Global MarketsInvestor PsychologySMSF Strategies

The cyclical view

22 Nov 2021 8 month(s) ago

The most common way to assess markets is to see them in terms of cycles. Because it is most common, it is what shifts markets.

It is the time for pundits to start looking towards 2022. Joseph Amato, writing in Firstlinks, has some interesting opinions, mainly based on the logic that markets go through cycles and so best returns come from picking where the cycles are out of kilter.

The idea of cycles depends on the belief that the markets have a fixed centre but the pendulum continually swings away from that centre. That is optimistic. The markets are in great peril. As analyst John Titus notes in BestEvidence, their future is extremeley uncertain.

Still, looking at it in terms of cycles is what most investors do, so, by definition, that is what most moves the markets most of the time.

Amato makes some interesting points about income and capital gains (returns from rises in the value of share prices). He thinks there is a reflation tail wind to be considered:

“We think inflationary expansion is likely to support cyclical over defensive sectors, value over growth stocks, smaller over larger companies and non-U.S. over U.S. markets. That pattern was interrupted after Treasury yields hit their peak in March 2020, but could reassert itself as yields start to edge up again—particularly if this is accompanied by a weaker U.S. dollar. This environment would normally bode well for emerging markets, but substantial headwinds mean we tend to favor only specific opportunities, such as leading companies in India’s innovation sectors.”

The All Ordinaries has had some cyclical swings, with the downturns shorter than the upticks:

Getting returns from income is becoming more important:

“The story of value underperformance is well known. But income, as a subset of value, has fared even worse over the past decade. There are three sources of equity returns: multiple expansion, earnings growth and compounded dividend income. Multiples appear stretched, and earnings have been growing above trend—which suggests to us that income may be more reliable over the coming year. Over the past 50 years, income has accounted for around 30% of equity total returns. Moreover, in an inflationary environment with low but rising rates, equity income is also a way to get short duration and inflation exposure into portfolios at relatively attractive valuations.”

He says the high market valuations are pushing investors into looking at alternatives, non-traditional diversification options:

Investors face high valuations in many growth markets, combined with rising yields and diminished diversification benefits from core bonds, and the potential for inflation running above recent trend levels. This appears likely to encourage all types of investor to make larger, more diverse allocations to alternatives, liquid and illiquid, as well as assets that can mitigate the impact of transitory and secular inflation, such as commodities and real estate. Individual investors may have the ability to make the most notable move, as private equity and debt products become more accessible to them.”

The markets are becoming less enamoured with the use of debt (leverage) to amplify returns. Given how absurdly high debt levels are that is a good thing:

“Whereas historical vintages often relied on buying cheap and applying leverage, we see that today’s average deal is comprised of more than 50% equity, and depends for its potential returns on successful operational and strategic enhancements, and merger-and-acquisition (M&A) 'roll-up' programs.”


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