This post shows how you, as an investor, can profit from understanding the 18-20 year economic cycle.  This insight on cycles is something that only Ascendant Strategy can teach you.

At cyclical peaks…

The news about emerging markets in recent months points to the fact that many of them are at or are approaching their respective cyclical peaks, in the way that Western economies were between 2006-2008.  As the stylised diagram below shows, once an economy reaches its 18 year cyclical peak, it will then experience up to four years of economic difficulties.  This happens cycle after cycle, without fail.

18 year economic cycle

The question is: what should investors do at such times?

The final years of the up-swing of a cycle involves a (credit-fuelled) spending binge during which asset prices, which have risen through the cycle, accelerate sharply and consumption increases conspicuously.  This was the case in western economies in the middle of the last decade and is now true of many emerging economies.  Such trends have been aided by ultra-low interest rates in the recovering West, global capital hunting for yield, lavish government spending on public works, high optimism after a decade (or more) of strong growth and so on.

Into cyclical peaks, the business case for investments looks strong, as they are based on good economic fundamentals, continued growth (projecting the recent past into the future), high demand, availability of credit and so on.  Such conditions bring a lot of investors to the party and so there will be lots of competition to acquire assets.

When the going is good, exercise caution.

Investments must be good value, based on robust fundamentals, current earnings (not capital gains, i.e. future earnings growth) and not dependent on rolling over loans.  We call the final two years before the cyclical peak the “Winner’s Curse”.    You may make some investments that realise gains for a couple of years but when the cycle turns down you may soon find you are holding assets worth less than what you paid for them.

How the savvy investor plays the cycle

We advise not following the herd.  Be patient and don’t be fearful of missing out.  Examine your portfolio and make sure its value is protected.  The last couple of years into cyclical peaks – when things are overheating – is a good time to dispose of the weaker elements of your portfolio.  It also helps to be in safe and liquid assets.

As the cycle turns down, there will be plenty of investors that are over-leveraged and in need of cash.  This is the time when good assets are available at good value.  Furthermore, in a downturn there will be fewer investors, so less competition to bid up prices.  The best deals are available at the bottom of the cycle.  If you have a strong cash position you will be in a position to snap them up.  This is a counter-cyclical approach to investing.

China’s richest man shows how it is done.

A good example of this concept was recently shown by China’s wealthiest man, Wang Jialin, who, it is reported, has just paid $385m to acquire the Edificio Espana in the centre of Madrid, one of the city’s landmark buildings which was Europe’s tallest when it was completed in 1953 (this tells us something about prior cycles in Spain, but that’s a story for another day).

The Forbes article documenting this investment notes that the acquisition price is a significant (33 per cent) discount from the price paid for the building at the peak of the cycle in 2006.  The article notes that: “the previous owner’s redevelopment project ran short of funds in 2007”: this always happens at the peak of the cycle.  Reference our advice above – he paid much less for this than the developer did in 2007, during the Winner’s Curse phase.

So he is getting a landmark development at a good price, in an area which will realise significant improvements over the next few years – much of it funded by the public and other private investors.

While we have no idea if he understands the 18 year economic cycle and whether this was simply lucky timing, i.e. moving money from an overheating market to one that will experience growth over the next decade; either way, we know it is a good play.

It is not always possible for investors to move money internationally, i.e. rotate capital between markets at different points in their respective cycles; but the principles are the same:

  • At the top of the cycle, it pays to be cautious, while everyone else is doing the opposite and investing funds (or, more usually, borrowing) to acquire over-priced assets for fear of missing out.
  • At such times, one should hold a good proportion of funds in safe and liquid assets that will hold their value
  • Be patient and wait for the downturn.  It will come, it always does.
  • At the bottom of the cycle, when everyone else is afraid, actively seek out those investment opportunities.  They will arrive because people are looking to sell or holding back.
  • When they arrive, be confident as there will be plenty of news around to tell you why you shouldn’t do it.  Also, it is unlikely to be possible to borrow much – this is why cash is handy.

Obviously, all of the above depends on knowing when the cycles will peak and turn down; find the bottom and then turn up, not an easy task (and, according to many people, impossible).  This is where Ascendant Strategy comes in.  We have developed a way of looking at economic trends that helps investors do just that.  Ascendant Strategy was established to help investors think through and make better investment decisions based on our unique research on economic cycles. We provide our clients with access to our research; and also help to apply these insights in a practical way to their investment decisions.

For an overview of how the cycle operates, please read this post.  For our thoughts on the Eurozone and its recovery, please see this guest entry on a blog hosted by the London School of Economics.