Late cycle; yes, late cycle
Fasten your seatbelts ladies and gentlemen, we are entering late cycle. Yes you read that right, late cycle. One of the characteristics of the last decade or so has been to forget about the business cycle. The Great Moderation allowed the exportation of deflation from the emerging markets to the Western world thus allowing our own inflation and interest rates to be low and stable for a long, long time. Against that backdrop it is easy to have forgotten about the business cycle, aka boom and bust.
No sooner than we seem to have safely navigated the turbulence of late 2008 and have been approaching our previous cruising altitude, we are already preparing for our descent (albeit probably less severe and nowhere near as low!).
Firstly let’s consider what we mean by cycle. We are less concerned about the business cycle (markets move on a number of things only one of which is business outlook and then there is a considerable early lag) but rather we are more focused on the liquidity cycle. The current liquidity cycle peaked in early 2009, since when liquidity has moved steadily downwards. Asset markets typically boom between 1 and 2 years after liquidity has peaked so we are expecting the second half of this year to be more challenging for markets.
Interest Rate Policy
Another cycle to be aware of is the interest rate cycle. Currently countries are falling into three camps;
• Those that are explicitly tightening interest rates such as Australia (who have raised interest rates 5 times in 7 months) and Norway (twice in late 2009);
• Those tightening implicitly (by means other than raising the central bank rate) such as China and America; and,
• The Rest of the World who are not doing anything – yet!
Eventually those in the last group will catch up and for that reason we have, ahead of time, reduced our exposure to Gilts and, given the very low corporate spreads, investment grade bonds.
What we are liking in the fixed interest space at the current time are strategic bond funds with low duration (i.e. low risk to rising interest rates) and high yield bond funds which tend to perform better in the latter part of the (business) cycle and where spreads over government bonds are still wide enough to provide some protection to the threat of interest rates.
There is still money to be made even with the spectre of rising rates looming larger.
Submitted by: Jason Britton
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