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Investors and the business cycle

The economy tends to expand, contract and expand again in a cycle that offers varying opportunities for investors. Dave Sandstrom explains in a Money Talk Video with Joel Dresang.

Joel Dresang: Dave, when we talk about growth stocks versus value stocks, they performed pretty similarly in 2014. But in 2015, growth stocks have taken over. What significance does that have for investors?

Dave Sandstrom: Joel, I think it’s a clear sign that we may be entering into the second half of the business cycle. I think it’s important for investors to realize that economies don’t grow at just an upward rate all the time. We go through periods of expansion, but we’ll also go through periods where the economy slows down and even contracts. And it’s that cycle of that expansion and contraction that is commonly called the business cycle.

Joel: So, growth stocks outperforming value is a sign that we’re in the second half of that business expansion. Let’s take a step back and define what value stocks are and what growth stocks are.

Dave: So value stocks, by definition, carry a lower-than-average PE. A lot of times, it’s dividend-paying stocks – stocks that are deemed to be underpriced, basically. Investors go to those to feel like they’re getting a good deal. And they have, over time, been one of the best performing classes out there.

Growth, on the other hand, is something that you’re going to be paying a higher PE for because it’s going to be a company that is growing faster than the average company, and investors are willing to pay a little bit of a premium for that growth.

Joel: Can you give some examples of value stocks and growth stocks?

Dave: Value industries would be financials, utilities – companies that pay dividends. On the growth side, you’re looking at pharmaceuticals, technology stocks – companies that are really growth-oriented.

Joel: So, why should investors be paying attention to where we are in the business cycle?

Dave: Well, I think it’s really important, Joel, because you’re looking at value and growth performing very differently, depending on where we’re at in the business cycle. Value stocks have a tendency to lead you out of recession. They’re sensitive to interest rates, so at some point in time, they may be affected by that.

And growth stocks have a tendency to really help us in that expansionary phase and take over for value at that point. They also have a tendency to drop rather quickly as recessions approach, so you have to be careful.

Joel: So knowing all that, what should investors be doing?

Dave: It’s critical to stay balanced, Joel. It’s very difficult to predict the length of the business cycles. So with that in mind, a good core holding in value and some nice exposure to growth is going to be the best thing that you can do.

Dave Sandstrom  is vice president and advisor at Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Peter May
(initially posted June 16, 2015)

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