How can investors make money in today’s climate of uncertainty? The economy is all over the place and the stock market with it. Meanwhile, interest rates on fixed-income investments are only getting closer to zero, but experts warn against buying very long maturities, as bonds will be annihilated when rates finally do an about-face.
There’s no controlling the economy or the stock market, but understanding the business cycle and the tax and regulatory environment can help with investment decisions.
That’s not all you need to know: The earnings of some companies and asset classes move predictably with the broader economy, while other industries and asset classes move along their own trajectory.
“There is the broader economy that affects a lot of things, but then there are individual economies that other businesses are on. Think of small to very large swirling circles. They overlap — some are swirling left or right or down or up,” says Robert Fragasso, Certified Financial Planner professional, chairman and CEO of Fragasso Financial Advisors in Pittsburgh.
How the business cycle works
Like waves in the ocean, the business cycle expands and contracts — only much more slowly, of course. It begins with an expansionary period, where the economy grows until it peaks, then it begins its descent. Eventually, it bottoms out in a trough, after which activity begins to grow again.
The U.S. economy is currently chugging up the hill of expansion, albeit gradually.
“We are still very definitely in a slow recovery phase. So the opportunities are still in front of us as we recover,” Fragasso says.
Some businesses do better than others at various points in the economic cycle. As the economy enters a recession, investors turn to businesses that will soldier on no matter what. For instance: “consumer goods, raw materials, the basic essentials of life. When we’re in an economic contraction with minimum growth in the economy, people tend not to spend their money on luxury or pursue longer term investments,” says Jeff Sica, president and chief investment officer of Sica Wealth Management in Morristown, N.J.
As the economy shifts into a higher gear, investors focus on businesses that are poised to grow in general.
“That’s the time to look to what’s next, and that would include things like technology and financials — anything that is oriented toward the future,” Sica says.
What to do now
To take advantage of the evolving economy, investors need to look into the future and understand current trends. That’s hard to do in a climate of uncertainty. But economic reports released by government agencies as well as some private businesses can reveal which way the wind is blowing.
Some economic indicators point to the future. For instance, the stock market is often called a leading indicator. Others, such as gross domestic product, are lagging indicators and tell you what happened in the past. Every month, investors piece together clues that hint at what could happen in the future.
“You have to be able to look forward and have a sense of reality. So you look forward to what you anticipate is going to happen down the line or what is happening now or what happened in the past,” says Sica.
For investors who believe the economic recovery will continue here as well as globally, adding money to sectors that may benefit from a growing economy could be a good idea.
According to Scott Wren, a senior equity strategist with Wells Fargo Advisors’ Advisory Services Group, those areas include the consumer discretionary sector, the technology sector and materials.
“When things are looking up and the economy is anticipated to be good, money moves out of those more defensive sectors like consumer staples, utilities and health care, and into the more economically sensitive sectors — the consumer discretionary sector and industrials, materials,” says Wren. “The consumer discretionary sector (includes) things we want, not need. When you think the economy is improving, the future is good, then you’re more willing to purchase discretionary items like new furniture or a car or go on a cruise.”
Putting the pieces together
Looking at the most promising industries in the context of the big picture is called “top-down” investing, an approach used by many fund managers.
As they investigate potential investments, investors should consider broad swaths of businesses and think about what they do and who buys their products and services. Further considerations include what’s coming down the tax and regulatory pipeline, and what’s going on within the industry itself.
For instance, consider energy companies. “We have natural gas beginning a long-term fundamental shift in the dynamics of production. What companies will benefit from that in the long term?” Fragasso says. “We have old steel mills being reopened to create pipe for natural-gas drilling and transmission, and housing is in a slow and painful recovery. So we’ll just have to look at what segments of the economy have a good long-term prospect and which, by contrast, are cyclically depressed because of the recession.
“Take a look at some that may be ambivalent, like heavy-equipment manufacturers. Are they doing well in the U.S. farm belt, and are they doing well overseas? Take a look because they present a different picture. What companies stand to do better in the recovery than others? That’s the way we have to look at populating our portfolio,” he says.
At the same time, investors may want to skimp on more defensive plays, such as utilities and health care, or areas where people hide when the economy slows down.
There are few shortcuts when it comes to finding investment opportunities. Once you’ve identified the areas you think are going to improve over the coming quarters, the next homework assignment is researching the individual businesses to determine what to buy.
“There’s no easy way. You can’t just say ‘OK, what mutual funds did well last year? I’ll pick those,'” Fragasso says.
That would be a good strategy if past results were indicative of future returns. Unfortunately, they rarely are.