We’re in a recession right now. Recently, a team of prestigious economists confirmed the economy peaked in February.
Of course, many of us didn’t need an official announcement to tell us the economy was contracting. We knew how bad it was when we saw local businesses shut down.
The pandemic provided a dramatic kickoff for the recession. But all recessions start in a similar way. Business slows down and unemployment rises.
Soon, the recession will end. Economic expansion always follows recession.
Recessions and expansions are part of the business cycle. News reports cover these two parts of the business cycle in detail. But the cycle breaks down into smaller components.
Smart investors focus on these smaller components. They realize that as we move from one part of the business cycle to the next, some stock market sectors do better than others.
For example, as the recession begins, consumers cut back on spending. This means when the recovery begins, there’s pent-up consumer demand.
This leads to increased buying of big-ticket items that were considered nonessential when job security was a concern.
History shows there’s a surge in purchases of new appliances and cars when the recovery begins.
To benefit from the mini cycles within the business cycle, some investors use a sector rotation strategy.
A sector is a group of stocks that are in the same general business. It’s a broad grouping.
For example, the consumer discretionary sector includes Starbucks and Tiffany’s since neither company sells necessities.
The chart below is an example of sector rotation:
(Source: Alpha Architect)
Right now, we know we’re in recession. The next phase of the business cycle is recovery.
This is where consumer discretionary and real estate stocks are expected to outperform. Materials, the sector providing the building blocks of manufacturing, should also do well.
At the same time, health care, consumer staples and utility stocks are likely to be laggards when compared to the broad stock market.
This doesn’t mean these sectors will lose money. It just means investors are likely to shun conservative stocks for more aggressive trades as the economy grows.
It’s important to note the chart is an idealized model. Market action is unpredictable. It’s possible another sector will lead the recovery.
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