The best asset classes to be in right now
By
Dominic Frisby Jul 01, 2009
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When making longer-term investment decisions by far the most important thing to get right is the sector. Studies have repeatedly shown sector allocation to be more important than individual stock picking.
You could have owned the best bank in the world in 2008 – you still lost money. You could have owned the UK's most horrible house in 2006 – it still went up.
If you are to get your choice of sector right, it pays to understand where we are in the grand scheme of things – or where we are in the economic cycle.
So where are we?
Economic cycles - where and when you should invest
Many dismiss cycles work as little more than hocus pocus, but there are definite repeating patterns in business and economics, just as there are in other walks of life. In his 1925 book The Major Economic Cycles Russian economist Nikolai Kondratieff identified a long-term cycle lasting approximately 50 years.
Before I look at it in detail, let me just issue the following disclaimer. It's easy to look at past events, find an arbitrary pattern to fit them – perhaps even stretch occurrences slightly to suit the pattern - and call it a 'cycle'. This goes on all the time with any type of cycles work. Nevertheless, history rhymes, as Mark Twain said, and as long as you are flexible and don't marry yourself in too blinkered a way to one cycle theory, there is a great deal you can glean from them.
In Kondratieff's cycle, also known as a Kondratieff Wave, there are three distinct phases - expansion, stagnation and recession – over a period of 45 to 60 years. Modern technicians have adapted the Kondratieff Wave into four 'seasons'.
In the 'Spring' phase, which follows the Depression that was 'Winter', there is a gradual increase in business activity, leading to rising employment. Consumer confidence, consumer prices and stock prices all begin to rise steadily from very low levels. Interest rates also start to rise as credit starts to expand. During Spring the best investment classes are usually stocks and real estate.
'Summer' sees a further increase in both confidence and credit. Inflation also quickens. Commodities and precious metals boom. The stock market, however, comes under pressure. War, according to some modern interpretations of the theory, is a likelihood at the end of Kondratieff Summer. The best investment sectors for this period are real estate, commodities and precious metals.
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'Autumn' sees a massive bull market in stocks and real estate, with both reaching an eventual, long-term, secular peak. Both commodities and precious metals can fall in what is essentially a period of disinflation, but debt increases astronomically. Consumer confidence is very high due to plentiful jobs and high stock and real estate prices. The best investment classes for Autumn are stocks, bonds and real estate.
Finally, we have Winter. Stocks begin a long-term bear market, some say of equal proportion to the preceding bull market. Credit contracts, lending tightens, banks collapse, as do some currencies, bankruptcies are widespread, business activity falls, unemployment rises and deflation takes hold. The best sectors for Kondratieff Winter are cash, gold and, after the crunch, bonds.
Ian Gordon of The Longwave Group has done as much work as anyone on Kondratieff – my explanation of the seasons derives from his work. These two charts are taken from his website, http://www.longwavegroup.com. The first shows the patterns and characteristics of each season [Click the image to view a larger version]:
This next chart shows an idealised version of the cycle since 1800 [Click the image to view a larger version]:
Warning: currency collapses are typical of a winter
Obviously, these are very general guidelines – it's not the sort of information you can use to trade individual stocks on a day-to-day basis. But the useful thing about cycles is that it can give you an idea – particularly when economic indicators are conflicting and times are confused, such as now – of where you should be looking to invest generally.
And it doesn't take a genius to deduce which season in the cycle I think we are in – winter, in case you hadn't guessed – which is why, in general terms, I would recommend gold and cash as the sectors to be in.
However, currency collapses are typical of a deflationary Kondratieff Winter, as any holders of Icelandic krona will vouch, so it is essential to be in a currency that is strong. With all our underlying debt, I see sterling as highly vulnerable and would advise diversifying into stronger, foreign currency, where possible. There will be rallies in both stocks and commodities, but these are, in my view, traders' rallies and are no good for the long-term, buy-and-hold investor.
It'll be a long time before stock markets rise
And for those who believe this current surge in stocks is anything more than a bear market rally, I post the following superb charts from www.dshort.com. The first shows history's more notorious bear markets superimposed. The similarities in their patterns should be noted, and also their duration , which suggest we have many more years of range trading before the stock markets break out to new highs.
Also from www.dshort.com , a similar chart shows the bear markets of 1929-32, 1973-74,2000-02 and 2007-09 .
I suspect that this bear market has many more years left to run. Again, this argues against 'buy and hold' investing, or simple market tracking. If you are investing in stocks, you have to be selective – you can read more about which stocks my colleagues at MoneyWeek favour in the current issue, out just now.
Our recommended article for today
As Western economies remain mired in recession, investors should head east to find solvent economies worth putting money into, says Martin Spring. And Asia in particular looks promising.
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