Alpha Beta | How do investors handle the volatility of the stock market?

Assets in all their forms are affected by economic cycles, and the financial returns for investors are determined according to the fluctuations of the economic cycle, and therefore we hear a lot about the importance of timing when choosing any of the assets to invest, because it is of great importance to investors and speculators in these markets. There are several ways to try to examine the times of entry and exit, which are of course very difficult, due to fluctuations in the course of markets, local and external economic changes, and regulatory and political influences, which can create rapid and unexpected fluctuations. Despite these challenges, there are broad lines that help to make a decision and determine the appropriate strategy for the investor, which we will discuss in this article.

The investor must first be aware that the economic cycle greatly affects the movement of assets up or down, and can refer to a previous article in which I spoke in the “Al-Eqtisadiah” newspaper about the main investment tools and their scope. interrelated, and their interaction during economic cycles. In short, the idea is that there are five major investment vehicles that form the backbone of financial markets around the world, which are: stocks, bonds, commodities, currencies and real estate, and there is an interrelationship between them, as each means influencing the others and is affected by new developments in the field of Macroeconomics such as interest rates, economic growth rates, and so on.

The economic cycle expresses the state of economic activity in the country, and it always oscillates between contraction and stagnation and then recovery and prosperity, to form one economic cycle, and then return to repeat the cycle again, and the average duration thereof in the United States. is about 5.5 years, according to the National Center for American Economic Studies. There is no doubt that there is an economic cycle, but the difficulty lies in determining the time from the beginning and end of each cycle in a sufficient period of time so that the investor can handle the situation.

Nowadays, there is great confusion in the US stock markets, caused by the fear of many that the economy will enter a state of recession, which often means that economic movement and poor financial results for companies slow down, in addition to high unemployment and other negative effects . These fears are justified, and first, real economic output fell by 1.4 percent in the first quarter of the year, while it was high in the fourth quarter of 2021 with a significant rate of 6.9 percent. According to the prevailing definition of economic stagnation, a decline in real output in two consecutive quarters is considered an economic stagnation, and it lasts on average for about a full year, before the economy begins to recover again.

Another strong proof of the possibility that the US economy is falling into a recession, we find it in what is known as the yield curve, which began to take the horizontal shape, or flat, and even the reverse shape on some days adopted in the past. weeks, and the importance of this comes in the fact that investors in the government bond market, and their Senior professionals with a long view of the economic situation believe that interest rates will continue to rise, so they sell bonds now and wait for new bonds that later higher interest rates will be priced. The challenge here will come when the economy enters a recession and at the same time interest rates are high.

How should the investor act if the US economy enters a recession?

From the study of the five investment methods: stocks, bonds, commodities, currencies and real estate, we find that the prices of stocks and most commodities fall at the end of the economic cycle and in a state of economic stagnation. this is what we’re seeing over the last few months, but – often – prices start to rise at these times. Bonds are rising, which means bond yields are falling, but this is not something we have seen since the beginning of 2022. The reason because the increase in bond yields is due to the time when interest rates remained low due to the action of the Federal Reserve and quantitative easing, so there is no more room for interest rates to fall. But in the event of an economic slowdown, the US Federal Reserve will have no choice but to cut interest rates later this year. This means that investment opportunities will be in bonds, perhaps in the middle of the year, assuming a recession.

What about equity investors?

It is known that most companies in various sectors have reached their highest selling limits at the end of the economic cycle, and therefore their forthcoming financial results will be discouraging, and as is well known, stock markets predict the economic situation several months before that. occurs, so we find that stock prices have started to fall. Despite this, the defense sectors remain at the end of the economic cycle and when they enter a state of economic recession, a safe haven for investors, such as: healthcare sectors, public utilities, energy and essential consumer goods. The companies of these sectors are distinguished by the fact that their commercial activity is not much affected by the economic cycle, and at the same time we find that most of these companies produce a fairly stable periodic return, in the form of distributed profits, and when there is a decline in their share prices, the percentage of distributed profits rises significantly And it becomes a strong competition for safe government bonds, but rather for the bonds of big companies.

If we look at the performance of equities over the past three months, and take the sectors of the S&P 500 index as an example of the main sectors in the market, we will find that the biggest declines have taken place in the following sectors “as last year Thursday ”: Information technology“ -14 percent, non-essential consumer goods ”-14%”, and these are the companies that are affected strongly and quickly by the end of the economic cycle. On the other hand, we find companies that are not much affected by the end of the economic cycle, and some of their share prices are rising even in this period, and they are defense companies: public benefit companies “+3.3 percent,” essential consumer goods companies “-0.28 percent,” health care. -1.7 percent.

Investing in stocks is difficult in all cases, and it becomes more difficult due to the economic cycle that most economies go through, and often many investors either move away from stocks at the end of the economic cycle or invest in defensive companies to achieve a high dividend yield, in addition to the retention of capital due to The stability of the share prices of these companies due to their lack of dependence on the economic cycle significantly.

Quoted from Al-Eqtisadiah

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