A long-term investor can use the SIP route; aggressive ones should accumulate cash.
At first glance economics and physics have little in common. Physics is a natural science and a physical hypothesis is verified by controlled experiment. It’s impossible to run controlled economic experiments.
But economics borrows many mathematical tools from physics. One of these is spectrum analysis. Scientists and engineers working with electro-magnetic waves and sound waves need to know the cyclical patterns of those waves.
Whether it’s recording an orchestra, or transmitting/ receiving radio or TV signals, or transmitting and distributing electric power, the action of different waves is involved. Spectrum analysis is also used in building bridges and rail-tracks because sympathetic vibrations caused by traffic can pressurise a structure and cause collapse.
The economic utility of spectrum analysis is also obvious. A business cycle actually involves multiple interacting cycles. Sometimes those waves reinforce each other, when many peaks or troughs coincide. Sometimes they cancel out when one peak coincides with another trough. Spectrum analysis can help work out the frequencies and thus, decompose a cyclical price movement into component waves. This is quite complicated mathematically.
It’s relatively easy to understand wave-interactions intuitively. For example, a high in crude prices may coincide with a low in vehicle sales since high crude prices make consumers reluctant to buy cars. A high in unemployment may coincide with a low in GDP growth. The end of a financial year may coincide with a spurt in tax-deductible expenses.
Of course, even when cycle analysis throws up apparent relationships, we often don’t know why. Cycles do change in frequency and when we don’t know the underlying reasons, the danger of being caught by a switch in cyclical behaviour is higher.
Cyclical insights are very useful when they can be translated into investment and trading strategies. Looking at broad relationships between GDP growth and stock market movements, it’s clear that financial market activity precedes the real economy. Financial cycles peak and hit lows earlier than the real economy. The bond market tends to precede equities. Many commodities are non-correlated to either interest rate cycles or equity moves or even broad GDP trends.
Inside the equity segment itself, various sectors have complicated interactions. In India for example, the IT and pharma sectors are somewhat divorced from the rest of the listed economy. Infrastructure has long cycles with extended periods of highs followed by extended lows. Shipping is integrated with the global pattern and so are commodities, such as metals.
At the long-term, there is no large listed sector that is obviously counter-cyclical in the Indian economy. In other economies, the primary energy sector, meaning crude and gas producers, is often counter-cyclical. But in India the subsidies and administered pricing mechanisms get in the way. Renewables could be a promising counter-cyclical but the listed sector is too small as yet.
Long-term cycles are relatively easy to deduce in terms of frequencies. However, analysis across long-term timeframes also throws up fewer signals. There might be a buy or sell signal every couple of years whenever a peak or low is hit.
A trader who’s looking for short-term cyclical patterns, which can be traded within short periods has to work considerably harder. There are apparent short-term patterns but they change quickly and may also be spurious in many cases.
The long-term cyclical patterns suggest the broader equity market may be neutral or bearish at this instant. It isn’t one of the periods when investors should be looking to change their long-term asset allocations by going massively overweight or underweight in equity.
Nor are there specific sectors that appear to be particularly attractive in the sense of being near the cyclical low. Most sectors seem to be reasonably close to the mid-point of their respective cycles and time-frequency analysis suggests that quite a few could be poised to head lower.
In terms of timeframes, the market could either head lower, or remain close to the current levels for several months. Sometime in the next six months to a year, the market should hit a cyclical low and start picking up steam on the rebound. It’s difficult to be more exact about either timeframe or levels. In terms of valuations, the market is on the high side of normal at a PE of 21-22. So, it could go higher but the chances of downmoves appear to be more.
This is the kind of situation where a passive long-term investor could just maintain a standard systematic investment plan. An ambitious investor should probably be looking to accumulate resources that can be held in other assets and redeployed in equity at lower valuations.
