Our Insights

About personal finance, investments and markets.
November 9, 2015

This cycle ain’t over

The most-read research article on our website was from May 2nd 2014, titled „Why this business cycle is highly unusual (and could last much longer than you think)“. More than one year later, it is time to update our view. Are we still as optimistic about the US and EU economy or are there first signs of a recessions? Our research shows that the odds of a recession are low and this remains one of the shallowest but also longest business cycles.

Where are we in the US business cycle?

Since 1800, the US business cycle lasted on average 39 months. The current cycle is already 73 months old. Understandably, many commentators are coming out to declare that the current cycle isn’t just long on the tooth, but already well past its expiration date.

But is this simplistic analysis correct?

We don’t think so for a couple of reasons:

  1. The most recent business cycles actually lasted much longer than the historical averages. The last three recoveries lasted an average of 94 months.
  2. The last recession in 2008/2009 was very deep. Generally, a deeper recession means more slack in the economy which means the economy can grow much longer until it overheats. Auto sales and building permits are nowhere close to normalizing.
  3. Economic expansions don’t die of old age, but die of excess. There is no fixed time limit for an expansion, each cycle is different. The typical consumer excesses we have seen at previous peaks of the economic cycle such as in 1999/2000 (internet boom) or 2005-2007 (US housing) are absent this time. Yes, there are some signs of excess in parts oft he economy like in biotech, but there are no big imbalances in the US economy at the moment.
  4. Typical supply-side issues that occure at the peak of an economic expansion such as high capacity utilisation or high corporate indebtedness are not visible (yet).
  5. US recessions are often preceded by surging, not weak commodity prices. Many investors associate the 2008 crisis with the housing bubble and overleveraged financials but they forget that the price of a barrel of oil had risen by more than 100% from the beginning of 2007 to mid 2008, thus hurting disposable income of the US consumer. Today? Most major commodity prices have been on a downtrend over the last 12 months.

Commodities vs business cycle

Europe’s recovery is even furher behind

The European expansion is probably 2-3 years behind the US expansion. There is simply too much slack in Europe to get worked up about a potential overheating: the unemployment rate is much higher and the capacity utilisation is much lower than in the US.

How this cycle differs

We remain positive about the US and EU economy. Not necessarily so much about the rate of growth which will remain below the average of previous recoveries. But most importantly, we do not see a recession in the immediate future. A long cycle of low growth is therefore our base forecast.

A business cycle is driven by risk appetite (=excesses). Cycles die when we get too optimistic, i.e. when we borrow or hire too much. When we then have to cut back, we create a feedback loop that drives us into a recession. Now? We can’t really see too much exuberance. This is not surprising: we are still scared as consumers, investors and businesses by the last crisis. The day after you get mugged, you think you will get mugged again – this is called recency effect.

Real economy ≠ financial markets

What should investors do? In very simple terms, corrections should be bought until there is too much exuberance and optimism.

However, while nearly all asset classes performed well since 2009, we think investing will no longer be so straightforward in the next couple of years. We are now at a critical juncture where the labor market is properly tightening for the first time since 2009. Hints of real wage increases in the US are becoming more prevalent – e.g. several companies have announced increases for their lowest paid employees, including Wal-Mart, McDonald’s, T.J. Maxx and others. As we get closer to full employement, wage pressure will start to creep higher. This is typically still a good environment for equities but less so for bonds and bond-proxies. What is important to keep in mind for equities though is that valuations are no longer cheap. Investors need to get used to lower future returns than what they witnessed during the last 5 years.

Please read our Terms of Use.