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Lunch with Louis
Where are we in the Business Cycle?
Jan 2024
Last summer I wrote about where we were in the Business Cycle, when inflation was still running relatively high in June at 7.3% (Consumer price inflation, UK - Office for National Statistics [accessed 24.01.2024]) and people were still concerned about the value of their cash savings depreciating. It was also a time when most people’s investments were still lower in value than the peak of December 2021.
This January, however, the picture already looks much different. In the December just gone, inflation had dropped to 4.2% (Inflation and price indices - Office for National Statistics (ons.gov.uk) [accessed 24.01.2024]). Meanwhile, the stock had returned to the peak of December 2021.
Amazing, really, how much inflation fell by and by how much investments grew on the whole in the space of just 6 months.
So what do we think will happen next? Are we about to see capital markets fly? But surely the economy is still in the doldrums?
Whenever someone asks me for my opinion on what the future outlook of capital markets might look like – and, by proxy, what their future investment value might look like – I always refer back to the business cycle, starting with a general idea of where we are along that cycle.
Are you wondering what the next 6 to 12 months might look like? Are you thinking about what could happen to your portfolio? Here’s an update to those ever so important questions.
What is the business cycle? (a quick guide for any new readers)
To better understand where we might be going, it would probably help to understand the components that make up the business cycle. By the way this is Austrian economic theory, should you really want to know…
The principle driver of the business cycle is the ease at which organisations and households can borrow and lend money. This is dictated by central bank policy by the likes of the Federal Reserve in the United States, the European Central Bank, the Bank of England, the Bank of Japan and the Central Bank of China.
Here’s a visual to demonstrate how the lowering of central bank rates (and vice versa) affects the ease at which the economy can lend and borrow money, creating the business cycle.
Figure 1.1: The Business Cycle
When fears of a recession are confirmed after a period of economic slowdown, central banks have the option to lower their lending rate. In turn this allows for high street banks to borrow more because the cost of doing is lowered, ultimately meaning there’s more cash available for the economy to call upon to stimulate growth (i.e. for an economic recovery and boom).
When the economy gets overheated because of excessive spending, the by-product is inflation which no one benefits from. So to curb inflation, central banks raise their lending rates, making it more expensive for organisations and households to borrow. Less money circulating around the economy would mean less expenditure and as such an economic slowdown.
Looking back at last year, does any of this sound familiar to you? Let’s take a look.
Where are we in the Business Cycle?
Clearly inflation has come down fast and by quite a lot since the last time I wrote about the Business Cycle. It seems the sustained period of higher rates, affecting the pockets of mortgage holders and companies with borrowed money, is finally showing in the inflation stats. We have also seen some weakness in the UK’s job market, most notably in tech and financial industries, creating fears of a recession.
So, if we were to paint a graph similar to the one above, you could say that we are currently in the middle of a slowdown period, with a potential recovery ahead (i.e. central banks cut rates to stimulate the economy again).
What could the next 12 to 18 months look like?
Now that we’ve established where we are along the business cycle, a great way to get a general understanding for what could be round the corner is to look at forward-looking indicators. These are sets of data that reflect how much productivity / output is being done at the beginning of the supply chain for goods and services.
Let’s get an update on the report from the Institute for Supply Management (ISM) in the United States who collect data and provide an indication of how strong or weak the supply chain is from both a manufacturing and services perspective. It’s called the Purchasing Managers Index (PMI)
Figure 1.2: The PMI
(Source: Terms of Service and Company Policy — TradingView 24.01.24)
You can see that when the PMI has reached lows between 30 and 40 the economy buckled during those times – the global financial crisis in 2009 and the onset of Covid in 2020, for instance. These were periods when manufacturers and service providers were at their least productive, indicating that the general economy was suffering.
But notice how steep (or quick) the recoveries were when they eventually did come.
Looking at the data from the last 12 months, are we seeing a gradual uptick in supplier output? Should we, therefore, expect a global recovery over the course of the next 12 to 18 months? It seems the stock market would like to think so, or at least in the case of tech companies (the front runners of innovation), as both the S&P500 and Nasdaq which are heavily weighted towards tech stocks, are back above the peak of December 2021*. Did the news make a big thing of this by the way??
*(Source: Terms of Service and Company Policy — TradingView 24.01.24)
To conclude: remember that the stock market likes to look ahead by about 12 to 18 months, so we could be at the beginning of an overall recovery for markets and therefore investments. By knowing where we are in the business cycle we can better prepare ourselves, at least psychologically, for what lies ahead.
Past performance is not indicative of future performance.
