Capital Cycle Thinking: A Contrarian Map to Industry Timing

Most investors chase demand, but theres edge to be had in following supply.

Capital cycle thinking flips the usual playbook. Instead of forecasting earnings or TAM, it tracks how capital flows in and out of industries—and what that does to future returns.

It’s less about vision. More about reflexivity.

The Capital Cycle in One Sentence

First:

Industries attract capital when times are good. That capital eventually kills returns.

Then the reverse:

Industries repel capital when times are bad. That lack of capital eventually revives returns.

New money floods in when margins are high, stories are strong, and CEOs are expanding. Then come the overbuilds, the price wars, and the write-downs. Finally, when the capital dries up, survivors start compounding again.

Why it Matters

Most people ask, "What will demand look like next year?”

Capital cycle investors ask, "How much new capital is being committed right now? And is that sustainable?”

That reframing gives you a second-order advantage (remember - mental models).

By the time demand shows up in earnings, it’s too late. Supply decisions, on the other hand, are long-cycle, path-dependent, and predictive.

The 4 Phases of the Capital Cycle

1. Undercapitalized → High Returns

   • No one wants to touch the sector (think energy in 2020).

   • Supply is tight, assets are starved, pricing power returns.

2. New Capital Flows In

   • Returns look great.

   • IPOs, expansions, and capex ramp up.

3. Overcapacity Builds

   • Competition intensifies.

   • Margins get squeezed, returns fall.

4. Capital Exits / Discipline Returns

   • Companies go bust or consolidate.

   • Capex is cut. Industry rationalizes. Survivors become cash machines.

The opportunity lies in buying during stage 1 or early stage 4—when narrative is bleak, but supply discipline sets the stage for a rebound.

Example: ✈️ Airlines - Growth Without Profits

Few industries illustrate capital cycle failure better than airlines.

• Demand for air travel has steadily increased for decades.

• But profits? Rare, cyclical, and razor-thin.

Why? Because whenever fuel prices dropped or demand spiked, airlines expanded aggressively—adding capacity, slashing fares, and starting price wars. The result: even in boom times, returns on capital remained dismal.

Warren Buffett famously avoided the industry for years, once saying:

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money.”

Ironically, he later invested in four major U.S. airlines—only to sell at a loss during COVID, reinforcing the lesson.

The base rate for airline profitability has historically been poor—a graveyard for capital discipline. Unless structural change or consolidation shifts the cycle, the math rarely works out for shareholders.

Mental Model: Follow the Scarcity

In investing, what’s scarce tends to become valuable.

Capital cycle thinking trains you to look where capital is fleeing, not rushing. That’s where future margins often hide - waiting for supply to clear and pricing power to return.

💡 How to Use Capital Cycle Thinking in Your Process

1. Track Capex Trends Look at industry-wide investment as a % of revenue. Are players growing or shrinking?

2. Watch Supply, Not Just Demand Ask: are new entrants flooding in? Is M&A heating up? Are assets being built or scrapped?

3. Be Patient Capital cycles are slow. You often have to sit through narrative pain before price catches up.

4. Invert Consensus If everyone’s bullish and capital is pouring in—exit stage left. If everyone’s disgusted and no one’s investing—lean in.

Capital cycle thinking is a contrarian map. It doesn’t give you timing precision—but it does show you where the crowd is sowing its own demise.

The hard part? Believing in scarcity before the market does

📚 Further Reading

• Capital Returns by Edward Chancellor & Marathon Asset Management — the foundational text

• Capital Account by Edward Chancellor — case studies of capital cycle investing pre-2008

• Letters from Marathon, GMO, and Longview Economics — practitioners of this mindset