Most of my articles are about leading indicators that tell us what is going to happen in terms of stock market returns and economic growth. In this article, I am going to ignore leading indicators and only focus on economic cycles.
The first graph shows two very important things. First, we are currently in the slowest post-WWII economic recovery. We are also in the fourth longest economic recovery. Only 1991, 1961 and 1982 had longer recoveries (and much stronger).
This slow growth happens after one of the longest and most severe recessions after the 1950s. One problem is the high amount of debt in our economy. There comes a point where new debt is not going to have a positive effect on the economy as it used to be, is one of the things that Ray Dalio mentioned at this year's Delivering Alpha event. This can be explained very easily. One can get credit to buy products or to invest in a company. However, debt needs to be serviced and repaid. That being said, we can conclude that getting a loan means that future expenditures are being brought forward in time. In this case, you need a accumulation of debt to keep the economy growing.
The graph below shows total public debt as a percentage of nominal GDP. We see a massive increase since the start of the credit crisis. It accelerated because debt levels stayed high while GDP fell. Even after the recession, debt growth was higher than GDP growth. Until 2014, when the economy started to peak in the third quarter. Coincidence?
This would mean that we are going to get an extended period of very slow growth or a reset. This reset could mean a recession with a massive wave of corporate and private defaults. After this reset, the economy has room to growth again. At a much faster pace. Note that I am just observing, I am not saying that we are going to get an Armageddon, we are just on very thin ice at this point.
Another point that supports growth slowing, is the fact that cyclicals like industrial production have started to contract already. They fell like a rock after the economy peaked in 2014. Normally, we see a pattern like this: cyclicals are leading the overall economy while the consumer (retail sales) lags a few quarters. Currently, we witness this pattern. The ISM index has peaked in 2014, industrial production started to contract and retail sales got weaker in 2015.
This definitely supports the picture of a late-cycle economy and increases the chances that the current red arrow (graph below) is going to result in a recession.
I am convinced that the economy has entered a late-cycle stage. I do not expect any big upside when it comes to GDP growth.
What does late-cycle mean for your portfolio. It means that upside potential is very limited. By going outright long, you buy a lot of volatility instead of future potential return. A big part of my portfolio is market neutral. I will keep posting market neutral trading ideas over the next few months to educate and inform about investment opportunities.
Thank you for reading my article, please leave a comment below if you have questions or remarks.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.