Cyclical investing is a strategy that puts money into sectors of the economy according to the stage of the economic growth cycle. During recessions or times of slow growth, more conservative investments are appropriate, while the reverse is true in time of fast economic growth. Using this strategy, investors have been shown to protect their funds and grow wealth over time.
Recession and Slow Growth Environment
During a recession, cyclical investing advises that investors choose safe, conservative sectors with high dividend payments and low volatility. These sectors include electric and water utilities, health care and pharmaceutical companies and food producers. These companies provide goods that everyone needs all the time, whether the economy is good or not. Investors should feel comfortable that these parts of the economy will continue to produce good cash flow that can be returned as dividends on the initial investment.
Rapidly Growing Economy
In a rapidly growing economy, cyclical investors should rotate sectors into the high growth companies that are more sensitive to changes in the economy. Examples include banking and housing, high technology, travel and manufacturing. For example, airlines are notoriously sensitive to slight changes in the economy as travelers quickly adjust their plans for vacation or business. High tech companies also do extremely well when times are good. The potential payoff of investing in these sectors is substantial.
Bond rotation is a term in cyclical investing which is similar to stock sector rotation. During times of high growth, you should invest in low-grade "junk" bonds to corporations and sub-prime borrowers, which produce high interest rates. However, when the economy slows down those bonds tend to lose value. Instead, government bonds such as U.S. treasuries and municipal bonds gain value. Those produce lower returns but are much more reliable.
While choosing your investment sectors for cyclical investing is relatively easy, timing those investments is much more difficult. For example, high growth stocks that do well when the economy is expanding actually start to go up at the very end of a recession. During that period, attitudes are quite negative and it takes great courage to invest in a high growth company. The same is true when the economy is still strong but has begun to slow. This is when you should invest in utilities or government bonds even though other investments might seem more attractive.
Kathy Zheng is a personal financial planner. She holds a Bachelor of Arts in economics and is certified as a level 1 financial adviser.