Our Business Cycle Work Is Close to Signaling a Stage III. Guess Which Market That’s Bullish For?
A large part of the Pring Turner investment approach is derived from the fact that the business cycle is nothing more or less than a repetitive chronological sequence of events. The cycle begins with a bottoming in the interest sensitive housing industry and ending with a pick-up in capital spending caused by capacity constraints in manufacturing. Fortunately for us as active investment managers, the primary trend turning points for bonds, stocks and commodities are also part of the sequence. We call it the seasonal approach to asset allocation since the business cycle, like the calendar year, goes through different seasons. For farmers, there are certain seasons, such as winter, when it’s time to rest but prepare for the spring planting season, and of course during summer and fall is when harvesting is the preferred task.
Allocating assets around the business cycle is similar in many respects. There is a deflationary season, when it’s time to play defense by emphasizing bonds and conservative equity sectors. Later in the cycle, when capacity tightens and commodities are running higher, it’s time to purchase earnings driven equities for our separately managed portfolios.
Figure 1 features an idealized growth path for the economy. It pinpoints the expected highs and lows for bonds (B), stocks (S) and industrial commodities ©. In the 1920’s, Joseph Kitchin identified the 41-month cycle in business activity that bears his name. Since the 1960’s though, there have only been seven recessions. That puts the trough to trough cycle closer to a 100-month cycle and suggests the 41-month span is no longer operative. On the other hand, including growth slowdowns into the mix expands the number of post 1960 cyclic events to seventeen. That translates to about 42-months. The Kitchin cycle then, is alive and well.
Our models, which identify the primary trend of bonds, stocks and commodities, suggest that the cycle is currently positioned somewhere in the green shading. Using the low in bonds as the start of the cycle (Stage I) and progressing forwards to the bottom of stocks (Stage II), the next event to look for is a low in commodities (Stage III). However, the economy is not emerging from a recession as indicated in Figure 1. Instead, it appears to be emerging from a growth slowdown or economic soft landing.
During growth slowdowns the chronological sequence of market turning points still operates. The principal difference, is that the magnitude and duration of the cycle’s “down” part is far less volatile than a typical recession. It also means that, the chronological sequence of financial market turning points are sped up.