The Late Innings of the Business Cycle?

by: , Managing Director and Senior Portfolio Manager, MainStay Investments

To borrow from a phrase attributed to Mark Twain, “reports of the death of this business cycle have been greatly exaggerated.” But, you can hardly blame the economic pundits. On average, economic cycles in the U.S. last around 34 months. The current expansion has now exceeded 108 months. While tax reform may trigger a growth spurt, it’s becoming clear we’re in the later innings of this business cycle. Following is a summary of the reasons why we feel the cycle is in its later stages and investment strategies for when the slowdown occurs.

A Less Accommodative Federal Reserve

As is typically the case in the late innings of a business cycle, leverage is elevated and rising. The Federal Reserve (Fed) has moved into action, raising interest rates five times since December 2015, with three more hikes penciled in for 2018. Less policy accommodation has historically resulted in decelerating growth. This is demonstrated below, with the vertical gray bars representing previous recessions.

Federal Interest Rate Cycles (Q1 91 – Q3 17)

Source: Thomson Reuters DataStream, New York Life Investments, as of 12/31/17. Past performance is no guarantee of future results. The real short-term interest rate that would be neither inflationary nor deflationary absent transitory disturbances. GDP is gross domestic product (GDP).

Seventh, Eighth, or Ninth Inning?

While it’s difficult to know exactly when the cycle will turn, several leading economic indicators may help to determine which inning we’re in:

  • Low unemployment: We’re currently at or below estimated, full employment levels. This tends to be inflationary, which triggers further Fed rate hikes.
  • A flattening yield curve: This implies tightening credit conditions. And an inverted yield curve is a reliable indicator of impending recession.
  • Excessive capital spending: This historically signals an overheating economy. However, there’s currently still room for capital spending to rise.

Unemployment

Source: Thomson Reuters Datastream, New York Life Investments, as of 12/31/17. This information is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results. NAIRU is an acronym for non-accelerating inflation rate of unemployment, and refers to a level of unemployment below which inflation rises.

Yield Curve

Source: Thomson Reuters Datastream, New York Life Investments, as of 12/31/17. This information is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results.

Capital Spending

Source: Thomson Reuters Datastream, New York Life Investments, as of 12/31/17. This information is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results.

Historical Winners and Losers in the Cycle

Where we are in the business cycle has significant implications for market returns. During a downturn, the Fed is usually lowering rates, aiding Treasury returns (yields and prices move in the opposite direction), while credit and equities generally decline. The opposite then often holds true during the recovery and expansion phases. Finally, during a slowdown, a “flight to safety” occurs as a recession approaches, with Treasurys again being the performance leader.

Historical Returns to Risk Factors Vary at Different Points in the Business Cycle


Source: Bloomberg, New York Life Investments, as of 12/31/17. This information is for illustrative purposes only and not indicative of any investment. Past performance is no guarantee of future results.

Investment Strategies Going Forward

Against this backdrop, what steps should investors consider? While valuations are high, growth remains largely entrenched for now. Equities have historically performed well in this environment, although if suitable, investors may want to favor non-U.S. markets that are earlier in their expansion stages. From a credit perspective, spreads are very tight, suggesting less reward for risk than usual. Finally, having a short duration could be prudent as inflationary pressures mount. Looking further out, we believe, growth will eventually exhaust available labor and capital resources and a slowdown will ensue. Shifting out of equities into long-duration Treasurys has been a winning formula during previous recessions.

Allocating around the Investment Cycle

Source: New York Life Investment Management, as of 3/13/18. This image is for illustrative purposes only and is the opinion of Strategic Asset Allocation and Solutions group. Past performance is no guarantee of future results.

Opinions expressed are current opinions as of the date appearing in this material only. The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results.

About Risk

All investments are subject to market risk, including possible loss of principal. There is no assurance that the investment objectives mentioned will be met. Diversification cannot assure a profit or protect against loss in a declining market.

High-yield securities carry higher risks and some of the Fund’s investments have speculative characteristics and present a greater risk of loss than higher-quality debt securities. These securities can also be subject to greater price volatility.

Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.

A bond’s prices are inversely affected by interest rates. The price will go up when interest rates fall and go down as interest rates rise. Bonds are subject to credit risk and interest rate risk.

Treasury Securities are backed by the full faith and credit of the United States government as to payment of principal and interest if held to maturity.  Interest income on these securities is exempt from state and local taxes.

A credit spread is the difference in yield between two bonds of similar maturity, but different credit quality.

A yield curve is a curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Jonathan Swaney

Managing Director and Senior Portfolio Manager, MainStay Investments

Jon is a Managing Director and Senior Portfolio Manager in the Strategic Asset Allocation & Solutions Group.  His current focus is on management of the MainStay and third party asset allocation strategies

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