CIO Insights 4Q2025

The Nov. 15th weekly edition of The Economist contained a thoughtful article entitled “The recession recession.” It notes that globally synchronized downturns have become a rare species in modern history, thanks to the maturation of capitalism and better policymaking. Skillfully dribbling around periodic macroeconomic pain may seem only desirable. However, the piece argues that a lack of economic contraction brings about its own set of dangers, something which we wholeheartedly agree with. Fortunately, at least when viewed from a bottom-up perspective, it has been our experience that business cycles are alive and well. Basic chemicals and automotive are examples of sectors currently in recession mode on a worldwide scale. On a regional basis, stagnation is evident in housing construction in North America and Northern Europe, as well as the broader consumer economy in China. Downturns like these inherently attract deep value investors like us. There are several reasons why this is the case.

The first reason has to do with behavioral finance: most investors act pro-cyclically; they are inclined to buy booming markets and sell actual or expected downturns. Also, stock price swings in either direction tend to get exaggerated. We surmise that structural arguments to buy or sell get mixed in with cyclical ones. That is, when things look bleak in a particular industry, analysts may “throw in the towel” and jump to the conclusion that it is in terminal decline. Conversely, in a prolonged upcycle, bullish calls may be based on the prediction that the industry has entered a “new era” of growth. These dynamics make cyclical stocks the ideal hunting grounds for true contrarians because they tend to be cheap when supply-demand dynamics are troughing and expensive when business activity signals continued tightness.

The second set of arguments relates to how we search for, evaluate and value investments. Today there are only a few fund managers left that take a fundamental/entrepreneurial view rather than a quantitative/ratio-driven approach to stock screening. In our quest to identify cheap cyclicals, we prefer to rely on industry- and company-specific analytical tools such as the Porter five-forces model instead of quantified search methods. The reason is that the latter generally do not yield useful results due to the notoriously erratic fluctuations in margins, earnings and cash flows. When evaluating the merits of cyclicals, we appreciate that we don’t have to go out on a limb to foretell the future. Steel, cement and paper/packaging are examples of industries that have long histories that exhibit both big cyclical swings in the short-term but reasonably stable and rational competitive behavior over time. Thus, it usually suffices to study whether a mean-reversion dynamic can adequately explain a company’s track record. If this is the case, then normalizing past growth-margin patterns can be appropriate when modelling the company’s trajectory going forward. In short, for many economically sensitive firms, historic comparison constitutes a simple but trustworthy statistical input to the valuation process.

Finally, our portfolio management discipline is exceptionally well suited to handle stakes in cyclical businesses. We customarily establish positions in such companies during a heavy downcycle, when their equities have already fallen a lot. But unfortunately, we are not blessed with the ability to call turning points in price, and stocks usually have further to fall. We therefore build positions bit by bit, anticipating continued weakness. Such spaced periodic purchases result in a low average entry price. By the time the cycle shows signs of recovery, stock prices usually react suddenly and violently to the upside. At some point, they will presumably approach our conservative estimate of intrinsic value, upon which we begin to trim a position. In short, we replace timing with the method of averaging-in and averaging-out, a practice which has yielded winning results over time.

While globally synchronized contractions have become rarer, we believe that the recent lack thereof is an aberration rather than the new norm. Cyclical swings remain at the heart of market-based economics. In fact, plausible arguments can be made that they may present an even bigger risk to the global financial system going forward. Our structural exposure to cyclicals ensures that we stay recession-alert and properly think through the key threats and opportunities involved.

Sincerely,

Gregor Trachsel
Chief Investment Officer SG Value Partners AG