what is business cycle fund
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The business cycle explained
Every economy, in any part of the world, tends to go through the following four phases of the business cycle:
1. Expansion phase
This phase, also called the recovery phase, occurs right after a period of economic downturn. In this phase, economic activity starts picking up again, that is, GDP expands, unemployment decreases, and consumer spending increases. Because of these reasons, the sales and profits of businesses increase, which, in turn, leads to a positive investment sentiment in the stock market. Moreover, interest rates are usually low, and the monetary policy is accommodative (credit is cheaper and more accessible, and investment is encouraged), which helps to stimulate economic growth.
2. Peak phase
In this phase of the business cycle, the economic activity is at its peak. Investment sentiment and consumer confidence are high. Economic growth peaks, and prices and other economic indicators, such as GDP, remain stable for a while before reversing to decline. At this point, the central bank may consider raising interest rates to curb inflationary pressures.
3. Contraction phase
This phase typically represents a recession when the economy starts to decline. This is marked by negative GDP growth, an increasing unemployment rate, and reduced consumer spending. In this phase, profits of companies start to decrease, and consequently, the investment sentiment is weak and cautious. Market volatility may increase in this phase.
4. Trough phase
The trough phase is an extension of the contraction phase and represents the lowest point of the business cycle. It is the lowest point of economic activity and spending, and income continues to stagnate.
How to Identify A Business Cycle
identify stage
Business Cycle in Growth Phase
- Consumer and businesses feel confident
- Factories run at full capacity – 3 shifts
- Business Plan expansion
- Employees have multiple job offers, Salary hikes
Business Cycle in Slum Phase
- Consumer & businesses nervous. Postponing Spending
- Factories have idle capacity. Not operating all shifts
- Busiess Cutting cost and capex
- Layoffs and salary freeze
- Consumer opt for spending cuts
Different sectors tend to do well in different phases
As mentioned in sector rotation, different sectors of the economy tend to perform better in different phases of the business cycle. Here are a few examples of the same:
Expansion phase
Consumer discretionary:
As consumer confidence and spending increase during economic expansion, sectors such as retail, entertainment, travel and tourism, and luxury goods tend to perform well.
Technology:
Technological innovation and increased business investments drive growth in the technology sector during expansion phases, including areas such as software, hardware, and semiconductors.
Peak phase
Financials:
During the peak phase, interest rates may be high, which benefits financial institutions such as banks, insurance companies, and asset management firms.
Industrials:
Industries involved in manufacturing, infrastructure development, and capital goods tend to do well as demand for goods and services remains robust.
Contraction phase
Utilities:
Utilities, such as electricity, water, and gas providers, are considered defensive sectors because they provide essential services that are less affected by economic downturns.
Consumer staples:
Companies that produce essential goods such as food, beverages, household products, and healthcare items tend to be more resilient during economic contractions because consumer demand remains relatively stable.
Trough phase
Healthcare:
Regardless of economic conditions, healthcare remains an essential industry. Pharmaceutical companies, healthcare providers, and biotechnology firms can benefit from sustained demand for medical services and treatments.
Utilities:
Similar to the contraction phase, utilities remain relatively stable during the trough phase because they provide services that are necessary to consumers, irrespective of economic fluctuations.
Why does the business cycle matter to investors?
Here is why it is important for you to understand the business cycle:
Timing of investments
The business cycle provides a framework for understanding various phases of the economy, namely expansion, peak, contraction, and trough. Each phase has distinct characteristics and can significantly affect investment returns. By identifying the current phase of the business cycle, you can significantly improve your investment decisions. For example, the expansion phase might be a favorable time to allocate more capital to stocks, while the contraction phase might be suitable for increasing allocation to defensive assets such as bonds or cash.
Sector rotation
Different sectors of the economy perform better in different stages of the business cycle. For example, technology and consumer discretionary sectors often outperform during the expansion phase, while utilities and consumer staples may fare better during the contraction phase. Understanding the business cycle allows you to engage in sector rotation strategies, where you shift your investments into sectors that are expected to benefit from the current economic conditions.
Risk management
The business cycle provides insights into the overall risk environment. During periods of economic expansion, there is typically a higher appetite for taking risks, while during periods of economic contraction, risk aversion tends to increase. By aligning your investment decisions with the prevailing stage of the business cycle, you can adjust your risk exposure, potentially mitigating losses during downturns and capitalizing on opportunities during upswings
Long-term planning
Understanding the business cycle can help you adopt a long-term perspective. Business cycles are cyclical, and economic expansions and contractions tend to occur over extended periods. By recognizing these patterns, you can develop investment strategies that account for different phases of the business cycle and avoid making hasty decisions based on short-term market fluctuations.
Scheme list-
- Axis business cycle fund
- Baroda bnp business cycle fund
- BOI Business cycle fund
- ICICI business cycle fund
- mahindra business cycle fund
- sundaram business cycle fund
- tata business cycle fund
- Quant business cycle fund