The Late, Late Cycle: Preparing for a World of Lower Returns

These are tricky days for the global economy. As growth downshifts and corporate earnings weaken, some investors are dusting off playbooks for late-cycle investing. That makes sense, but there are a few twists to today’s market conditions that may require new responses.

For more than a decade, the global economy has trudged forward in a steady recovery from a near-apocalyptic crisis. Macroeconomic growth patterns are typically seen as a cycle, in which periods of rapid expansion are followed by periods of stagnation that culminate in recession. Today’s environment feels a lot like a late-cycle economy: growth and employment are above trend, while inflation is near its target and financial conditions—interest rates and monetary policy—have tightened from highly accommodative positions in recent years. In the past, conditions like these often ended in recession or, at least, a more challenging investment environment.

Why Is This Cycle Different?

But a closer look reveals some anomalies. Today’s market has been shaped by extreme and unusual policies over a decade. Fiscal stimulus, debt levels, deficits and demographics are adding some uncommon ingredients into the late-cycle stew. Taken together, these could extend the late-stage features of the current cycle for much longer than usual, which means lower returns might be the norm for longer than expected.

Stage 1: The Supercycle Fueled Fundamental Returns

How did we get here? To answer that question, you need to rewind to the beginning of the supercycle in 1981, when the fed funds rate peaked at about 19%. Several things began to unfold that would dramatically change market dynamics for a generation (Display).

First, interest rates and inflation would decline from their peaks for the next 20 years. Second, the baby boomer generation, children of the post–World War II population explosion, entered their prime earning years, which buoyed economic growth and funneled massive amounts of savings into the markets via their retirement plans. Third, a wave of globalization and technological progress began that increased productivity and profitability on an unimaginable scale. This powerful fundamental cocktail drove real wage gains, corporate sales, earnings and, ultimately, the stock market, creating a bull run that lasted nearly two decades.