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Exp Late Expansion Phase

In the late expansion phase of the business cycle, corporate profits remain strong but are slowing, while interest rates are rising which causes fixed-income security values to fall. A dynamic asset allocation strategy would rebalance the portfolio by selling appreciating equities and buying discounted fixed-income assets, securing gains and increasing safety. In the long run, returns should be enhanced when interest rates return to normal levels and fixed-income securities purchased at a discount appreciate substantially. A tactical strategy suggests shifting to cash or defensive stocks until interest rates peak, and shortening the duration and maintaining high coupons of fixed-income holdings to reduce interest rate impact. It is important to properly reposition the portfolio toward the end of a contraction or trough phase

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66 views1 page

Exp Late Expansion Phase

In the late expansion phase of the business cycle, corporate profits remain strong but are slowing, while interest rates are rising which causes fixed-income security values to fall. A dynamic asset allocation strategy would rebalance the portfolio by selling appreciating equities and buying discounted fixed-income assets, securing gains and increasing safety. In the long run, returns should be enhanced when interest rates return to normal levels and fixed-income securities purchased at a discount appreciate substantially. A tactical strategy suggests shifting to cash or defensive stocks until interest rates peak, and shortening the duration and maintaining high coupons of fixed-income holdings to reduce interest rate impact. It is important to properly reposition the portfolio toward the end of a contraction or trough phase

Uploaded by

lenovoji
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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9/16/2016

CSC

Example:LateExpansionPhase
Inthelateexpansionphaseofthebusinesscycle,corporateprofitsremainstrongalthoughprofitgrowth
slowsandmaybeapproachingitspeakforthecycle.Capitalappreciationanddividenddistributionswould
stillbeattractive.AstheBankofCanadaraisesinterestrates,themarketvalueofmostfixedincome
securitiesshouldbegintofall.Theseoppositetrendsinthefixedincomeandequitypositionsofaportfolio
wouldquicklytriggerrangelimitationsimposedbyadynamicassetallocationstrategy.
Rebalancingwouldineffectsecuregainsfromstrongequityperformancewhileforcingthepurchaseof
fixedincomeassetsatadiscount,thusincreasingthesafetyfactoroftheportfolio.Thetradeoffisthat
overallportfolioreturnishinderedintheshorttermbysellingsomeofthestrongestperformingsecurities
andbuyingcurrentlyunderperformingassets.
Thelongtermreturnshouldbeenhancedwheninterestratesreturntonormallevelsandsubstantial
capitalappreciationisexperiencedonthefixedincomesecuritiespurchasedatadiscount.Dynamicasset
managementinaweakmarket(contractionandtroughphasesofthebusinesscycle)wouldimprovelong
termreturnsasequityholdingsareacquiredatattractivepriceswhenthevalueoffixedincomesecurities
exceededtheirstrategicallocationrange.
Atacticalportfoliostrategywouldsuggestshiftingassetstocashholdingsuntilinterestrateshavepeaked
andthenreturningtothelongtermstrategicmix.Atacticalportfoliostrategywouldsuggestshorteningthe
durationofthefixedincomecomponentoftheportfoliowhiletryingtomaintainthehighestcoupons
(interestrates)possibletheshorterthetermtomaturityandthehigherthecoupon,thelessimpactrising
interestrateshaveondebtsecuritymarketvalues.Tacticalmanagementwouldalsosuggestshiftingequity
holdingstodefensivestocks,whichtendtomaintainmarketvaluewhilecontinuingtoofferattractive
dividendsthatcanbereinvested.Atacticalstrategymayalsoincludetemporarilyshiftingassetclass
weightingsfromfixedincomeandequitytocash.
Itwouldbeextremelyimportantfrombothadynamicandtacticalmanagementperspectivetoproperly
repositiontheportfoliotowardtheendofthecontractionphaseorinthetroughphaseofthebusiness
cycle.Historically,monetarypolicyhashadgreaterimpactthananticipated,resultingintheneedtoreduce
interestratesquicklyandsubstantiallytopreventrecessionaryconditionsoncesupply/demandequilibrium
hasbeenachieved.
Wheninterestratesfall,theytendtofallfast.Stockmarketsareleadingindicatorsbecausecompaniesand
investorsanticipategovernmentpolicyandareturntostrongeconomicconditions.Theendofatrough
phaseandbeginningofanexpansionphasecomesquickly,doesnotlastlong,andthemajorityofthe
returntendstobegeneratedwithinafiveto13monthperiod,eveniftheexpansionphaselastsmany
years.Thesameappliestofixedincomesecurities.Priortointerestratesfalling,theastuteportfolio
managerwouldshiftdebtholdingstoalongdurationwithlowcoupons(interestrates)cashholdingswould
bereducedtoaminimum.

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