Since the Great Financial Crisis, the classical business cycle that business school classes teach about has been nonexistent. This can easily be seen by looking at a chart of the Dow Jones Industrial Average from the beginning of 2010 to the end of 2019.
From 2010 through 2019, markets were almost a straight line. The cycle had disappeared, and we weren’t sure if it was coming back. It’s debatable what brought about this phenomenon, but very interventionist and easy Fed policy combined with low inflation are thought to be the main causes. If easy Fed policy and low inflation muted the cycle, it’s only logical that the reverse would cause the cycle to return. Newly restrictive Fed policy and a resurgence in inflation looks set to push us into a highly cyclical period that we haven’t seen in some time. The 1970s and early 1980s give us one example of what that looked like from a market perspective.
Investors could do very well in the last decade by just buying one of the major US stock indexes and then just holding for the rest of the decade without having to do anything else. The 2010-2019 decade was a remarkably strong decade for US stock indexes. However, that was not the case during the 70s and may not be the case now. To do well during one of these highly cyclical periods like the 70s, you really had to invest around the cycle. This means positioning portfolios defensively ahead of cycle downturns while being prepared to shift more aggressively ahead of a shift to a cycle upturn. Adjusting investment weightings at an industry and sector level and across different asset classes was a good way to go about this. Real assets have also tended to do better than financial assets. This could be in part because the price volatility of real assets contributes to the cycle phenomenon.
Looking at where we are now, I believe that right now we are in a downturn in the cycle. Thus, we are positioned defensively with an overweight to lower volatility assets and real assets. If my thesis on this next 5-10 year period being highly cyclical is correct, then this won’t be a permanent allocation. A catalyst will emerge that will support an upturn in the cycle. This will be the signal to shift to a more aggressive portfolio stance. That catalyst could be many things, such as the Federal Reserve pausing or pivoting away from their restrictive policy stance, leading economic indicators hitting an inflection point, or asset prices declining to levels that would be much more attractive. We don’t know when this would happen, but it is almost certain to happen at some point in the future. Until then, we will have to patiently bide our time and remain vigilant as always.
