in the final stages of the life cycle, demand tends to be price sensitive.
Thus, Universal can not raise prices without losing volume.
Moreover, given the
industry’s maturity, cost structures are likely to be similar across all competitors,
and any price cuts can be matched immediately.
Thus, Universal’s car business
is boxed in: Product pricing is determined by the market, and the company is a
Idata should have much more pricing flexibility given its earlier stage in
the industrial life cycle.
Demand is growing faster than supply, and, depending
on the presence and/or actions of an industry leader, Idata may set prices high to
maximize current profits and generate cash for product development, or set
prices low in an effort to gain market share.
A basic premise of the business cycle approach to investment timing is that
stock prices anticipate fluctuations in the business cycle.
For example, there
is evidence that stock prices tend to move about six months ahead of the
In fact, stock prices are a leading indicator for the economy.
Over the course of a business cycle, this approach to investing would work
roughly as follows.
As the investor perceives that the top of a business cycle
is approaching, stocks purchased should not be vulnerable to a recession.
When the investor perceives that a downturn is at hand, stock holdings should
be lightened with proceeds invested in fixed-income securities.
recession has matured to some extent, and interest rates fall, bond prices will
As the investor perceives that the recession is about to end, profits
should be taken in the bonds and reinvested in stocks, particularly those in
cyclical industries with a high beta.
Abnormal returns generally will only be earned if these asset allocation
switches are timed better than those of other investors.
Switches made after
the turning points may not lead to excess returns.
Based on the business cycle approach to investment timing, the ideal time to
invest in a cyclical stock such as a passenger car company would be just
before the end of a recession.
If the recovery is already underway, Adam’s
recommendation would be too late.
The equities market generally anticipates
the changes in the economic cycle.
Therefore, since the “recovery is
underway,” the price of Universal Auto should already reflect the anticipated
improvements in the economy.