General Strategies in Stock Market

22 October 2008

It is essential to understand that the stock market always goes through the cycles of phases of expansion and contraction with peak and trough. In the expansion phase, the stock prices move in an upward trend that may continue for several years; in the contraction phase, the prices and volume in the stock market move in a downward trend that may last as long as a year. As the stock market is an important factor in the modern economy, the stock market cycle has a definite link of the economic cycles of inflationary and contraction phases. The peaks and troughs are mirrored by each another, although the stock market often leads the general economy (nevertheless, 50 percent of the dips in the stock market did not seriously affect the economy as measured by the changes of GDP in the past). Therefore, it is useful for an investor to distinguish the temporary trough of the stock market cycle from the real contraction phase of the economic cycle.

The following table shows the general strategies for an investor in the stock market from the The Canadian Securities Institute Course Textbook (Vol. 3, 1998):

Business Cycle Equity Cycle Strategy
End of Expansion through peak, into the Contraction Phase Contraction Phase [] Recession conditions are apparent.
[] Recommendation: Lengthen term of bold holdings. e.g. sell short-term bonds and buy mid to long-term. Try to maintain same yield (income). Avoid or reduce stock exposure.
End of contraction phase, into the Expansion phase Stock Market Trough [] The bottom of the business cycle has not been reached but has begun to advance because of falling interest rates and the expectations of an economic recovery.
[] Recommendations: Sell long-term bonds ahead of stocks in response to falling interest rates. Common stocks usually rally dramatically; often the largest gains occur in the higher risk cyclical industries.
Expansion Phase Expansion Phase [] Sustained economic growth generally allows stocks to do well
Typically before End of Expansion phase peak Equity Cycle Peak [] Economic growth has been sustained, however, this has also led to higher interest rates and the Bank of Canada may be tightening its monetary policy. Short-term interest rates tend to be higher than long-term rates, i.e. the yield curve is inverted.
[] Recommendations: Stop buying common stocks and invest in short-term interest bearing paper. The equity cycle peak is followed by the contraction phase.

After you have judged on the state of the stock market, you can decide on your investments. Depending on your time frame and your risk tolerance, you may want to optimize your investments by increasing or decreasing your stock portfolios.

A Description of My Strategy for The Volatile 2008 and 2009
Because of limited qualifications and experiences, I can only describe my own portfolios. In the early beginning of the year, I had switched a small amount of money to coins and to a mutual fund of Canadian equity to counter the likely volatility in the economy. The latter investment was placed to shelter from the fluctuations and, hopefully, to grow inside the larger asset pool of the mutual fund. At the same time, I sold some of my US stocks with very modest gains. In the late Spring, the gold price reached the highest peak above US$1,000 of one troy ounce and the US$ was equal to about 1.02 Cdn$.

In the summer, I had switched my variable rate savings bond to cash anticipating the decline of interest rate. With the cash, I invested in stock shares of energy, precious metals, and resources. By the end of September, I had taken out a small cash loan of 1.99% interest rate and expanded my portfolios and now included some investments in the manufacturing and gold mining sectors. With the mind on the uncertainties, I have invested only on solid companies with favourable ratings, some with good dividend payout. Without giving up the opportunities of US stocks, I had also traded limitedly some US stocks in the consumer and high-tech sectors. So far, my strategy almost worked out in spite of the low rates of Canadian GDP for several quarters.

In October, the sudden meltdown of US financial banks surprised me by the depth or the breath of US financial woes. Luckily I have already sold most of my US stocks and made a modest gain from the exchange rate. But, the rest of my portfolios lost over one third of their values. At the same time, I received a timely amount of money originated from the sale of my deceased father's old small villa; my father died in October 1992. With this extra money, I kept my portfolio basically intact and increased the depth of my investments. In this very busy October, I traded very actively but cautiously; I sold and re-bought daily to keep down the adjusted cost of my portfolio.


Warren Buffet, the most respected US investor, said that when people are greedy, one should be afraid and when people are afraid, one should be greedy and he advised to invest in the US stocks now. I do not help but agree with him, although I choose to implement his approach with a very prudent, systematic and incremental tactic (especially with my very limited resources). And, as a small investor, I am to formulate a contingency plan to exit from the market instead of holding on when the down trend exceeds my limit tolerance. Meanwhile, I keep working hard to maintain cash inflow from other income sources in order to balance my personal finances.

[The article is written for personal references only. No advice or no qualified idea nor opinion are given herein, G. Li, 22/10/2008]

1. My strategy survived from the low of October low, and the portfolio made a very modest gain by January 2009.
2. The stock markets suddenly plunged again and are sinking well past the October level. A very prudent manner is advisable in investing stocks under the present environment of worldwide financial turmoils and global recession (5 March 2009).

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This article is written for personal references only. No advice, nor qualified idea & nor opinion are given; also no accuracy of figures are guaranteed