Edge-ucation

Are Your Blue Chips in the Red?

  • Juwan Richards

    Juwan's focus is on the intersection of investing and media. Simply defined as a creative with an appreciation for curating content that audiences can both learn from and enjoy. As a buy-and-hold investor, Juwan is a trend-spotter and likes to invest in companies at the ground level. As an avid believer of Web 3.0, his strategy consists of finding companies with a unique competitive advantage and interpreting their market sentiment within the retail audience.

    View all posts

Here at Edge, we mainly focus on small cap stocks and emerging companies in the venture market. We like innovation. We like disruption. We like scalable 10x opportunities.  

However, without a doubt, knowing how the market world works from an aerial perspective is important. Being familiar with Blue Chip stocks and recognizing economic patterns is a highly valuable faucet of knowledge for your ongoing exposure to the world of capital markets.

Today we’re diving into this giant piece of the market, which seems to gloom over the capital world. While these buy-and-hold plays seem stable, the smaller overall return potential seems only suitable for big wigs looking for a safe place to park their millions of dollars.  

So, is there any place for newer investors to take part in the world of Dow Jones and S&P500 worthy stocks? 

AbsolutelyHere are few things you should know first, though. 

Be Active. Outperform. 

No, we don’t mean exercise. We mean actively monitor the blue-chip world and look for strategic ways to park your money according to the economic cycle. 

We all know that buying and holding benchmark indexes such as the Dow Jones and S&P500 are the easiest way to passively yield 8-9% on the year. But what if we want more than that? How can we utilize the economic cycle to rotate our portfolio?  

Let’s start at the start: definitions. 

Here is a quick glossary to make this easier. 

GDP: Global Domestic Product – a monetary measure of all the goods and services produced by a country, in a set period of time (which is usually a year). This is an important indicator of the economic performance of a country. 

Monetary Policy The governmentinfluence on interest rates and money supply, used to regulate inflation and GDP. 

Fiscal Policy: The governments influence on government spending and taxationalso used to regulate inflation and GDP. 

Beta: The measure to which a company moves according to the benchmarks. Ex. A stock with a Beta of 1.5, will move 1.5% every time the benchmark moves 1%. If the stock had a beta of 0.5, it would move 0.5% every time the market moves 1%. 

The economic cycle has 4 stages. Just like the chicken and the egg, none of them come first, so lets start from the bottom. 

  1. Trough: This is known as the “support” level of the economy. GDP is at its lowest, high interest rates and inflation have done their damage to consumer spending. Unemployment tends to be high and the stock market tends to be low, which includes your bluechip stocks. 
  2. Expansion: This is when GDP starts to pick up. The government tends to use monetary policy (via decreased interest rates and increased money supply) and fiscal policy (decreased taxation and increased spending) to stimulate the economy. Employment increases, upward pressure on inflation ensues, and stocks tend to start rallying.  
  3. Peak: The “resistance” level of the economy. Economic output is at a maximum, employment is at or above full employment, inflation is at an all-time-high, the markets benchmark indexes are at all-time-highs. 
  4. Contraction: The correction or “pullback” level of the economy. Output slows down, employment drops slowly, inflation pressures start to subside. The government tends to use monetary policy (via increased interest rates and decreased money supply) and fiscal policy (via increased taxation and reduced spending) to push the brakes on the economy to keep it regulated up until it hits a peak again. Benchmarks and bluechip stocks tend to... well... contract. 

Different stocks respond differently to these economic cycles.  

Cyclical stocks, which are companies that tend to move with the economy, are very sensitive to the economic cycle, therefore also have a high beta. These stocks tend to be companies who are in demand when the economy is strong yet underperform when the economy is weak. Cyclical stocks tend to be made up of companies within the sectors of travel, automobile, liquor, restaurants, clothing retailers; you get the picture. 

Defensive stocks are the companies that tend to stay strong all year round, even when the economy is poor. Evidently, these stocks tend to be reliable and have a low beta. Dividends also tend to be prevalent and consistent. Healthcare, food, banking, utility, and ecommerce tend to be some of the sectors that the economic cycles hardly affect. 

Using this knowledge, it would make sense to shift your portfolio into cyclical, high-beta stocks during a period of expansion, or just at the end of a trough. This is when the market and the economy tend to be on the rise, and opportunities for capital appreciation are abundant. Look for growth stocks and cutting-edge tech, as well as consumer-heavy sectors. 

In a period where the economy is sitting at a peak, waiting for the contraction period, it would be the best time to shift your holdings to more defensive stocks. This is when those cyclical stocks would tend to lose value, as consumer spending goes down heavily and their high beta amplifies any losses on the benchmark. Look for low-beta, stable earning, dividend-paying stocks. 

Some consumer stocks, such as Coca-Cola, seem cyclical, however due to their stable earnings and never-ending dividends, these would poise a great choice during a period of economic turmoil. You just have to do your research. 

Leverage, Leverage, Leverage.  

While maximizing capital gains on this “safer” side of the market by playing the economic cycle correctly is great, you are still going to see your returns more on the conservative side. Outperforming the benchmarks by 400% still yield only a 25-35% return, which is modest compared to most small cap returns.  

Now that we’ve gone over how to effectively utilize the nature of certain bluechip stocks in accordance with the economic cycle, is there a way to capitalize a bit further? After all... 30% of a $5,000 account is only $1,500. 

If you were around a couple weeks ago, you may have seen our introductory piece on Options and the subsequent article explaining a couple of methods for using them. Options let you control 100 shares of a company at a time, in a contract that you either have bought the right toor have been compensated for the obligation to, buy or sell the underlying stock at a specified price. 

Option contracts are much, much more affordable than actually buying 100 shares of underlying stocks. Yet, the yield on even as little as a 10% surge on the underlying stock can lead to anywhere around a 50% gain on the value of the options project. As you’ll read in our previous article about options (which you should definitely go read right now), they also bear more risk, as all option contracts have expiry dates at which time you could lose your entire investment, should they expire out-of-the-money.  

Do you know what out-of-the-money means? If the answer is no, it’s because you haven’t read our options article yet.  

Are we telling you how to use the economic cycle to actively outperform market benchmarks? Yes. 

Are we encouraging you to use this method with options so you can even further increase your returns by bearing a little more risk? Also, yes. 

Are we telling you to use your entire portfolio balance to start learning this newly acquired technique? No. Definitely not. 

Please invest with caution and know the economic cycle isn’t going anywhere. There is always opportunity for capital gains in the market. Start slow, learn correctly, and exercise the same kind of caution you would if you were investing in penny stocks. 

  • Juwan Richards

    Juwan's focus is on the intersection of investing and media. Simply defined as a creative with an appreciation for curating content that audiences can both learn from and enjoy. As a buy-and-hold investor, Juwan is a trend-spotter and likes to invest in companies at the ground level. As an avid believer of Web 3.0, his strategy consists of finding companies with a unique competitive advantage and interpreting their market sentiment within the retail audience.

    View all posts

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