There is a big difference between owning a share and a bond of a company. There can be many arguments about how we should classify convertible bonds, perpetuals, high yield bonds etc. But when a company is below investment grade, there is no difference between owning the credit or the stock. The difference between a bond / stock is much bigger when you invest in an investment grade company.
When the economic cycle turns down, a bond of an investment grade company may drop 10 - 20% at most. If it is rated AA or AAA by a reputable rating agency like S&P, Moodys or Fitch, it may even rise in value during a recession as investors flock to safe havens that pay higher coupons than fixed deposits. As a bond investor, you don't care as much that the company's earnings grow year after year. You only care that the company doesn't borrow too much and is able to service your coupons.
In a down cycle, a stock can be worthless if the company does not survive. Hence investors / speculators tend to throw their shares at the slightest hint of a down turn. Typically, a blue chip share can drop by 30 - 50%, a cyclical, small cap stock 60 - 80%.
In a down cycle, a company's earnings may be affected so the dividend payout may suffer. Insurance companies, sovereign wealth and pension funds may move their funds to bonds for more secure payouts.
In a recession, unemployment rises, factories' capacity utilisation falls. Capital investments are delayed as the budget shrinks. A factory or a shop is allowed to deteriorate during a recession. Weaker players default and leave the industry. The recession hits a bottom when the number of companies that produces goods and services hits equilibrium with the overall demand for the same. Capital investments then start to increase slightly to touch up the shop, to repair the machinery. Employment then increases.
Once there is a hint of recovery, insiders of companies will purchase their shares first. The company's stock will bottom up. Four to five months later, CNBC and various news papers will report that earnings are starting to improve. By then, the stock would have risen by 15 - 30%.
Property Market Cycles (By Philip J Anderson)
Didn’t see the downturn coming? Neither did the Queen. She was forced to ask the English houses of Parliament in 2008: “Why couldn’t anyone see this coming?” Hardly surprising she was curious. She has a lot of property to look after…
The economic system we have today is built on the economic rent. It’s pretty simple once you see it. The process is underpinned by the enclosure of the economic rent, a concept first formalized by English economist David Ricardo. Ricardo’s Law of Rent states, simply, that the economic rent is not a cost of production. A house costs pretty much the same to build, wherever you build it – wages are the same, and materials costs are the same. But the selling price will depend on the location.
So builders, for example, will bid more for the best locations. That money doesn’t go to the workers building the house, and nor is it spent on improving the materials used. It purely benefits the owner of the land.
This bid is what Ricardo was first to identify as a “surplus”: the economic rent. Property investors know it today as locational value. Wherever a price is put on this locational value of land, a property cycle will develop - a boom and then a bust in other words - as speculators and companies chase land prices higher and higher, reducing the proportion of wealth being invested in creating jobs and investing in productive businesses. This cycle is beyond the control of central banks.
All good so far. The significance of what you can read here, though, is that with everything I do and teach about the cycle, a careful study of it and you too will then be able to work out not only how and why the cycle will turn, but more importantly WHEN.
Timing; this is the most important part.
Then who knows? One day we might have as much property to look after as the Queen does…
