By Guest Blogger Ryan Lewenza
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Who’s excited to talk about cycles? Just me! Ok, then let’s get started.
In developing my economic and market outlook, a key component of this exercise are the different cycles that I track. In fact, I would argue the ‘business cycle’ is one of the most important things that I focus on in trying to forecast the direction of the economy and equity markets. Today I’m going to review the key cycles that I follow with many of them pointing to better days ahead and additional stock market gains.
First, the business cycle, which captures the fluctuations in an economy. All economies go through periods of growth/expansion followed by periods of contraction/recession. Then rinse and repeat.
We can then break up the business cycle into four distinct phases – early, mid, late and recession – with each one having different implications for the economy and stock market.
Coming into 2020 I was of the view that we were ‘late cycle’ believing we were getting closer to a recession. This was why Doug and I had been reducing risk in client portfolios for the last year or two (e.g., low volatility ETFs, healthcare stocks, no small caps). Then the pandemic hit with this shock sending the global economy into a deep recession.
As seen in the chart below, which comes from Fidelity and perfectly illustrates the typical business cycle, I believe we’ll soon be exiting the recession and move into the early phase of a recovery. As I keep saying to clients, the question is not if the global economy will emerge from this recession, rather when and how robust the recovery will be.
In the ‘early’ phase of the cycle we typically see a rebound in economic activity, low interest rates and easy monetary policies, and a rapid rise in corporate profits. This phase often delivers the strongest equity market returns as we transition from peak pessimism to recovery. During this period stocks historically return more than 20% during this phase, which typically lasts around 12 months. If I’m correct that the US/global economy is transitioning from recession to early cycle, this bodes well for equity markets over the next year.
The Typical Business Cycle
Source: Fidelity
The next bullish cycle that I track is the ‘secular’ or long-term equity cycle. I’m a strong believer that the US equity markets go through these long-term bull and bear cycles, each lasting roughly 15 years. This can be seen in the long-term chart of the Dow Jones Industrial Average below.
The secular bear markets are captured in the red boxes and the secular bull markets can be seen with the blue arrows. Let’s look a bit closer at this chart.
Since the Great Depression there have been three secular bull cycles – 1942-1966, 1982-2000 and the current one which started in 2009. The current secular bull cycle is 11 years in, well below the 1942-66 cycle (lasted 23.8 years) and the 1982-2000 cycle (lasted 17.4 years). If history repeats then that would imply another 6 to 12 years left in this secular bull cycle.
Now it’s important to stress that even during these long-term bull cycles the equity markets will still endure market sell-offs or what I would ‘cyclical’ bear markets. For example, in the 1982-2000 secular bull market we had the terrible 1987 market crash. But that looks like a blip on the charts in the context of a secular bull cycle.
I believe we entered a new secular bull cycle in March 2009 and see it lasting for a number of years. What does this mean for US stock market returns? The long-term average return for the S&P 500 including dividend is around 9% annually. In secular bull cycles average returns are closer to 16% annually, which is exactly what the S&P 500 has returned annually since March 2009. Giddy up!
Secular Cycle for the Dow Jones Industrial Average
Source: Bloomberg, Turner Investments
The last cycle I track is the average performance of the US stock markets over the calendar year. The strongest seasonal period for equities is the November to May period. This can been seen clearly in the chart below. On average the S&P 500 returns 7.5% in the November to May period, and only 0.5% for the June to October period. You may have heard the “sell in May and go away” expression and this chart speaks to this.
Ned Davis, one of the research providers we utilize, recently noted in a report that 81% of the time the equity markets deliver a positive return in the fourth quarter or the October to December period.
Given these very bullish stats I believe post the election we could see the stock market regain its footing and start rallying into year-end and into H1/21. As covered in my last blog topic, November could be a bit bumpy if Trump losses and contests the US election, but once this is resolved we could be off to the races based on this strong seasonal cycle.
S&P 500 Average Daily Performance over the Calendar Year
Source: Bloomberg, Turner Investments
Cycles are around us (calendar, weather, planetary, astronomical etc.) and they have real consequences on our lives. Well, there also economic and market cycles, which impact our lives and based on my understanding and interpretation of these different cycles, I see better days ahead for the global economy and equity markets.
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.