John Husselbee, multi-asset manager at Liontrust, shares his views in a short article below.
A fixture in our presentations for many years, the investment clock is a useful way of showing how a business cycle typically develops over time and has proved as good a method as any of pinpointing ‘where we are’ in terms of markets and economies at any particular point in time.
While many have claimed its invention – and a number of investors have certainly evolved the concept over the years – the idea of the clock goes back to the 1930s when it was first published in the London Evening News.
Noise or sentiment (primarily those old classics of fear and greed) are typically the drivers behind short-term market direction; over the longer term, however, more fundamental factors tend to dominate and for us, the most important are the path of inflation and economic growth.
This is ultimately the thinking behind the investment clock, with these forces peaking and troughing at different points: if you plot it as a graph, economic growth is on the vertical axis, from bottom (falling) to top (rising), while inflation is on the horizontal, moving from deflation on the left to rising prices on the right.
The investment cycle moves through waves, with central banks usually inflating or deflating monetary policy to stabilise activity within the economy. Tracking the movement around the clock’s quadrants, reflation and recovery on the left, overheat and stagflation on the right, can give some guide to investment rotation across assets and sectors.
It is possible to include a lot more information on the clock ‘face’, drilling down into the types of bonds or commodities that will outperform at particular points, but we prefer to keep to the relatively simple model below. This shows inflation and growth and which of the four main asset classes (as well as which sectors of the equity market) is likely to be in the ascendancy during each period. Anecdotally, I typically describe the clock as heading North when the economy is expanding, South when contracting, East when inflation is rising and West when it is falling.
Source: Liontrust, January 2020
While there is no fixed term for a cycle, a full turn of the clock would typically be expected to last the best part of a decade. Long-term trends have been more muted over recent years, with persistently low inflation and anaemic growth during perhaps the slowest bull market in history. As we all know, however, that quickly gave way to one of the fastest bear markets when the implications of Covid-19 became clear, moving the clock into fast-forward mode and jumping to the dreaded bottom left-hand corner of recession and deflation.
Conventional wisdom would dictate this is typically a period that favours bonds and there could certainly be an argument made for this once again, with government intervention skewed towards fixed income and the asset class benefiting from its mandatory coupons as equity dividends suffer suspensions and cancellations.
Despite this, however, equity markets have already bounced back to a large extent and retraced most of their losses, nominally pushing us deep into the clock’s recovery zone. Financial markets are well known for their discounting ways as they price in expected future events, but given how fast things are moving, it is worth stepping back to take a good look at exactly where we are on the clock in reality.
If we go back to those two driving factors of growth and inflation, we can probably push any serious concerns about the latter into the future. Given the scale of government intervention during the current crisis, growing fears about higher prices are understandable, although talk of a spike seems premature.
During a previous period of government largesse, in the wake of the Global Financial Crisis, there were similar concerns that quantitative easing would spark inflation but, ultimately, the forces of globalisation and technology were enough to keep it in check. This time, however, we would suggest technology is more embedded than it was then, and perhaps less disruptive, and we might also see companies eschew global supply chains and seek more local suppliers in a post-Coronavirus world, both of which could put upward pressure on inflation longer term.
As for economic growth, equity markets appear to be rising on the assumption that the damage caused by the pandemic will be offset by massive monetary and fiscal stimulus. But forecasts show real global GDP in 2020 falling by 4.5% to 5%, with developed markets expected to shrink by 6.5% to 7%, and there is huge uncertainty as countries move out of lockdown: how will unemployment affect consumer-led economies like the UK and US, for example, and should the world brace for another wave of the virus in the winter or earlier?
We would not expect markets to collapse again as they did in March, given the level of state intervention and the prevailing ‘whatever it takes’ narrative. But as previous recoveries have shown, there are often several chances to invest on the way up and we would caution against the assumption we are already out of the reflation stage and heading towards recovery and a new bull market. As has been the case many times before, we are perhaps not as far around the clock as those giant discounting machines in the shape of equity markets are signalling. For us, the global economy is still around the 8pm mark, based on fundamentals, while equities have rushed ahead to 10pm – and with tough times ahead, patient investors might do well to reset their watch.
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