The Market Cycle Peaked, the Business Cycle Didn't: A 3/3/2/2 Approach
Investors can track two clocks. The business cycle moves slowly with hiring, spending, and investment. The market cycle turns faster as money flows in and out of stocks. Today the two clocks disagree. The economy is still expanding: third-quarter GDP grew at a 3.4% annualized rate, and the OECD's leading indicator for the US is above its trend level and rising. Yet the market cycle appears to have peaked after the S&P 500's record on October 6. The Invesco QQQ, which tracks the Nasdaq-100, was still 9.4% below that level on November 12.
Why Strong Companies Still in Demand
Large investors decide first which phase of the cycle the market is in, then which investment styles fit that phase, and only then which companies to own. When the phase changes, their weightings change too, even for businesses whose orders are booming. In October, hedge funds cut their net leverage to 73.4% and sold roughly $20 billion of technology stocks in two weeks. BlackRock lowered its rating on US stocks to neutral and raised short-term Treasuries to overweight.
Demand for AI hardware remains strong: South Korea's chip exports rose 259% from a year earlier in October. Even so, rotations like this typically take one to two years to come back around. Buyers tend to return only once growth stocks have fallen far enough to look like value stocks.
Three Phases of the Cycle
Before the market peak: Nearly everything works, including momentum stocks, small companies, and emerging Asia.
After the peak, while the economy still grows: Companies with strong balance sheets, less volatile stocks, and defensive sectors lead, with health care at the top.
In a recession: Treasuries and high-grade corporate bonds hold up, while even defensive stocks fall.
Current conditions point to the middle phase.
The 3/3/2/2 Allocation
The response is a portfolio split designed to hold up however the next year unfolds:
30% growth, including AI: These companies still have strong earnings, even though the economic tailwind behind their valuations has faded. Use cash to add to them gradually after pullbacks rather than all at once.
30% defensive, led by US health care: Health care is among the large sectors least tied to the economy, and it has benefited most from the rotation. The Health Care Select Sector fund (XLV) rose 12.4% from October 6 to November 12.
20% bonds, in intermediate maturities: The 10-year Treasury yield topped 5.3% this fall, its highest in about 24 years, and was near 5% in mid-November. Locking in yields like that is attractive if growth slows, because rates usually fall when it does. Inflation is the main risk: October consumer prices rose 0.4% against 0.3% expected, and futures markets now expect a Fed rate hike in December. Intermediate bonds carry less of that risk than 30-year bonds.
20% cash: Three-month Treasury bills pay about 4.1%, so investors earn a return while they wait and keep cash ready to buy on dips.
How the Split Has Held Up
From the October 6 peak to November 12, a fund holding only growth stocks fell as much as 14.8% and finished down 9.4%. Over the same period, the 3/3/2/2 split never lost more than 0.5% and finished up 1.3%.
Health care's rally added about 3.7 percentage points to that return. Without it, the split would have fallen roughly 2.4%, about a quarter of the growth-only loss. Bonds helped during the growth scare but gave back more than half their gains after the inflation report. That shows Treasuries protect better against fears of slowing growth than against fears of rising inflation. A test from a single start date proves little. What it shows is the pattern that matters: small losses in bad weeks leave cash available to buy.
Washington as the Swing Factor
After the November 3 elections, Democrats hold majorities in both the House and the Senate, which makes US policy the factor to watch.
Data centers: In Texas, both the current governor and the governor-elect have favored pausing new data center approvals pending review. Local opposition held up nearly $200 billion of projects in the first half of the year. New builds are likely to become slower and costlier, which makes capacity that is already built or permitted more valuable.
Budget and taxes: Government funding runs out on December 11, and the debt limit could be reached as early as February. Priorities such as restoring Affordable Care Act premium credits and clean-energy credits compete for the same budget room as tax breaks that support AI spending. Because the president can veto bills, negotiation is more likely than sudden tax changes. The detail to watch is whether any deal changes how quickly companies can write off AI equipment.
Tariffs: The president can act on trade without Congress, and the administration is now pursuing tariffs through Section 301 trade cases. The dollar's role as the world's main currency looks secure, though the Korean won could weaken if tariffs expand.
Oil: Brent crude fell from above $112 to about $91 on hopes of renewed US-Iran talks, and the risk of a wider conflict appears lower.
Signals to Watch
Three indicators would signal that the expansion is ending:
Equipment investment: After inflation, it is about 14% higher than a year ago. If that growth rate slows for two quarters in a row, the AI build-out is no longer carrying the economy.
The OECD leading indicator: Its monthly gains have shrunk since June. A decline while the reading is still above 100 would mark the start of a downturn.
Fed rate hikes: Raising rates into a strong economy is a classic late-cycle sign, though it rarely ends an expansion quickly.
Discipline in Volatile Weeks
In volatile weeks, restraint matters. Sharp post-election moves in some sectors reversed within days, so investors who chased them lost twice. The rules are simple:
Hold steady: Make no changes to the allocation while market swings are extreme.
Rebalance later: Once markets settle, return to 30/30/20/20.
Buy what has fallen: Use cash to add to holdings that have fallen most, as long as their business case is intact.
This reflects one of many approaches, not personal financial advice.