By Marie Buffiere | Bricksave
April 22, 2023
For most individual investors, the investment world can seem like a rollercoaster, full of unexpected highs and sudden lows. But smart investing is about understanding the economic cycle and knowing the right times to invest in different types of assets.
The economic cycle is the name given to the recurring patterns of expansion and contraction that every economy faces. There are four key stages: expansion, peak, contraction, and trough. Each one brings its own set of unique opportunities and challenges, particularly for investors.
Also known as the growth or boom stage, expansion is characterised by increased economic activity, low unemployment, rising consumer and business confidence, and higher corporate earnings. This makes it a good time to invest in stocks and bonds, as well as real estate and other assets. In this stage, investors are looking to maximise the potential rewards on offer, and will be looking at the following investment strategies in particular:
• Growth investing: investing in companies expected to grow faster than the market average. This will include companies with innovative products or services (technology companies and healthcare companies are a great example), strong earnings growth, or high revenue growth rates.
• Cyclical investing: companies that are expected to perform particularly well during periods of economic expansion, but do poorly during economic contractions. Examples include companies in the construction, automotive, and retail sectors. That’s because people have more money to invest in property development, and consumers are looking to spend their gains on cars and other expensive goods.
• Property: investing in real estate is also very popular, as during the expansion phase, property values increase and so do rental rates, providing investors with a consistent and rising income. Also, real estate can act as a useful hedge against inflation, as property values tend to rise as the prices of other goods and services also increase.
Of course, all good things must come to an end, and the expansion phase is no exception. The peak stage is the point in the cycle where economic growth begins to slow down. Investors will be on the look-out for signals that the expansionary phase of the economic cycle is ending or is about to end. These usually include rising inflation, increasing unemployment, falling consumer confidence, and an increase in interest rates. Additionally, investors will be closely monitoring economic indicators such as gross domestic product (GDP) growth, industrial production, and slowdown in construction activity. If these indicators start to decline, it is likely the expansionary phase has peaked and is coming to an end.
At this stage, investors start to become more cautious. Investors will also usually consider adopting a more defensive investment strategy overall. This could involve selling some of their more growth-focused, higher risk investments, and investing instead in companies that are less sensitive to the economic cycle slowing down. Examples include companies in the healthcare sector, utilities (companies that provide essential services, such as water, electricity, gas, and telecoms), and consumer staples (companies that sell everyday essentials such as food and beverage companies, supermarkets and grocery stores, and personal care product manufacturers). These companies tend to keep performing well even during economic slowdowns.
At the peak point in the economic cycle, real estate investment tends to slow down also. The peak of the economic cycle, is often when prices are highest and there is the greatest potential for a market correction. It is usually more sensible to invest in real estate during times when the market is lower and prices are more attractive. During the peak stage, it can be wise for investors to hold a significant portion of their portfolio in cash or cash equivalents, such as money market funds. This can help protect against market volatility and provide liquidity for future investments.
If you’re not sure what the economic contraction phase is, well take a look around, because that’s the stage where the world is at right now. Also known as ‘recession’, the contraction stage is when you see falling economic activity, rising unemployment, and lower corporate earnings. Companies are starting to struggle, and many more households are finding it harder to make ends meet too.
During this stage, investors are inherently more cautious about where to invest. They will be prioritising defensive investments such as those already mentioned. And during an economic contraction ‘value’ investing also becomes more popular. Value investing involves finding companies that are undervalued by the rest of the market and are therefore considered ‘cheaper’ to buy. Investors often do well during recessions by identifying undervalued companies and holding onto them for the long-term.
Similarly, it can often prove to be a good idea to invest in real estate during a recession. Real estate prices can be lower and there is often more opportunity for growth if you can find attractive properties that will continue to generate consistent rental income and recover their value over time. However, it is also important to be aware of the potential risks associated with investing in recessionary times, such as falling rents and limited opportunities to sell. At times like these, real estate should really be considered as a long-term investment rather than a short-term one.
The trough stage of an economic cycle is the lowest point before recovery begins. This will usually be the point at which GDP growth, industrial production, and other economic indicators are at their lowest levels. During this stage, unemployment is at its highest, businesses are closing, and consumer confidence is at its lowest. In other words, when you reach the trough, the only way is up! The cycle then begins again with economic recovery, which sees increased demand from consumers and businesses, employment picks up and growth returns. Before you know it, the economy is back into an expansion phase.
The reality is that the economic cycle is very hard to predict, because at each stage it is very hard to determine when that phase will end and the next will begin. For example, you will only ever know when the trough – the lowest point – has been reached when the economic indicators have started to recover. So, for most investors, there is little point in trying to predict the timing of the economic cycle, it’s more important to own a diverse portfolio of assets that will respond differently at different phases, ensuring you spread your risk and don’t get caught out when the seasons change.
Fortunately, real estate investments can play a key role in all phases of the economic cycle. In times of growth, it can deliver good returns as property values tend to rise during expansionary periods. Real estate can also be a safe haven for investors during uncertain times. Not only do property values tend to be more stable than stock market investments, real estate can continue to provide consistent cash flows in the form of rental income.
Real estate is also a valuable portfolio diversifier, as it typically behaves differently than other assets such as stocks and bonds. So, when one asset class is performing poorly, real estate may be performing better. And as well as providing investors with a steady income, buying real estate investments during the trough stage can give investors the opportunity to buy at discounted prices and then profit when the market recovers.
Finally, if you’re worried about whether now is a good time to invest, it’s worth remembering the words of Warren Buffett. He says: “Be fearful when others are greedy, and greedy when others are fearful”. If you apply that logic, this could be the time to be greedy.
With Bricksave you can start investing in real estate with as little as $1,000. Find out more: https://www.bricksave.com/about/
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