Updated: Nov 24
Author: Sara Diamante
Date of Publication: 06/04/2023
Strategic Market Analysis
1. Integrated Analysis
Having known the complexity of markets, it is good to observe their functioning by proceeding with an integrated analysis. In particular, this is given by the sum of technical analysis, fundamental analysis, macroeconomic analysis, and volume analysis.
2. Macroeconomic Analysis
Moreover, macroeconomic analysis studies the evolution of the main aggregate economic variables. The latter explains the health of the economic system and the consequences on financial markets. The main objective is the construction of medium- to long-term scenarios capable of interpreting broader market movements. On average, up to 10 years ago the stock market anticipated the real economy there for 6 months today
instead, the timeframe has shortened.
The business cycle can be divided into 4 phases:
Recovery (early cycle)
Concentration (late cycle)
1. Recovery or early cycle
In this phase of the business cycle marked by robust growth expectations, future consumption and industrial production soar, fueled by increased demand. The real economy sees a resurgence, aided by liquidity injections from Central Banks. Strategic moves include favoring equity sectors like industrial and technology, alongside building positions in Basic Materials, energy, and finance.
For the bond sector, opting for floating-rate bonds is prudent. Additionally, a "close-all" approach for fixed-rate securities, especially those with extended maturities, is advised. Sensitivity to interest rate risk underscores the importance of strategic decisions in this dynamic market scenario.
2. Expansion or mid-cycle
This phase is characterized by a rapid rise in interest rates to curb inflation driven by peak consumption. Once stock market highs are reached, expectations for consumption growth begin to falter as do expectations for industrial production. Unemployment declines and investment is at very high levels.
The technical analysis begins to provide signs of a reversal of the long-term trend. The goal at this stage is to reduce the weight of equity. Equity exposure should be limited to non-cyclical sectors such as technology, energy, and financials. On the other hand, the bond sector is being pushed down by inflationary forces; it is good to prefer floating-rate bonds.
3. Contraction or late cycle
The reversal of the business cycle begins, with expectations for consumption at a low. Rates are still high and hurt the economy, rising from unemployment. In addition, inflation slows but does not yet reverse. Apart from that, investment and industrial production are slow and central banks begin to lower rates.
At this stage, the equity component should not be in the portfolio, in stock picking it is always better to prefer opening hedged positions. As for sectors, only defensive sectors such as Consumer Staples, Utilities, and health care are preferred, the only viable equity component. Fixed-rate bonds are preferred because a reduction in rates can lead to an increase in capital value.
Central Bank interest rates are around 0, and consumption is at a low. Financial markets hit lows, and we then reach a crisis level from which a recovery usually starts.
Before signs of recovery, the only sectors to consider are always the defensive sectors. Recall that the defensive sectors par excellence are the food & beverage and pharmaceutical sectors. This is one of the most important phases in terms of portfolio management. In fact, at the first signs of recovery in macroeconomic data and technical reversal, it is advisable to close any short positions. This way, we make room for new long trades. At this stage there is no one sector to prefer; one must be cautious and assess if and when the recession will end.
Interest Rate Risks
Moreover, fixed-rate bonds remain viable until banks start raising rates, threatening a loss of capital value. In the end, it is good to keep in mind that these rules should always be applied critically because they do not always work. So, one main and more valid rule is the cash rule. According to it, in times of crisis, it is necessary to have a lot of liquidity.