Reply of 100 words to a student colleague:
CLASSMATE POST :
Through the progression of this course, it has been indicated that they are various contributing factors that can affect the price of stocks.
In his article titled, "Stocks and the Economic Cycle: What Performs Well-and When" (2003), author Wayne Thorp suggests that although a stock's price is highly related to a company's ability to sustain growth in sales and earnings, other aspects also play an essential role in the company's success or failure. This article, which was written approximately during the middle of 2003, provides its reader with an opportunity to explore the correlation between stock prices and the state of the economy as it explained by an individual currently living through a recessionary period.
The Business Cycle can be thought of as the events leading up to, during, and after the expansion and decline of the economy. It consists of three component parts, which include the business peak, the recession, and the recessionary trough. The business peak is characterized as the point at which "most businesses are operating at full compacity, and real Gross Domestic Product (GDP) is growing rapidly" (Thorp, 2003). A recession is marked by slower business conditions, lower sales, declining GDP, and increased unemployment. Prolonged and severe recessions are categorized as depressions. The recessionary trough signifies the bottom of the economic contraction phase, after which economic conditions are expected to improve, and the economy enters the expansion phase. The expansion phase usually has the opposite effect of recession component.
Although it may be easier said than done, Thorp (2003) indicates that there are opportunities to benefit from adequately timing peaks and troughs in the business cycle. It has shown in the past that stocks tend to decline in price before recessions. But as it has been previously stated, there is usually a time lag between the time an economic reversal occurs and when it is announced; making it very difficult ascertain the optimum time to make changes to a stock portfolio. Stock market rotation is "the shift of assets from one investment style, industry, or sector to another" (Thorp, 2003). Sector rotation involves moving between cyclical, defensive and growth stocks. The main idea behind this concept is that economic cycles exhibit characteristics that impact sectors or industries differently during the stages of expansion and contraction. Similar to sector investing, certain styles of investing respond differently to the different stages of economic growth and decline. Studies have shown that over a long period, choosing to invest in small company stocks yields better performance than investing in large company stocks. Research has also shown that "value" stocks tend to outperform "growth" stocks in the long run.
Many approaches can be utilized when deciding to construct a stock portfolio. Economic indicators of future events may exist but predicting the appropriate time to act upon them is often a difficult task. I agree with the author's suggestion to incorporate a diversified strategy. It's never a good idea to keep all of your eggs in one basket.