end of the expansion

We are still in the expansionary phase of the business cycle, a place we have basically been in since June 2009. And although the old adage goes that “bull markets don’t die of old age”, most would agree that we are now in or at least nearing the tail-end of the cycle. That is typically associated with an overheating economy that faces tightening monetary conditions and credit availability, slowing productivity and GDP growth that begins to stall. Not great news, all in all.

With interest rates going up and economists anxiously looking at economic data to spot either a pick-up in inflation or slowdown in the economy, stocks have been showing the first real signs of bull market fatigue in early 2018. They recently broke through their 200 days moving average for the first time in 2 years.

Once the bull market ends and things turn down, there won’t be many places to hide except for cash, gold and treasuries (and maybe, just maybe a select few consumer staples stocks). But calling the end of the rally has been unsuccessful for many, and DT’s fiscal stimulus plans may yet extend things for quite some time to come. Until it all comes crashing own there may still be decent returns to be found in certain places of the market. Here are three investments you could consider.

#1 Non-US equities

While the US may be nearing the end of the good times, in Europe and many emerging markets, the expansion is still very much going on. Europe in particular seems a step behind the US in terms of the business cycle, having been slower to recover from the previous bear market. With still low inflation and interest rates, and growth having missed out on the strength of the recovery that the US saw post crisis, European equities should have some room to run still. Emerging markets have also been showing notable resilience to recent US-led market volatility. Investing in these two markets may yet yield good results, bar a total systemic crash like we saw in 2008.

#2 High quality stocks and specific sectors

Defensive sectors like utilities, healthcare, energy, and consumer staples would generally be expected to perform better than their cyclical peers in this period. Also more generally, companies with stronger balance sheets (which tend to pay higher dividends) will be expected to stand firm while their more speculative peers take the brunt of the initial hits.

#3 Commodities

A key aspect of the late business cycle is that inflation should start picking up. Inflation-sensitive sectors like energy and commodities are expected to outperform off the back of this.

Portfolio construction: cash, commodities, non-US and high quality stocks

  • The suggested portfolio contains a lot of cash to cushion the blow that a recession will undoubtedly deal the markets at the end of it
  • Until then, commodities, European and Asian equities as well as high quality US stocks should be expected to perform better than the market as a whole
CategoryNameIDTERAlloc %
Asia equityiShares MSCI All Country Asia ex Japan ETFAAXJ0.69%10.0%
Europe equityiShares MSCI Eurozone ETFEZU0.48%10.0%
High dividend low volLegg Mason Low Volatility High Dividend ETFLVHD0.27%20.0%
CommodityiShares Commodities Select Strategy ETFCOMT0.48%30.0%
CashCash-30.0%

Risk level: low / diversification: high

  • Dividend yield: 2.6%
  • Ex-ante predicted volatility: 5.7%
  • 1 year 95% Value-at-Risk: –8.8%
  • Scenario 2008 Lehman Brothers default period: -11.6%
  • Scenario Interest rates +100bps: +1.7%
  • Scenario 2008-2009: -5.8%
  • Scenario 2010 onwards: +55%

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