Perplexed over various business cycle diagrams and how/which financial assets to trade in at each critical juncture? Here’s a quick and dirty guide. I have tried to find the perfect business cycle diagram to better delineate the explanation below but no such luck. So please just make do with the above picture. Global macro hedge funds typically trade all 4 asset classes namely stocks, bonds, commodities and foreign currencies. The 4 markets are actually interlinked which is why global macro is synonymous to the queen on the chess game, the most powerful subject to weave through all nooks and crannies of the market, unconstrained across geographical segments.
The USD influences commodities, and then bonds, which therefore influences stocks. For instance, a rising USD normally has an adverse effect on most commodity prices, as it is construed to be a noninflationary event. Read, The case for investing in commodities http://www.gurufocus.com/news/143308/the-case-for-investing-in-commodities
There is an intermarket relationship on how the dollar affects large and small cap stocks. Large MNCs typically are exporters, thus with the very strong dollar, their stocks will be adversely affected as their products will be more expensive in foreign markets, thus lowering their sales. However, domestic small cap stocks are typically unaffected by strong dollar movements as their principal business activities typically reside domestically (eg stocks in Russell 2000).
The 5 phases of business cycle are as follows:
Recession: Buy late cycle stocks and commodities
Recovery: Buy cyclical stocks, commodities and other risky assets
Early upswing: Buy stocks and real estate
Late upswing: Buy bonds and interest rate sensitive stocks. Sell commodities and inflation sensitive stocks
Economy slows: Buy bonds and interest rate sensitive stocks
What constitutes interest sensitive stocks? They are typically utilities, financial stocks and consumer staples. Interest rate sensitive stocks like utilities, financials and consumer staples stocks will benefit from the rise in interest rates. What about inflation sensitive stocks? Well, gold, energy and oils will be the good vehicles.
It also pays to remember that oil prices have on energy and airline stocks. Rising oil prices help energy shares whereas airlines profitability is negatively affected, unless they managed to hedge their risk.
In a normal market (without any black swan events), one will see the above scenarios typically being played out. What is your position in the market now? Take a vote here and you can view your fellow voters’ results on the same page.
Part 2 continues here.
