Your Finances: Riding the Cycles

“To everything there is a season”.

It’s true in life and it’s true in investing. The financial world moves in cycles. The most successful investors recognize this and take advantage of it.

It’s especially important to understand when one cycle ends and a new one takes hold because markets tend to overreact. When a particular commodity or security class falls out of favour, investors stampede for the exits. Conversely, when a sector is hot people can’t buy into it fast enough.

We’re experiencing a major cyclical change right now. The longest bond bull market in history finally appears to be over, which suggests a bleak outlook for fixed-income securities in the near to medium term. This has had a spill-over effect on other types of defensive securities including REITs and low-growth dividend stocks.

Gold is also in a downward spiral, despite a modest rally last week. It wasn’t that long ago that the precious metal was flirting with US$2,000 an ounce; now it is struggling to get back over US$1,300. Gold mining companies have been hit even harder than the metal itself; industry giant Barrick Gold has lost almost two-thirds of its value since reaching a 52-week high of $42.08 last September.

In fact, the mining sector as a whole has been battered as commodities have sold off as the economic news out of China keeps getting worse. As of the close of trading on July 16, the S&P/TSX Capped Metals and Mining Index was off 28.4% so far in 2013 while the Capped Materials Index was down 28.5%.

There is always a temptation to jump in and aggressively buy during these sell-offs with a view to picking up some bargains. Unfortunately, this is like trying to catch a falling knife. Momentum plays a critical role in market movements; once a downward cycle starts there is no predicting where it will end.

Teck Resources (TSX: TCK.B, NYSE: TCK) is a classic example. In May 2008, its shares were closing in on $50 on the TSX. Less than a year later, in February 2009, they were down to $4.47, an astonishing loss of more than 90%. Undoubtedly some investors bought on the way down, thinking they were taking a position in a high-quality company at a cheap price. As so often happens, the price got even cheaper.

The flip side of the story is that you can almost always find sectors that are moving in the opposite direction and have momentum on their side. So what’s doing well now?

The best place to look is the U.S. market. The TSX is so distorted by its heavy weighting in resources and financials that it doesn’t provide much insight into what investors are snapping up these days.

The biggest story so far this year in the U.S. has been consumer discretionary stocks, with the S&P sub-index up 28.1% so far in 2013. This comes as a bit of a surprise given the slow recovery in the States but the numbers don’t lie. This index is a catch-all of companies ranging from on-line retailer to tire maker Goodyear so it’s difficult to get a handle on it.

The U.S. financial sector, which has a tighter focus, is much easier to understand. It is ahead 24.5% year-to-date, thanks largely to the strong recovery in banks and insurance companies. Citigroup (NYSE: C), which was trading in the US$25 range not long ago is now over US$50 a share. Wells Fargo (NYSE: WFC), which I picked in my Internet Wealth Builder newsletter in January at US$35.14, is up to US$43.59 for a gain of almost 25% including one US$0.30 dividend.

U.S. health care stocks have also been strong, advancing 24% so far this year as investors’ concerns over the effects of President Obama’s medical insurance reforms have faded.

Looking overseas, Japan continues to be the hottest international market with a year-to-date gain of 40.4%. However, it has been an up-and-down affair. The Nikkei pulled back significantly in June after hitting a five-year high of 16,000 in May. However, it has since bounced back and was trading at 14,615 at the time of writing.

While cycles are important, I’m not suggesting that you change your whole approach in an effort to take advantage of them. You should always maintain a target asset mix and hold on to core securities through good times and bad. However, maintain flexibility in a portion of your portfolio (whatever percentage you are comfortable with) to take advantage of changing circumstances. And always be careful of falling knives!


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