For many of us, it's hard to imagine embarking on a car journey without the help of a Global Satellite Navigation System (GNSS) device, or as we'll more usually know it, a Sat Nav. Largely driven by expected increases in GNSS penetration in smartphones from around 30 percent to 100 percent, annual global shipments of GNSS devices are forecast to almost double to around 1.1 billion units by 2020.
Photo: Jacobs Stock Photography | Getty Images
Forked Road
Yet investors still stumble around global investment markets without navigational aids. The lack of a strategic direction is one of the three avoidable asset allocation blunders that too many investors will commit in coming years (the others being a failure to adhere to an appropriate level of risk management and the adoption of a too rigid, too passive investment outlook that fails to exploit tactical or short term opportunities).
Responding to tactical opportunities may be the most challenging of these and while we feel a certain sympathy for investors who, under the duress of seeking yield or return in a Zero Interest Rate Policy (ZIRP) environment abandon risk management criteria, it's neither particularly difficult nor in any way forgivable for investors not to have a strategic roadmap.
Detailed work on business cycles dates back to the earliest days of economic theory but the most essential reading of the business cycle remains Part 1 of Murray Rothbard's 1963 study of 'America's Great Depression'. This has also been supplemented by the more recent Kondratieff-inspired work by Ian Gordon's Longwave Group.
The body of research strongly suggests business cycles are quite clearly and directly responsible for recurrent patterns of economic behavior throughout recorded history.
The entire business cycle is characterized by four different phases or seasons.
The economic year starts with the springtime of new businesses selling new products and services from a low base with low levels of leverage. Increasing economic activity creates employment, generates confidence and brings with it the beginnings of inflation last seen in the aftermath of The Great Depression. The last economic spring in western developed markets (from 1949 to 1966) saw stocks increase 435 percent whilst real estate was the second best investment during this period. Gold, restricted by the new Bretton Woods construct, lost around 85 percent of its buying power relative to the Dow Jones Industrials while interest rates gradually and rather gently increased through the period.
The successes of spring give way to a summer characterized by higher leverage, higher employment and higher prices (runaway inflation) resulting in much higher interest rates. Surplus capital created during spring is allocated less efficiently in summer while crowding out reduces margins. This environment is quite negative for stocks (which fell 1 percent per year on average in the period from 1966 to 1980) and very poor for fixed interest. Best performing assets in this period were gold (whose real value appreciation finally forced the collapse of the Bretton Wood System, resulting in a 23 fold increase in the gold price) and other precious metals along with commodities, and property.
The fall season is marked by the onset of disinflation, which in the 1980-2000 cycle was misinterpreted as the central bank policy driven great moderation. In reality it had much more to do with demand failing to keep pace with organic supply which was supplanted by a dramatic increase in leverage as interest rates fell. Primary beneficiaries of this were stocks (which increased over 14 times), bonds and real estate while commodities and precious metals suffered – gold losing almost 3 quarters of its nominal value and a staggering 98 percent of its buying power against the Dow.
Since 2000, we've been in deflationary economic winter because the excessive debt that built up has been a drag on economic activity. Slower economic activity has reduced ability to service debt, causing further slowdown, higher unemployment, asset price weakness and also the banking crises that fully manifested themselves in 2007, leading to further reductions in organic economic activity. Since 2000 the best performing assets have been gold, fixed interest and cash while equities have gone nowhere.
This long term cycle is still playing out but if the lessons of 1929 to 1949 are repeated the green shoots of spring time are unlikely to reappear until debt levels are much lower (history teaches us that repudiation/forgiveness every 50 years or so actually does reduce debt whereas the idea of deflating winter levels of debt away appears to be a figment of monetarist imagination).
While the past is at best an imperfect guide to the future (in the words of Mark Twain, history doesn't repeat but it does rhyme) business and socio-economic cycles are so fundamentally rooted in human behavior that there are no indications that this cycle has been or can be broken.
Therefore, our economic Sat Nav should, at some point, tell us to take a sharp turn away from gold and fixed interest into the direction of property and stocks. However turning too soon is likely to lead to an economic dead end as the resolution of the debt supercycle is likely to cause a significant correction in equity and property prices (at least 30 percent and possibly much more) coinciding with a final blow-off top in gold and bond prices whilst turning too soon towards buying stocks and property could see investors significantly overpay.
Waiting too long could result in missing a 5-bagger equity rally.
Getting out of gold too soon could miss a final top that is 100 percent or more above current levels.
Conversely holding gold too long could see falls of 75 percent or more from that blow off top.
The shift from economic winter to spring is one of the most dramatic seasonal transitions because the best two winter assets reverse sharply in spring whereas the worst winter assets are the best in springtime.
This is why, even if spring is not yet be upon us, now is the best time to start thinking ahead about suitable responses. Set your asset allocation navigational device now if you want to successfully reach your target investment destination or ignore the recurrent patterns of long term cycles at your peril.