Picture two neighbors separated by a fence, both deciding how to seed and fertilize their respective lawns.
One goes for a combination that grows like crazy in a typical wet spring and turns a lustrous green -- only to quickly brown during the first extended dry spell in the summer heat. The other opts for a heartier seed and slow-release nitrogen fertilizer that greens more gradually but holds up better throughout the summer.
Which do you prefer — or do you find yourself on the fence? As an investor, you can choose the dull-grass defense of stocks that stay alive during down cycles. Or you can go for the big-green offense of stocks that often yield bushels of cash clippings when it rains prosperity, but quickly go to seed during downturn droughts.
Some investors try to hop from one side of the fence to the other, depending on their instincts or educated guesses concerning the future direction of the economy. As a result, they move aggressively into higher-risk, higher-return stocks when they think a boom cycle is coming, and shift into recession-resistant stocks in anticipation of an economic slowdown. But as anyone who has straddled a fence can tell you, a badly time leap over a fiscal fence is as painful to your portfolio as a badly timed leap over a physical fence is to your posterior.
With clairvoyant timing, you can steal (off with) a great deal when stocks are at lows, and you don't even have to lose any profits by fencing them at (deep discounts to) their highs. But the only market timing that's been proven to work consistently is the opening/closing bell at the stock exchanges.
Furthermore, except on rare occasions, the "market" as a whole doesn't go up or down. However, certain sectors tend to go up or down in unison in response to financial conditions that favor or disfavor them. So on a typical day when the market moves strongly up or down, a majority of sectors have moved either up or down.
When the economic horizon is bright for as far as the eye can see, the strongest-performing sectors feature companies that benefit from discretionary spending by individuals, businesses, institutions, and government. Think exotic travel, expensive cars, high-end electronics, home additions and improvements, new offices and plants, technology upgrades, and university construction projects. In addition, businesses keyed to strong economic activity also benefit — as financial-services firms almost always do during bull markets.
But when the economy is poised to cool, those same sectors suffer. Company profits take a double hit from revenues decreasing while incurring higher amortized expenses built in from expansion. This happens despite being more careful about going overboard in capital expansion and staff addition during boom times.
Some companies avoid this plight by internally diversifying into profit centers that aren't so tied to the ebb and flow of business cycles. That's one reason why many financial-service companies that focus on investments also have a big stake in insurance, which people need regardless of the state of the economy.
But companies that do best — although not necessarily great — in a slumping economy are businesses geared to providing the necessities or habitual desires of life, and those that offer alternatives to higher spending. This includes companies that sell food staples such as bread and cereal; auto parts and accessories for routine maintenance; home maintenance hardware and materials; and everyday personal care and medical-supply products. In addition, companies that cater to human weaknesses — such as smoking, drinking, gambling and prurient interests — also serve a steady market.
Ideally, you want your investment portfolio to resemble the internal business portfolio of companies that combine "good-times" lines of business and continuing-consumer-needs businesses. That way, you'll be in line for some of the huge gains possible when the economy is running hot, while having some cushion against when it is running cold.
However, there's no universal recipe. The right mix depends on your individual financial circumstances and risk tolerance.
Get in touch today and find out how we can help you meet your objectives.
