Cycle risk — business cycle sensitivity

Business cycles are recurring swings in economic activity — expansion, peak, contraction, trough. A complete cycle typically lasts 5–7 years. The causes are disputed — monetary schools (Friedman) point to interest rate policy, real schools (Schumpeter) to technological shifts, Keynesian ones to aggregate demand.

For Swedish retail investors, cycle risk is concrete. The industrial sector (Atlas Copco, SKF, Sandvik) has order books that vary 30–50% between the trough and peak of the cycle. The car sector (Volvo Cars) has sales that crash 20%+ during a recession. The banking sector (Handelsbanken, SEB) has credit losses that multiply several times over.

Cycle position is thus a central investment issue. Buying a cyclical company at the top of the cycle (low P/E, high profit) is a classic 'value trap'. Buying at the bottom (high P/E, low profit) can give high return when the cycle turns.

In order to identify cycle position, 'leading indicators' are used — employment index, building permits, interest rate spread (10-year minus 3-month). These turn 6–12 months before the cycle itself. The National Institute of Economic Research publishes Swedish cycle analysis quarterly.

Cyclical companies have revenue that varies sharply with the business cycle. Swedish examples: Atlas Copco (capital goods), SKF (bearings with its inventory), SSAB (steel), Volvo Cars (cars), Electrolux (appliances), H&M (fashion). Their revenue can vary 30–50% between the trough and peak of the cycle.

Acyclical companies have revenue that is stable across the business cycle. Swedish examples: ICA (food), Telia (telecom), Essity (hygiene), Investor (investment company with a broad portfolio). Their revenue varies less than 10% between cycle trough and peak.

For portfolio building, the balance between cyclical and acyclical is crucial. A portfolio with 100% cyclical companies gives high return during expansions but deep crashes during contractions. A portfolio with 100% acyclical gives stable but lower return.

A 'barbell' strategy — 60% acyclical + 40% cyclical with active rebalancing — usually gives the best risk-adjusted return. When the cycle turns down, cyclical companies are sold and acyclical bought. When the cycle turns up, cyclical companies are bought cheaply.