Business Cycle Investing: Navigating Growth, Slowdowns And Shifts

Business cycles typically consist of alternating periods of economic growth and economic slowdowns. In the growth phase, businesses thrive, incomes rise and consumer spending increases. A sustained period of positive growth usually results in overconfidence and overcapacity which paves the way for slower or negative growth. In a downturn, businesses struggle, incomes fall, and consumers get nervous and postpone discretionary spending. Eventually, when the supply of goods and services starts to lag demand, the upward cycle starts afresh. [EasyDNNnews:PaidContentStart]

The monetary policy responds to both such cycles, and also influences these business cycles. When economic activity was disrupted by the corona virus pandemic and the resulting lockdowns in 2020, economic growth the world over took a hit. Global central banks responded by slashing interest rates and pumping money into the economy in a bid to support growth. As a result, global growth saw a sharp recovery in 2021 and 2022. This was followed by a period of higher-than-expected inflation which led the central banks to undo some of the monetary excesses. 

They raised interest rates in 2022 and 2023 to deter businesses and consumers from borrowing and consuming. The effects of this monetary tightening are expected to show up in the form of lower inflation and lower growth going forward. On September 18, the Federal Reserve cut its benchmark interest rate by 50 basis points. This rate cut marked a change in the central bank’s  monetary policy stance from restrictive to accommodative. While a rate cut was widely anticipated, given that inflation in the US has been steadily easing, what caught the markets by surprise was the size of the rate cut. 

Historically, the Federal Reserve has opted to cut interest rates by a chunky half percentage only at times of crisis like in 2001, 2008 or 2020. This outsized move when seen against the backdrop of weakening US labour markets and the possible risk of a US recession is being perceived by the markets as a sign of deteriorating economic conditions. After posting healthy GDP growth numbers post the pandemic, is the US economy at the risk of stalling? Has a sustained period of high interest rates finally begun to weigh on US’ economic activity? Is a change of business cycle at play? 

Going by the Federal Reserve’s indication to cut rates by another 150 basis points by the end of 2025, the answer could be in the affirmative. Similarly, in India, the Reserve Bank of India has been striving to keep inflation in check, possibly at the cost of growth. After bouncing back in the aftermath of the pandemic, supported by accommodative policies and pent-up demand, India’s economic growth has been moderating in recent quarters, possibly signalling the start of the next phase of the business cycle. 

While the central bank continues to keep interest rates elevated for now, a rate cut is widely expected by the end of 2024 to lower borrowing costs and aid the domestic growth momentum. Business cycle investing or business cycle mutual funds can help to identify and capitalise on the phase of the business cycle that is currently underway. Each phase of the business cycle affects different sectors of the economy in unique ways. 

For instance, sectors such as IT, pharmaceuticals, consumer staples and utilities benefit when the domestic economy is in a downward cycle. Sectors such as financials, consumer discretionary, automotive, real estate and metals tend to do well in periods of strong domestic growth. Export-oriented sectors gain when the global economy is thriving. Business cycle mutual funds can be useful to identify and invest across sectors that are set to benefit from the prevailing global and domestic business cycle. 

Based on a macroeconomic assessment of domestic factors like GDP growth, fiscal deficit, interest rates, inflation, credit growth, capital expenditure growth, and external parameters like global growth and global interest rate outlook, business cycle mutual funds can tactically position their portfolio by either increasing exposure to cyclical sectors during an upward cycle or defensive sectors during a downward cycle, thereby managing risks and optimising returns. This top-down macroeconomic analysis is then complemented with bottom-up stock selection to improve the investment outcomes. In an ever-changing economic landscape, one would do well to align their investments with the ebbs and flows of the business cycle.

The writer is Director, Degree 212 Investment Services & IMF Private Limited ■ Email : [email protected] ■ Website: www.degree212.in 

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