Sean Hyman
Contributing Writer
instructor@mywealth.com
Is there a “holy grail” out there to be had? No! But if you want to know something that is about as close as it gets….it’s sector rotations.
You see, it’s no wonder that Wal-mart (WMT) has done well in the recession. It’s because it’s in a “defensive” sector of the economy. Then you look over at Whole Foods Market (WFMI) and it gets creamed. That’s because it’s in a cyclical sector that does good when “the cash is flowing” pretty good in the economy.
So over the past year, Wal-mart moved up from $44 to $54 a share while Whole Foods went from $40 down to $10 a share. Considering the economic/business cycle can help to keep you in the right stocks at the right time.
Let’s take a look below at a diagram that visually represents that.
Read it, Know it, Profit From It!
You see, as economies expand, the money that people have expands. Yet when the economy contracts, the money that they have contracts.
So you will spend more on technology, services and goods when times are good. Yet when times are bad, you are going to stick to what you need: medications (drugs), the “staples of life”, utilities (electricity), etc. This is what makes the cycle work from a consumer stand point.
In a Recession, Corporations Feel the Pinch Just like Individual Families.
Now let’s talk a bit from a corporate stand point. When a company feels that the economy is just about to come out of a slump, they order more products …because after all, consumers can’t spend money on what’s not there. So in order to get those products to the store, they have to be “transported”. This is why transportation stocks pick up at the beginning of an economic recovery (matter of fact, a bit before the recovery happens).
Another thing they beef up on is technology. If you can do more work, more efficiently…then you can take in more profits with the same level of employees. Since employees are one of their biggest costs, they try to hold off on the hiring process until the recovery is underway.
Also, the use of technology is a great way to speed up their profits and help to recover quicker from the slump that they just went through. It also helps to give them an edge over their competitors.
As the economy gets back rolling once again, consumers and corporations both use more services. This means they are once again willing to pay someone else for something they formerly did for themselves or felt they could do without at the time.
This is where Commodities & Commodity Related Stocks Shine!
Then later on, there’s more of a run on “goods and materials” as corporate (and residential) expansions happen. Businesses and home owners want to expand their operations or homes and so that puts a demand upon the materials sector of the economy. This is where commodities shine. They start really kicking in the most towards the latter stages of a bull market in stocks.
Hence, the next category…energy. You will find that oil in particular really gets its “second wind” right at the latter stages of a bull market. The economy has expanded a lot and is more of a demand upon the energy supplies, thus causing the price to spike higher.
However, once we get to the “tipping point” in the economy, consumers and business owners realize it and start cutting back on “extras” and mainly use the necessities of life – consumer staples. I like to refer to this as the stuff you have to use in life OR the stuff you are not going to do without in good or bad times.
You won’t quit buying groceries for instance, just because times are tough. Good or bad times…you have to eat.
People are also going to still take their medications during those bad times too. In fact, the stresses caused by the economic slow down could even bring on even more “stress induced” illnesses. However, even if this doesn’t occur, you will still “guard your health” by taking your doctor prescribed medications. This is why the drug sector still holds up in tough times.
Since you will still have a need for water, electricity or natural gas, you aren’t likely to shut those off. After all, we still need to take showers, cook, keep warm or cool, etc. So those tend to hold up in economic slumps better than most things.
Businesses and Consumers Step on the Gas Pedal Once They See the “Light at the End of the Economic Tunnel”.
Right before an economic upturn, remember we said that businesses stock up on inventories? Well, these are typically financed on the front end and then paid off once the inventories are worked down. Thus this calls for the need for a wave of lending which helps the banks.
Also, since rates will be at their lower points for the moment, businesses want to “borrow cheap” before rates go up in the expansionary period. So they “borrow ahead”, meaning they apply for the loans when things are still cheap…knowing that in the upcoming weeks to months, they will need to purchase inventories. Because the cheaper those loans are, the wider their profit margins are on their net profits once they pay off the loans.
They will also now start to spend on their “wants” for their businesses and the consumer will tend to do the same once they feel the “worst is over”. This is why consumer cyclicals come back in vogue. Consumers and businesses love to get back to buying what they “want” as soon as possible rather than just what they need. Especially here in America, you can count on that happening just as soon as consumers and businesses think that it is possible.
So once you find out what’s prospering and what’s not….you know where we are in the economic cycle and you know what stocks might fare better and which ones likely won’t.
Once you know this, you have a plan of attack with which to go into the markets and invest.
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