WHAT IS A BUSINESS CYCLE? HOW CAN WE TAKE ADVANTAGE OF BUSINESS CYCLES?
Simplifying greatly, the economy has periods in which it experiences growth, and periods in which it experiences decreases, that is, crises. After these periods of decline or crisis, a period of growth begins again.
This process - growth, decrease, and starting again with growth-decrease - has been repeating itself for centuries.
These cycles obviously have a great effect on the stock markets, real estate, etc...
For an investor, theoretically the problem lies in knowing when we are at the end of a period of growth and one of decline. In reality, the investor's objective is not to identify the moments in which one is going to go from growth to decrease and vice versa; Pinpointing exactly the moments in which the change from growth to decrease and vice versa occurs is very complicated. The real objective is to buy assets whose market valuation is lower than their real (or future) value, and consider selling them when their market valuation is much higher than their real (or future) value. Let's take an example to better understand the effects of economic cycles and the objective of an efficient investor. We will use the SP 500, the most important stock index in the United States and the world, as a reference.
August 2000: Approximate maximum of 1,525 (historical maximum to date).
October 2002: Approximate minimum of 768 (minimum of the fall, which was close to 50%).
October 2007: Approximate maximum of 1,576 (historical maximum, increase of 105%, compared to previous minimums).
March 2009: Approximate minimum of 666 (minimum of the fall, which was close to 58%).
February 2020: Approximate maximum of 3,393 (Historical maximum, increase of 409%, compared to previous minimums).
Basically, it could be interpreted from this data that approximately every 10 years, we have a 40% drop in the stock market. It is correct for the last two crises (2000-2002 and 2007-2009), but not for the previous ones. So, what guide do we use to know when to buy on the stock market? The problem is that there is no single valid indicator or method. A very conservative one, but one that hardly fails, is to look at the PE (Price / Earning ratio, that is, the ratio between the share price and the company's earnings per share; also known as PER).
A low PER is good for the buyer, and bad for the seller. A high PER is good for the seller, and bad for the buyer.
When there is a crisis, the PER rises because company profits fall; but when the company's price falls, the PER falls; Normally, in periods of crisis, the PER falls a lot. When company profits rise, the PER falls; Normally, when company profits rise, the company's price soars and the PER rises; In proportion, the price rises much more than profits rise.
A high PER indicates that it is not interesting to buy an index or a stock. A low PER indicates that it is a good time to buy. Below 20, buying is considered a smart choice. There are exceptions: for example, in recent years, with debt yields at a ridiculous level, a P/E of 33 was considered not a bad P/E for buying high-quality companies. In the previous crisis, that of 2008 / 2012, the PER fell below 15. Although there are numerous factors that must be taken into account, a PER of 15 indicates an excellent purchase if one considers that the company is solid or that the index It will be recovered in the future.
The H&B team.