My approach to investing is based on the business cycle (see below). Our economy goes through different stages of the business cycle, where different types of investments will do better or worse. In my practice, we adjust the general allocation of stocks, bonds and other investments based on where we are in the cycle and where we think we are going, as well as the underlying investments in the sectors. .
Our goal is to manage the portfolio to find the highest potential rate of return for the least risk (also known as risk-adjusted returns), adding growth potential during periods of growth and adding capital protection through the use of insurance products in uncertain times.
The 4 cycles of the economy
This graph above is a representation of the economy as we go through the four stages of the business cycle. The part of the curve above the baseline represents a period of economic expansion and the part below the line represents an economic contraction.
We believe we are in mid-cycle right now, poised for further growth because of the cash savings Americans were able to accumulate during the pandemic. When they resume eating out, traveling, shopping, etc., a good chunk of that money could flow back into the economy. Another factor is that the Federal Reserve’s monetary policy is favorable to equities.
We keep an eye out for many risks, including inflation, taxes, government policies and spending, COVID-19 policies, and more. As challenges arise, we assess and monitor them and make appropriate changes to our investment strategy in order to manage portfolios as effectively as possible.
What tends to do well at the start and middle of the cycle
In a diversified portfolio, the allocation of stocks and bonds will generally determine the risk of the portfolio. The more stocks there are in the portfolio, the more risk there is. Stocks tend to do better at the start and middle of the cycle, and bonds tend to do better during a recession. The reason is that since investors are reluctant to invest in stocks, which usually carry more risk, they seek safety in bonds. Thus, dollars move from the stock market to the bond market, so the demand for bonds increases, and therefore their price too. This typically provides an inverse relationship in a recession designed to add protection and stability to the portfolio.
There are other categories of investments that make up a much smaller portion of the portfolio, but are also stable in late stages and recessions, including high yield bonds and potentially commodities. (All investments involve risk and the potential loss of capital, so it’s important to keep this in mind when building your retirement portfolio.)
Beyond the general allocation of stocks and bonds, we also take a look at which sectors are doing well in which parts of this cycle. In the beginning, when we see high growth, sectors that are generally sensitive to the economy will outperform, while more defensive sectors will underperform. Examples of economically sensitive sectors include technology, industrials, and consumer discretionary. The first part of the cycle is relatively short, averaging a year, and has produced an average of around 20% returns.
What about as we progress into the late cycle?
The mid-cycle is a longer stage in the economy, averaging around four years. This stage is one of sustained growth where we do not see any sector significantly outperforming the others. This step is a good opportunity to redefine the asset allocation to avoid losing some of the gains from previous growth. The average yield in the middle of the cycle was about 14%.
The end of the cycle is when we turn to defensive and inflation-protected categories, such as materials, consumer staples, healthcare, utilities, and energy. This stage is simply a slowdown from the period of higher growth in the middle of the cycle – it doesn’t mean that we have negative growth in the economy, it just means that we are not growing at the same rate. The return has historically been lower, on average around 5%.
How we position portfolios during the recession cycle
Finally, in the recession cycle, there is usually no sector that is doing very well. Stocks behave badly most of the time. The areas of investment we look for in times of recession are companies that offer stability and are more defensive. These include consumer products, that is, businesses that provide goods and services that people need, regardless of the economic situation.
Health care is a good example, because people need health services and medicines, regardless of economic conditions. Another example would be utilities. These are not negotiable for people. In addition, the more defensive companies will generally have higher dividends, which will help weather the storm of the recession, which has generated average returns of -15%.
Either way, some adjustments are still needed
Every market cycle is different, and we can see different sectors behaving in different ways depending on economic conditions, and we see that coming out of a pandemic-inspired recession versus a typical cycle. Real estate and financials are a good example today, where they are positioned for growth compared to 2009, where they were decidedly not positioned for growth! Also, we can move forward and backward on this curve, not always in constant motion from the beginning to the middle, to the end, to the recession.
We use our research and metrics to figure out where we are in this cycle and which sectors we think will perform well, and we tilt portfolio allocations slightly to find the best risk-adjusted returns.
These strategies, along with our research teams, are designed to enable us to preserve and help protect our clients’ retirement portfolio, which is so important to our retired clients.
Stuart Estate Planning Wealth Advisors is an independent financial services firm that creates retirement strategies using a variety of investment and insurance products. Investment advisory services offered only by duly registered persons through AE Wealth Management, LLC (AEWM). AEWM and Stuart Estate Planning Wealth Advisors are not affiliated companies. Neither the firm nor its representatives can give tax or legal advice. No investment strategy can guarantee a profit or protect against loss in times of declining values. Any reference to protection benefits, security or life income generally refers to fixed insurance products, never securities or investment products. The guarantees for insurance and annuity products are backed by the financial strength and claims-settling capacity of the issuing insurance company. Bond bonds are subject to the financial strength of the bond issuer and its ability to pay. Before investing, consult your financial advisor to understand the risks of buying bonds. 01010056 08/21
Vice President and Head of Institutional Financial Management, Stuart Estate Planning Wealth Advisors
Sean Burke joined Stuart Estate Planning Wealth Advisors as Vice President and Head of Institutional Financial Management of Fidelity Investments. He holds a master’s degree in financial valuation and investment management. At Fidelity, Sean has worked with clients on plans and strategies to help them achieve their financial goals, focusing on tax-efficient investments, an investment strategy with good risk management, estate planning, protection of capital and income, etc.