Articles tagged with: Recession
Cyclical companies are companies who are strongly tied to the business cycle and their stocks move sharply up and down when economy turns around. Because of this, they require special handling by the intelligent investor.
Definition of a cyclical company
During recessions and economical downswings the stock market as a whole usually goes down, but a special type of companies suffers most: the cyclicals. Examples for cyclical companies are Caterpillar, US Steel, General Motors and International Paper, all makers of products with a fairly flexible demand curve. Automobile manufacturers, airlines, steel, paper, heavy machinery and hotels are the best examples. Examples for non-cyclical companies are Coca Cola, Proctor & Gamble, and Quaker Oats, all makers of products with a fairly inflexible demand curve. In bad times, people still have to eat and buy stuff for the household. Getting a new car or some new whirlpool parts on the other hand, can be delayed for some time.
Marc Thomson, a friend of mine who works at a big bank here in Munich, Germany, said last week: “A lot of our clients feel it now, the recession is hitting them hard. We’ve seen that before in downturns, but as usual, industries like the steel and automobile industry suffer the most and request new credits. ”
Chart for aviation support company AAR Corporation
Great opportunities ahead
When you look at charts of cyclical companies like the one above, there are always big up and downs. But when economy turns around, cyclicals can outperform growth companies and be great turnarounds. The problem is to catch the right moment of the cycle to buy. Take a second and analyse the chart of AAR Corporation for yourself and you will recognise that after this recession great opportunities will come ahead.
There are two problems when it comes to investing in cyclicals: timing and selection.
When it comes to timing, no one really can predict the economy as a whole and additionally cyclicals tend to doing well many months before the economy comes out of a recession. Best indicators seem to be interest rates and the companies’ financial ratios which show when demand goes up again, but also insider buying. It also helps if you know the industry. But all in all it is quite difficult to catch the best moment for the ride.
When it comes to selection, it makes sense to pick an industry that is due for a bounce. Choose the biggest company for more safety and smaller companies if you want to take some risk. These companies who suffered the most can produce the most impressive returns, but you have to make sure, they also don’t go bankrupt. More than usually, you have to check the balance sheet. An indicators that the company is healthy is for example a strong cash position.
If you do your homework well, I’m sure you can find plenty of good opportunities. While it certainly never hurts to have a college education you don’t need a bachelors degree to find good investments. Solid research, patience and a solid understanding of your limits will go a long way in your success.
How to invest successfully
So, successful investing in cyclicals requires careful timing and a good selection. At this point, it’s time to make a watchlist and be prepared to invest when the recession comes to an end which no one know how long it will take. When taking action, take advantage of cost-averaging by buying the stock for several months and building up your position. To be save, you should also set a stop-loss limit to protect you from loses.
Most of all, never forget the up-and-down nature of the economy. And be careful, some cyclical companies die when it finally comes to a economic slump, because of bad management which thought the good times will go on forever and building up a cash reserve is not necessary. When you decide to invest in a cyclical company, you have to follow the news about the global economy and the industry the stock is in. Also cyclicals are not suitable for long-term purposes because of no protection in recessions. Buy-and-hold doesn’t work here. Please keep that in mind.
As Joseph Schumpeter passionately argued in his 1942 book Capitalism, Socialism and Democracy, recessions are a necessary evil in capitalist societies. Well, there are some arguments, that back up this theory. Although the word recession strikes fear into the hearts of people, recessions heal the economy from unrealistic developments and creates opportunities for investors. In the long run it is just a periodic downturn in the economic cycle and for some good reasons it seams.
Effects on the economy
Recessions correct economic imbalances and helps the economy to get back to a healthy, realistic, and sustainable rate of growth. The “job” of a recession is to clean the “fat” out of the system, mop up excess, and pave the way for the next expansion. However, there are always bankrupts, but in a recession the weak companies get put out of business and the strong ones are forced to optimize their business models and come out with better products. This brings job losses which are freed up to be efficiently used somewhere else in a flexible market. Recessions also eliminate these sorts of unsustainable bubbles like the technology bubble in the late 90s or the actual housing crisis. Of course, it hurts to lose a good paid job and suffer from financial loss, but it is necessary for our economy to become healthy once again.
The Stock market drops
Stocks markets go down in recessions, but as stated in one of my previous articles, Search for opportunities in crises, there are great opportunities in stock market declines. During periods of mass panic on the market all stocks go down for a while, because people like to panic somehow, I don’t know why. The important thing is, both good and bad companies go down. This means, that you can get high quality companies at a low price and with good long-term perspectives. That’s the time to position yourself to profit from these companies and catch the opportunity while it is there.
In fact, I even know a few investment guys, who are really cheered up and looked forward to the upcoming recession because of new investment chances.
According to a report by CNN, I found on moneysocket.com, the average American owes $10,000 in credit card debt annually. If people will ever recognise this misbehaviour, it maybe will happen during a recession. Although, I don’t believe people are easy to change, I think if suffering from financial loss, unemployment and hard times, maybe they start to think about there personal finances and learn something from it.
As we know from the past, a recession lasts for about 10 months, so good times will be back. Nevertheless, they are necessary and you will experience a few recessions in your life, so better be prepared. The important thing is not to panic and learn from crises. In fact, recessions can make you better and more skilled after all, just like they do with our economy on a regular basis.