What Is A Procyclical Asset?
When we refer to a currency or asset as being procyclical, we are referring to how the particular asset is expected to perform with respect to the economic cycle. This video explains in more detail...
----
We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co
-----
We have a question from Alexander asking what exactly is a procyclical currency, he’s been hearing us refer to that a lot lately and just wants some more clarity on the topic.
Thanks for the question Alexander. So, when we refer to something like a currency or any asset being procyclical, we are referring to how the particular asset is expected to perform during various stages of the business cycle.
If we take a look at a typical sine curve of the business cycle we can see some popular patterns that you’ve most probably seen before such as the boom, the peak, then we go through contraction, then through recession, possibly depression but not always, then we go through the trough, then there is recovery, which goes into expansion, and then boom and so the process repeats itself.
Now, when we refer to something being procyclical, it means that the particular asset is positively correlated with the overall health of the economy, so when the business cycle is going from contraction to expansion it’s performance will vary.
For procyclical assets, they usually outperform when we see good times in the economy, and they underperform when we see bad times in the economy. They also tend to be correlated with the overall risk appetite among investors and falls in line with the business cycle because if the economy is coming out of a recession or a depression and investors think the recovery has started, they will rotate into more higher yielding assets and procyclical assets are a favourite during these type of environments.
So, this illustration from intermarket.com illustrations how certain asset classes might be expected to perform during certain parts of the business cycle. What you’ll notice, is that both equities and commodities tend to do really well as the cycle turns from contraction into early recovery or expansion. Things that tend to see a lot of growth during these times are commodities, especially things like Copper and Oil because as the economy starts the recovery that will lead to bigger infrastructure spending and will obviously lead to more demand for things like Copper and Iron Ore etc, and if recovery and early expansion sets in there is anticipation of increased demand for travel which is good for oil etc.
Now, even though equities as a whole do perform well during the early stages, there are of course certain sectors that perform better and worse during certain parts of the business cycle. So when we are coming off the peak and going into contraction that’s when things like Utilities will do well alongside things like growth stocks as they usually showcase stronger fundamentals like stronger cash flow and balance sheets etc, what can also do well is housing as expectations of contraction will spark expectations of interest rate cuts which is good for housing, and during these environments that really bad for things like industrials and financials which tend to take a beating when we are going into contraction or recession.
So, then the opposite is also true, when we move into a early recovery we tend to see things like Financial and Industrials and Materials outperform and things like Utilities underperform. When it comes to the major currencies, the AUD and NZD and CAD are seen as cyclical, alongside most of the emerging market currencies as well, because most of them are closely tied to commodities, so if we enter into early recovery and expansion or the market at least believes we are we tend to see these currencies outperform.
-----
If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
----
We interpret and explain price moves in real-time, 24 hours a day. Our team of analysts produce text, video and audio commentary.
You understand the markets and trade with confidence. Learn more at our website here: https://financialsource.co
-----
We have a question from Alexander asking what exactly is a procyclical currency, he’s been hearing us refer to that a lot lately and just wants some more clarity on the topic.
Thanks for the question Alexander. So, when we refer to something like a currency or any asset being procyclical, we are referring to how the particular asset is expected to perform during various stages of the business cycle.
If we take a look at a typical sine curve of the business cycle we can see some popular patterns that you’ve most probably seen before such as the boom, the peak, then we go through contraction, then through recession, possibly depression but not always, then we go through the trough, then there is recovery, which goes into expansion, and then boom and so the process repeats itself.
Now, when we refer to something being procyclical, it means that the particular asset is positively correlated with the overall health of the economy, so when the business cycle is going from contraction to expansion it’s performance will vary.
For procyclical assets, they usually outperform when we see good times in the economy, and they underperform when we see bad times in the economy. They also tend to be correlated with the overall risk appetite among investors and falls in line with the business cycle because if the economy is coming out of a recession or a depression and investors think the recovery has started, they will rotate into more higher yielding assets and procyclical assets are a favourite during these type of environments.
So, this illustration from intermarket.com illustrations how certain asset classes might be expected to perform during certain parts of the business cycle. What you’ll notice, is that both equities and commodities tend to do really well as the cycle turns from contraction into early recovery or expansion. Things that tend to see a lot of growth during these times are commodities, especially things like Copper and Oil because as the economy starts the recovery that will lead to bigger infrastructure spending and will obviously lead to more demand for things like Copper and Iron Ore etc, and if recovery and early expansion sets in there is anticipation of increased demand for travel which is good for oil etc.
Now, even though equities as a whole do perform well during the early stages, there are of course certain sectors that perform better and worse during certain parts of the business cycle. So when we are coming off the peak and going into contraction that’s when things like Utilities will do well alongside things like growth stocks as they usually showcase stronger fundamentals like stronger cash flow and balance sheets etc, what can also do well is housing as expectations of contraction will spark expectations of interest rate cuts which is good for housing, and during these environments that really bad for things like industrials and financials which tend to take a beating when we are going into contraction or recession.
So, then the opposite is also true, when we move into a early recovery we tend to see things like Financial and Industrials and Materials outperform and things like Utilities underperform. When it comes to the major currencies, the AUD and NZD and CAD are seen as cyclical, alongside most of the emerging market currencies as well, because most of them are closely tied to commodities, so if we enter into early recovery and expansion or the market at least believes we are we tend to see these currencies outperform.
-----
If you find this content helpful, you’ll love Financial Source.
There’s a link below were you can learn more about it
https://financialsource.co
