In fact, our course leader did his best to avoid the word ‘cycle’ altogether; he said it implied an erroneous scientific regularity and predictability. Chris Dillow, our resident economist here at the IC, takes a similar line.
The difficulty of anticipating the cycle – I will stick to the word, whatever its failings – explains the enduring popularity of shares in big multi-national companies like Unilever (ULVR), Vodafone (VOD), GlaxoSmithKline (GSK) and SAB Miller (SAB). Investors need not worry about a cyclical downturn, so the theory goes, firstly because it will be counteracted by an upturn somewhere else in the world, and secondly because demand for toiletries, drugs and the like should hold up even as the wider economy wobbles.
This can be debated; for a start, globalisation has reduced the efficacy of geographic diversification. But even if the theory worked, investors would be severely limiting themselves if they stuck to blue-chip multi-nationals. Like it or not, investing in shares often involves making a call on some inherently unpredictable cycle.
House builders are a topical example. Their basic business model is very simple: buy land, build on it and then sell it at a profit. But because they need to secure an income stream for staff and shareholders, they hold land for a number of years. This time lag exposes them to the sizable risk of mistiming the cyclical land and housing markets. Having bought land dear - and with debt - in the run up to the 2007 peak, they were forced to sell houses cheap when the market turned. Margins collapsed - a trend anticipated by share prices right from the beginning of 2007.
This cyclicality has since turned from vice to virtue. Having pushed through rescue rights issues in 2009, the likes of Barratt Developments (BDEV), Bovis Homes (BVS), Redrow (RDW) and Taylor Wimpey (TW) had the cash to buy land at low prices after the crash. The average operating margin of the top seven players, having plunged from a peak of 17.5 per cent in 2007 to 4 per cent in 2009, should rise to 16 per cent this year, calculates Stephen Williams of brokerage Brewin Dolphin.
As this trend has become clear over the past two years or so, share prices have rocketed. This has richly rewarded investors brave enough to call the recovery early, but leaves little value on the table for late buyers. Even after a slight correction in recent weeks, the sector trades on about 1.6 times book value – above the average of 1.3 times for the 1995-2007 housing boom, according to Chris Millington of Numis Securities.
That raises the suspicion that the cycle has already moved on. Mr Williams defends this view: he bravely pins his colours to a prediction that 2016 will be the next peak. “This is a sector that has always lurched from boom to bust. I might be a little early, but if anybody tells you it will be different this time round, I’d be very suspicious,” he says.
Many professional investors have also been reducing their exposure, in favour of less direct – and hence ‘later-cycle’ – plays on the housing recovery. Mark Martin, head of UK equities at fund manager Neptune, sold out of house builders last year, but is still keen on paving supplier Marshalls (MSLH). Richard Bullas and Paul Spencer, who co-manage the UK small and mid-cap funds at Franklin Templeton, have cut their exposure in half since the autumn. “The sector was starting to look overvalued in some areas,” says Mr Bullas. But he is still confident that the housing recovery will continue – “I live in Huddersfield, and there’s no bubble here”. That explains stakes in Topps Tiles (TPT) and estate agent LSL Property Services (LSL).
Expectations of some Bank of England action to cool the hot London market are rising, which probably explains the latest sell-off in house-building shares. Otherwise, however, there is little sign of weakness in the sector. Housing transactions are rising strongly, yet remain at 2005 levels. House prices outside London have only been rising for a year. Banks are still reluctant to lend to small builders, limiting competition for land. The house builders have net cash for the first time in living memory.
But perhaps that’s the point: in sectors subject to inherently unpredictable cycles, it may make sense to sell when times could not get much better.
