Investment
A business cycle approach to sector investing uses probabilistic analysis to identify the shifting phases of the economy, which provides a framework for allocating to sectors according to the probability that they will outperform or underperform. We use a business cycle approach to potentially generate positive active returns over an intermediate time horizon. We enhance this outperformance with complementary analysis on sector & industry fundamentals, drivers, and valuations. Outperformance can be further enhanced by adding bottoms up security analysis within each sector & industry.
Source:Fidelity Investments Asset Allocation Research Team (AART)
Source: Fidelity Investments Asset Allocation Research Team (AART)
Over the intermediate term, asset performance is often driven largely by cyclical factors tied to the state of the economy, such as corporate earnings, interest rates, and inflation. The business cycle, which encompasses the cyclical fluctuations in an economy over many months or a few years, can be a critical determinant of equity market returns and the performance of equity sectors.
Understanding The Business Cycle:
Every business cycle is different in its own way, but certain patterns have tended to repeat themselves over time. Fluctuations in the business cycle are essentially distinct changes in the rate of growth in economic activity, particularly changes in three key cycles—the corporate profit cycle, the credit cycle, and the inventory cycle—as well as changes in the employment backdrop and monetary policy.
While unforeseen macroeconomic events or shocks can sometimes disrupt a trend (e.g. COVID), changes in these key indicators historically have provided a relatively reliable guide to recognizing the different phases of an economic cycle. Our quantitatively backed, probabilistic approach helps in identifying, with a reasonable degree of confidence, the state of the business cycle at different points in time.
The performance of economically sensitive assets such as stocks tends to be the strongest during the early phase of the business cycle when growth is rising at an accelerating rate, then moderates through the other phases until returns generally decline during the recession. In contrast, more defensive assets such as Treasury bonds typically experience the opposite pattern, enjoying their highest returns relative to stocks during a recession and their worst performance during the early cycle.
There are Four Phases of the Business cycle:
Generally, a sharp recovery from recession, marked by an inflection from negative to positive growth rates in economic activity (i.e. GDP, Industrial Production), followed by an accelerating growth rate. Credit conditions stop tightening amid easing monetary policy, creating a healthy environment for rapid margin expansion and profit growth. Business inventories are low, while sales growth improves significantly.
Typically, the longest phase of the business cycle. The mid-cycle is characterized by a positive but more moderate rate of growth than that experienced during the early-cycle phase. Economic activity gathers momentum, credit growth becomes strong, and profitability is healthy against an accommodative—though increasingly neutral—monetary policy backdrop. Inventories and sales grow, reaching equilibrium relative to each other.
Emblematic of an “overheated” economy poised to slip into recession and hindered by above-trend rates of inflation. Economic growth rates slow to “stall speed” against a backdrop of restrictive monetary policy, tightening credit availability, and deteriorating corporate profit margins. Inventories tend to build unexpectedly as sales growth declines.
Features a contraction in economic activity. Corporate profits decline and credit is scarce for all economic players. Monetary policy becomes more accommodative, and inventories gradually fall despite low sales levels, setting up for the next recovery.
Sector Performance by Business Cycle Phase
Due to structural shifts in the economy, technological innovation, varying regulatory backdrops, and other factors, no one sector has behaved uniformly for every business cycle. While it is important to note outperformance, it is also helpful to recognize sectors with consistent underperformance. Knowing which sectors of the market to avoid can be just as useful as knowing which tend to have the most robust outperformance.
| Sector | Early | Mid | Late | Recession |
|---|---|---|---|---|
| Financials | + | - | ||
| Consumer Discretionary | ++ | -- | ||
| Technology | + | + | -- | -- |
| Industrials | ++ | + | -- | |
| Materials | -- | + | ++ | |
| Consumer Staples | - | + | ++ | |
| Health Care | - | ++ | ++ | |
| Energy | -- | ++ | ||
| Telecom | -- | ++ | ||
| Utilities | -- | - | + | ++ |
Covered Call Strategy: Income Generation
Source: Project Finance
Option Strategy. To enhance returns and generate income, the Fund may from time to time incorporate a covered call option writing strategy. Covered call option writing is an investment strategy of writing (selling) call options against securities owned by the Fund to generate additional returns from the option premium. The Fund’s option strategy may also have the benefit of reducing the volatility of the Fund’s portfolio in comparison to that of broad equity market indexes.
The Fund pursues its options strategy by writing (selling) covered call options on an amount from 0% to 100% of the value of the underlying security in the Fund’s portfolio. The Fund seeks to earn income and gains both from dividends paid on the securities owned by the Fund and cash premiums received from writing or “selling” covered call options on securities held in the Fund’s portfolio.
The Fund may not sell “naked” call options, i.e., equity options representing more shares of a security than the Fund has in the portfolio.