2 August 2012

Investors often refer to the “investment cycle” as though it is a regular, predictable occurrence that can be used as a basis for strategic trading. A good graphical illustration of the investment cycle can be found in this recent article by Don Stammerin The Australian. However as Don states in his article:

“Of course, the real world is far more complex. No two cycles in investment markets (or in the economy) are ever the same. Turning points can be sharp or drawn out. Cycles can be wide or narrow. Also, the duration of individual cycles varies greatly. Some observers suggest that investors need to allow for several cyclical patterns that overlie each other: the inventory cycle, which tends to last for one to three years; the business investment cycle, which is usually seen as running three to seven years; and the super cycle which they say extends over 40 to 60 years.”

In other words, it’s one thing to be aware of the business cycle but it really does not help much if you want to use that knowledge to underpin any trading activities you might be contemplating. So we think it best to use the understanding of the investment cycle as just one more input into your decision making process and not an end in itself.

Another interesting point in this article relates to the relative performances of earnings, dividends and prices of Australian equities since the GFC. Dr Stammer points out that:

“Our sharemarket is still 40 per cent below its 2007 peak while earnings per share and dividends per share are respectively 28 per cent and 15 per cent lower.” This is an important observation and one that we often return to at Whites IFM. It is increasingly common for sharemarket prices to disconnect from underlying value. The price of a share should reflect the on-going earnings potential of that company. Earnings are down 28% on average since 2007 and with companies reluctant to cut dividends by more than they have to, dividend distributions have only been reduced by 15%. However market prices are down by 40% and have been for a protracted period of time. It is quite plausible that prices will eventually “catch up” with the fact that earnings and dividends are not as bad as the market might suggest. We recommend that investors pay attention to a company’s underlying performance and its ability to keep paying dividends. Leave it to the speculators to be concerned about share prices.