Much has been written recently about the business cycle – the end of it, that is.
Most investors fear the consequences of a business cycle in a contraction or downward phase. More about that in a minute. The business cycle is that period of time containing an economic expansion and contraction in a continuos sequence. Business cycles are generally recognized as exhibiting four phases: expansion, crisis, recession and recovery. Or, as Malcom Churchill Rorty (1875-1937), co-founder of the National Bureau of Economic Research describes: Revival, Prosperity, Liquidation and Depression – see the chart below. I prefer Mr. Rorty’s definition, it’s more descriptive, in my opinion.
Rallies always stop before we want. Downdrafts never do. So, is it reasonable to believe that the market distress we’ve experienced portends the beginning of the end to our economic growth, our bull market? If not, then what’s going on? Is the phase of the business cycle changing? Are we on the downhill slope headed for armaggedon?
So are we at the first stage, REVIVAL? Probably not. Are we in the LIQUIDATION or the DEPRESSION phases? Probably not. Look around, please. From our view it looks like we are at the tail end of the Revival phase, maybe just entering the Prosperity phase. For example: We’ve reached full employment, I think. But, we’ve not experienced significant increases in prices, inflation, CPI, less food and energy is at 2.2%. Profit margins are at near all time highs of 11.14%, but off of their highs. Manufacturing activity is growing, PMI® 56.6% an increase over December.
What does this transition in the business cycle mean? We believe that things get harder to accomplish, risks become slightly greater. For example, it’s harder to hire top personnel and if you do, usually you have to pay more. It’s not as easy to make money in equity markets, we are well above the low, firesale prices of 2008. We do not believe markets are overpriced but do believe stock selection today is more important that buying an index fund or ETF. Some bonds and money market funds have higher yields than a couple of years ago providing a total return alternative to stocks. Commercial real estate seems attractive in the form of REITs. It’s probaly a good thing to start reducing risk: buying more blue chip companies with a track record dividend increases, owning good quality and municipal bonds, and buying high value (cheap) stocks whenever and wherever they can be found.
Is a recession around the corner? Probably not? A bear market? We do not really known the answers to these questions, but we do believe it’s time to start driving the car at eight-tenths not ten-tenths. That’s an easy ride down the other side of the mountain, cycle, I mean.
Our portfolios are fully invested: we’ve added emerging market equities, REITs, munis and more dividend payers.
Carlos Dominguez – Portfolio Manager, RJFS
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