The problem with business cycles is that investors never want to think about them. When markets are booming, thoughts about business cycles tend to spoil the fun. When markets are down, thoughts of things other than the dumps seem foolhardy. And yet, business cycles are here to stay and their existence must be kept in mind in both good times and bad.

Business cycles - booms and busts - normally turn over two or three years. In the 1990s, however, there was a very long period of general prosperity. The boom period turned out longer than usual, economists applauded themselves, and some even thought that the business cycle was dead. Recent events and statistics show the snake biting and slithering.

The fact that cycles exist does not mean that they are easy to figure out beforehand or to time. The shape of any cycle is difficult to predict and so is deciding when things have hit top or bottom. You would know that tomorrow there are going to be cycles on your chart but you would know little else. If you are lucky, or experienced and alert, you may get hints.

At the top many people feel optimistic and carry the market on good sentiment. It is difficult to tell when that good sentiment is going to dry out. The peak is reached when "animal spirits" start turning lukewarm and the trough when people feel things could only get worse. Actually, in the depths of the trough, things could only get better.

Market cycles, the value of assets, such as shares and bonds, reflect but are not the same as business cycles. Markets go up as investors become willing to pay a higher price for assets because they expect that in future they would benefit to a greater extent. In this way, for example, shares start trading at a higher price-earnings ratio, that is, for the same amount of earnings per share, investors would be willing to pay a higher share price thus trading future income at higher multiples.

Market cycles reflect sentiment and are forward looking while business cycles deal with what is happening in the real economy, that is demand and supply for goods and services, and the employment or otherwise of physical and human resources.

There is no firm rule but usually the market cycle is a loose predictor of the business cycle: the market peaks before business does and starts improving when business statistics are still bad. This is what normally happens. At other times, the market remains overly optimistic in the face of worsening business statistics or dismisses business recoveries as false starts. You never know, though experience helps.

So-called "cyclical stocks" are an important link between business and market cycles. These are shares in companies whose value tends to move quickly with the business cycle, down when economic fortunes start declining and up when they start to improve. Automobiles are a classic example. Housing is another. There are other stocks which take longer to react. These include food and pharmaceuticals.

Cycles are important not only because they help keep things in perspective and give hints as to market timing but also because the behaviour of market participants, and their likes and dislikes, change depending on the stage of the cycle.

At peaks businesspersons and investors tend to be greedy, aggressive, risk-taking, big spenders. Recent experience has shown that some (Enron, WorldCom) also tend to do atrocious accounting, especially when things start slowing down. In troughs, fear reigns and there is more prudence. There is less adrenalin in the blood, less fun, but more sobriety, even perhaps some tranquillity. When things are high people tend to push them higher, when low, people tend to keep them so. Then the cycle starts turning again.

Investors must beware of the "performance trap". They are more likely to invest when the markets have a recent history of great performance than after heavy market falls. Many investment funds tend to be launched after the market has gone to high levels. Investors pile in and find, to their disappointment, that they are part of the tail end of the rally. Lesson: when you see too many investment funds being launched, think thrice.

Companies which are attractive at certain stages of the cycle would become unattractive at another. Small companies, usually boosted by shares with low denominations, so-called "penny shares", may be the darlings of a booming market where everything is carried along the great river, with twigs being fastest of all. It is solid companies with good profits and good cash flow that investors seek when the market turns sour. Such staid companies are called dinosaurs in go-go times. In times of plenty, the lean look reigns.

Investment managers change their styles too. When the market is booming they ride anything that moves in the right direction, which is called momentum investing. When the market is sluggish, they look for value, and start doing a lot of research and analysis. It is then back to the fundamentals.

The fact that you know that there are cycles may not solve all your investment problems. And yet, in spite of their volatility, investors have to keep cycles in mind, and put the market in context, to understand it better. At peaks thinking about cycles may indeed spoil some of the fun but the cautious attitude they induce may also open one's eyes to the importance of taking gains by selling. In troughs, cycles may seem to be cuckoo-land talk but the perspective they give on the market may make investors buy at a good time and reap huge gains. The market is about timing and a cycle is the embodiment of recurrence which is also about time.

pvazzopardi@usa.net