Cycles
The business cycle tracks an economies recovery, expansion, maturity, contraction and recession. The market cycle measures all investments made into financial securities, sectors, industries, regions or corporate capitalization to adjust to expected changes to the business cycle. Below we present some excellent research and models that attempt to illustrate the dynamic between the economic or business cycle and the market, behavioural and credit cycles which attempt to react to these changes in advance of their reality.
Within these major sector rotations exist narratives or idiosyncratic differences relative to a particular stock versus the industry sector at large. On the positive side these may include product breakthroughs, service execution, superior economics or new markets and on the negative front they may include a poor quarter, controversial news, new competition or increased government regulation. Stock specific decisions are impacted by behavioral bias, however for the most part fund managers employ similar playbooks and are especially influenced by confirmation bias, herding effect, anchoring bias and the disposition effect.
As is well documented the majority of fund managers underperform their index or benchmark every year, however in aggregate the decisions they make follow the business cycle expectations six to twelve month into the future. This creates a discounting mechanism or market cycle which anticipates this future economic activity and these sector, industry, country and capitalization rotations are the narratives that count.
Stock Style
Mutual Funds, ETFs and Hedge Funds try to group the world of securities into a never ending stream of categories but the truth is as far as the market is concerned there are only two - risk on and risk off. These are the only rotations that are ever made and irrespective of interest rate policy, fed policy or any other macro factor it is the never ending battle between the bulls and the bears over the psychology of the market itself that brings on the animal spirits to take on risk or remove it. Greed versus fear, positive sentiment versus negative, excelerating versus slowing economic growth, job losses versus job openings and on and on. It really comes down to this tug of war between the bulls and the bears over whether risk should be taken or shunned.
