Here comes the cycle again

Australia hasn't had a recession for almost 30 years. That's the kind of statistic so stunning it almost ceases to make sense. We now hold the record for the longest uninterrupted run of growth globally. That record brings kudos but it also has other implications.

Many, if not most, investors active today have never lived through a recession. I barely remember the last from the early 1990s and I don't think it adequately informs my investing decisions. But at least I know that I don't know.

My guess is that many investors think recessions are scary things that happen in faraway places. Investors have forgotten what they look like and how they affect businesses.

That might be about to change. 

Here comes the slowdown

The latest batch of numbers suggests Australia's economic growth is slowing dramatically. Car sales, home prices, consumption trends, GDP forecasts, and any other indicator you care to mention all point one way: our growth record is under threat. 

That is no reason to panic. The worst reaction would be to sell stocks just because of your view on GDP. I do suspect, however, that over a long economic boom, many cyclical stocks have masqueraded as growth stocks. 

Investors have forgotten what real cyclicality looks like and have failed to price it adequately.

A few examples are now starting to emerge. The classified businesses - carsales, seek, REA and Domain - are some of the best businesses in the land but the long boom has disguised that they are also cyclical. The number of job ads, cars bought and houses listed does move with the cycle. 

Although we haven't had to deal with those cyclical movements in decades, financial results from these companies is starting to reflect cyclicality. Carsales, Domain and REA have all suggested economic conditions are slowing. Again, that shouldn't be a cue to panic. 

The meeting of quality and cyclicality can often be a prime opportunity for the patient investor. We should, however, be greedy with our buy prices and realistic with our expectations.

Masks off

As the economy slows, some of today's high-growth stocks may be revealed as cyclically exposed. Two examples could be Cleanaway and Transurban.

Cleanaway is a waste collection business often described as defensive, reliable and steady. This is a decent business but I find it hard to believe it isn't cyclical.

Consumption is the ultimate cyclical variable. People buy more stuff when the economy is growing, and they buy less when it's not. It stands to reason, then, that waste volumes will rise and fall with the cycle. That will be true of consumer waste and industrial waste. Cleanaway's revenues are likely exposed to the cycle and that might surprise many investors.

Another stock often mentioned on a list of high-quality defensives is Transurban, which owns almost every toll road in the country. This is an outstanding business, but traffic volumes are cyclical, and its revenues threatened.

Car volumes show some sensitivity to economic conditions but it's commercial traffic - trucks, cabs and lorries - that are most affected by the cycle. Commercial vehicles make up a fair portion of traffic volumes but, because they are charged higher tolls, they contribute a larger portion of revenues. Although not considered a traditional cyclical stock, Transurban is undoubtedly exposed to the cycle.

A long boom has disguised cyclicality and inexperienced investors have forgotten to look for it. Don't be surprised when it shows up.