Rotating your investments in step with the economic cycle can pay off.

Capital goods, such as Boeing aircraft, tend to see an uptick in the middle of an economic expansion. Photo: Jetstar Airways

By Gaspar d’Orey

Many people consider the stock market an alien and complex thing to grasp. But it doesn’t have to be this way. With some grounding in the basic elements of investing and a little demystification of the terms involved, anyone can further their interest in investing and develop a solid portfolio that will sow the seeds of investment success .

To help you develop a more thorough understanding, I want to share some of the knowledge I’ve gained from my years as a professional fund manager. And for those who want to take their portfolios to the next level, let’s look at some advanced techniques you can employ to read the stock market more accurately and select the appropriate industry to invest in.

What Influences Your Share Price?

Throughout the years, the economies of the different countries in the world have become much more closely linked through constant exposure to trading, importing, and exporting. The creation of this network has been a really positive development, but it has also dramatically increased the number of different factors that impact share prices. This means that any portfolio you develop will likely be a global one, and that to really reap the benefits, it’s vital to understand which factors influence share prices.

Many believe that the biggest factor in a company’s year-on-year performance is its share price. However, while thats true to an extent, there are four other interrelated factors to consider when you’re looking at the different influences on the shares in your portfolio.

1. The economy
2. The market
3. The sector

4. The industry

Let’s look at a hypothetical example. My shares in one company are performing really well. That company is in the consumer-facing technology industry, which is also thriving. Consumer tech falls into the wider tech sector, which is going through a boom; likewise, the market at large is positive right now. And the economy? It’s in a positive cycle.

That’s a very simple way of looking at a larger problem: No single share exists in isolation on the stock market. Therefore, to get a complete picture of your share’s potential, you need to understand its context. How is its sector performing? Is the company situated in a solid industry?

But this doesn’t only work if you’re looking at the share in isolation – starting with a well-performing sector or industry is a great way to select the stocks you want to purchase, and can help you establish a strong framework for future investment success.

The Effects of the Economic Cycle

In the above example, I mentioned the economy being in a positive cycle as a factor you can use to judge the likely performance of a stock. But what exactly is a cycle, you might ask?

It’s a term used by economists to describe the five identified economic stages which together form a cycle of economic performance. The cycle covers the economy’s expansion, slowed growth, crisis, and recovery periods. And as the economy at large affects the markets within it, as outlined above, the five stages correlate with the stock market cycle.

Why does an investor need to know this information? Because each sector within a market has a different optimal moment for trading in the economic cycle. This isn’t an exact science, as is the case with so much investment advice, but general trends emerge that we can use as we gather information to support our decisions.

A good place to start is market data from the last couple of decades. By looking closely at those results, we can identify performance patterns to see where in the cycle sectors are at their most profitable and when they generate the most returns.

Stage in the Economic Cycle

Sectors That Tend to Perform Well