Changing Investment Styles and the Economic Cycle

Changing Investment Styles and the Economic Cycle


Monitoring the rate of change in the business cycle (ups and downs) is an important part of enhancing or reducing the risk of owning stocks. It’s what we spend hours doing daily in order to advance your account balances and preserve your capital.

In the mature stage of an economic cycle, growth stocks tend to underperform value stocks because fewer value stocks are available and future growth expectation determines value relative to current price. Credit Suisse research analysts believe the economic cycle may be reaching an inflection point. In this case, the inflection point is leading to still another leg higher in U.S. growth.  Their point is that an unusual amalgamation of disruptive technology companies has come together in the United States to further boost corporate profits.

By historic standards, our current modern economic upcycle hasn’t been impressive. Rebounds tend to be much more powerful. One could predict that therefore if the next recession started tomorrow, a corresponding down cycle would be muted. Let’s assume this would be due to slowly rising interest rates and slowly advancing labor costs, though of course, pipe dreams are what they are in a world of North Korea, dirty bombs, and ISIS terrorists with drones.

So is this a trudge higher and potentially slog lower cycle?  Or will something more dramatic affect the next economic cyclical descent? We diligently watch for signs of market cyclicality every day. We are prepared to act. At present, if interest rates are an indicator, the cash equivalents and bond markets are showing great respect for the unknown. Rates remain very low.

As a reminder, the Federal Reserve Board was created in 1913 in order to mute economic cycles. Stability is what all governments want. Much of what happened after Pearl Harbor and 9/11 was based upon reestablishing economic stability. Recessions strain the government purse. Recessions create terrific human suffering. Overheated economic booms tend to separate the haves from the have nots. Periods of high inflation topple the respected life style decisions of those living on a fixed income.

This economic cycle is unique in that disruptive technologies are forcing all world citizens into an ongoing cycle of low inflation.  In fact, despite a massive sum of economic stimulus by the world’s central banks, new technologies are changing the business model of businesses, straining the number of high paying jobs and uniting a small group of disruptive technologies all at the same time.

Greater connectivity has seen the rise of the smartphone, currently one of the most important drivers of disruption on the planet. The success story of the smartphone in combination with an ever-faster mobile infrastructure (3G-5G) enables users to have both the functionality and speed to exploit high-speed mobile broadband allowing businesses to impact customers with service 24 hours a day, seven days a week. This trend is powering social media, information, and the sharing economy. Innovative business models such as Airbnb and Uber allow customers to avoid making big purchases. It also reduces the barriers to entry among several business categories. To illustrate, you don’t need to own a hotel anymore to compete with hotels.

The rise in computing power is changing the way we live and do business. One research report recently estimated that 47% of total US employment is at risk of being automated over the next twenty years. Machine learning can already be a substitute for humans in simple repetitive tasks.

The development of 3D printing makes it easier than ever before to make parts at low cost in relatively short time, disrupting the supply chain industry aftermarket, and lowering the cost of everything from dental implants to automobile parts.

All of these merging disruptive technologies can be very positive to equities overall, as long as you are in the right group of growers. This theme of disruptive technologies can also be a brick in the underemployment scenario leading to a “slog-lower” recession.  After all, once the negative physiology of bear market thinking begins, inclusive of consumer pullbacks, it tends to last six months to three years before a rebound ensues.

For now, we are not in a cycle characterized by falling prices, high unemployment or recession, though underemployment is a growing problem.

The good news for savers who have invested in stocks is that they are part owners in these wealth building technologies. Therefore, as these technologies are utilized throughout society, wealth accrues to shareholders. This leads to excess savings, which is generally a good thing for retirees.

As to how boom and bust cycles go (or trudge vs slog), despite outperforming recently, the cost of purchasing growth equities in the United States is reasonably cheap by historic standards; this according to Credit Suisse analysts, who put relative values currently at some 0.5 standard deviations below the norm on a 12-month trailing (price to earnings) comparison.

So while this trudge-ahead economic cycle continues, helped along by trillions of dollars of Federal Reserve Board stimulus, evidence suggests that a turning point to faster growth may be at hand. The charts below show that while value stocks have outperformed growth stocks for years, growth as a style is on the rebound.

As always, thank you for your continued support and trust. Our mutual trust is the qualitative energy and the formidable mindset that drives account performance. I wouldn’t write these words here if I didn’t believe what I just wrote one hundred percent. So again, thanks so much.