How to use cyclical asset allocation | An article on understanding Merrill Lynch's investment clock

I believe everyone is familiar with the cycle. Howard Marx divided the business cycle into four stages in his book “The Cycle”:Economic boom, recession, depression, and recovery。

The cause of the business cycle is that investors invest excessively during economic booms, leading to oversupply and overcapacity in the market, leading to economic depression and recession. As markets rebalance and the economy recovers, the economy will enter the next boom period.

The theory is similar. On the other hand, looking at the Merrill Lynch clock, the economic cycle is also divided into four stages:Recovery, expansion, stagflation, recession。

The recovery period is a phase where the economy is rising and inflation is declining. In this period, enterprises can often make better profits and increase financing through stocks, etc. Furthermore, stocks are often more sensitive to economic forms, so the yield of investing in stocks is best at this time. Interest rates are generally low during this period, and bond prices have an inverse relationship with market interest rates, so there is some room for bonds to rise.

The recovery period shifts from a recession period, so during the recovery period, investors and consumers tend to be more careful in allocating commodities. Furthermore, tight monetary policies are not conducive to commodity prices, so the yield of commodities is low at this stage.

Economic inflation has all been rising during this stage. Commodity prices rise along with inflation, so commodities are the most worth allocating at this time. Due to rising inflation, interest rate hike policies are often implemented at this time, causing interest rates to rise, bonds to fall, and rising inflation also increases the opportunity cost of holding cash.

Although companies expanded and profits increased during this period, stock returns were not as high as commodity returns due to interest rate hikes and liquidity.

The economy declined during this period, and inflation rose. At this stage, as interest rate hikes continue to increase, interest rates rise, and cash yields increase. The profitability of enterprises has declined, and stock liquidity has weakened. The bond market is a little better than the stock market, but it is also weak. Commodities, on the other hand, benefit from rising prices along with inflation.

During a recession, both the economy and inflation fall. At this time, inflation will decrease, monetary policy will be relaxed, interest rates will fall, bonds will perform well, and the stock market will gradually recover. However, as inflation declined, prices also declined, and commodity yields lost their appeal.

In addition to the above four types of commodities, if we focus our attention on stocks, how can we allocate stocks at different times to maximize our win rate?

It is better to allocate stocks to cyclical industries during this period. Cyclical industries usually benefit from economic recovery, and performance is expected to improve, such as:

Economic growth was strong during the expansion period. At this time, the benefits of investing in growth stocks and stocks with higher beta values were higher. These stocks often had better earnings performance during economic growth, such as:

Periods of stagnation and recession are better configured with defensive industries and countercyclical industries. The performance of these sectors is generally not affected by economic downturns, such as:

Of course, it is important to note that stocks suited to the cycle are not immutable; we need to make specific adjustments to our investments according to the current form and various influencing factors such as policies.