There are four stages of the economic cycle. These are the early phase, mid phase, late phase and recession. The characteristics of the economy currently point us to the view that we are in the late phase of the cycle. Some of these characteristics include low appetite for risk, flattening of the yield curve, a fall of consumer spending, slowdown in growth, and low levels of unemployment. Each cycle requires a different approach to investing. If you can understand what part of the cycle we are in, you have a better chance of improving your returns. These are the sectors to consider in a late cycle market.
Consumer staples tend to perform better in the latter part of the business cycle. They are not affected by inflation and are stable. These stocks are less prone to interest rate risk and are less economically sensitive. Consumer staples usually perform better than the broader market in economic weak environments due to their defensive characteristics. Products and services in consumer staples will still be in demand even if the economy slows. These stocks include food, beverages, waste services, funeral services. Some defensive stocks include Cleanaway (ASX: CWY), Woolworth (ASX:WOW), and Coles (ASX: COL).
The healthcare sector is a good sector to invest in when economic growth is slow. This is because it provides investors with growth and it is also defensive. Healthcare is an area where people are still spending on even if their deposable income is not growing. The healthcare sector is also a sector with growth potential as we are seeing longer lifespans for people. This may mean a longer period of medical treatment for the aging population. An example of healthcare stocks include CSL (ASX:CSL) and ResMed (ASX:RMD).
3.Energy and Materials
Energy and material stocks perform well in the late cycle. This is because the use of resources and labour is almost at full capacity so demand for energy and materials is higher than supply. This may mean prices are pushed higher for these products which is news good for these companies. Energy producers are reaching new production highs but demand is still increasing. This may mean energy supply may still fall short of demand. Hence the energy sector and material sector are attractive sectors to invest in when economy growth starts to slow.
The market gravitates to defensive stocks when the economy starts to slow. In the late cycle stage, investors look to stable and interest rate resistant stocks such as utilities. Consumers will consistently use utilities even if the economy is not doing well. Utility stocks tend to perform badly when the economy is booming in the early and mid-cycles but do well in economic slower times such as the late and recession cycle.
Telecommunications is another sector which is unpopular during economically stronger period such as the early and mid-cycles. They become popular again in the late to recession cycles. They can be used as a defensive strategy when the economy is slowing. Defensive stocks perform better when the economy is no longer growing as rapidly and the market is expensive.
Lauren Hua is a private client adviser at Fairmont Equities.
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