Late Cycle Investing – Does Anybody Know What Time It Is?

Late Cycle Investing – Does Anybody Know What Time It Is?

by Bo Billeaud on October 16, 2018 The All-Weather Investor

On Friday, October 5th, the monthly Civilian Unemployment Rate was released. It stands at 3.7%. This is the lowest measured unemployment since 1969.

While such a figure should be celebrated as a marker for the remarkedly strong economy, it also potentially carries information regarding where we may stand in the general business and economic cycle.

You may notice the grey vertical lines included in the chart. They indicate economic recessions. An examination of the above graph shows that the trend and direction that the unemployment rate is moving in are both a coincident, and importantly, a leading indicator of recession. Prior to the onset of all post-war recessions, the unemployment rate troughed and turned up, usually from relatively low levels. Admittedly, that has not yet happened. But we need to be mindful of this data series. When it does turn up, the information conveyed by this data has the potential to be meaningful. If history is a guide, an upturn in the unemployment numbers will likely point to the waning days of this current expansion. As a matter of fact, as a leading indicator of the economy, the lead time from an employment rate trough to the beginning of recession varied, but the average was roughly 3.55 months.

Unemployment now stands at a 49-year low. There is no way to know where the ultimate low point for this measure during this cycle will be. It certainly could move even lower. It also could simply stay at this current low level for an indeterminate amount of time. But, this we do know. It is cyclical. And as with all cycles, the series of events that brought us to this point are exactly the series of events that eventually give rise to their successors. In other words, quoting Howard Marks,

“…it’s extremely important to note this causal relationship: The economic cycle consists of a series of events that cause the next one that follows”.

While it is not possible to know exactly when this economic expansion will peak, it is possible to know whether or not we are early or late in the game. The unemployment figures would seem to argue that we are likely late in the current economic cycle. The markets seem to agree, as recent price movements across all asset classes reflect typical “late cycle investing” (stock prices up, bonds and commodities (including gold) down).

As an economic expansion persists longer and longer, it becomes easy to be seduced by the notion that it could continue in perpetuity. If it seems that current conditions are virtually golden (and right now, they are), a recognition of the cyclical nature of the economy must not be forgotten.

As usual, it’s a matter of timing. Bonds, and gold are exactly the asset classes that you want to hold when the economic cycle peaks and turns, as they historically have buffered the shock of recession-induced stock market declines, such as we experienced in 2008 – 2009 and 2000 – 2002.

Investing is simple, but it is not always easy. Maintaining a diversified balance of asset classes in your investment portfolio can be difficult when certain assets classes are not performing well. But, for those of us whose investment horizon is 5 to 10 years, rather than 5 to 10 months, holding those recently-underperforming asset classes it is paramount to long-term success.

Over the next several months, should you question if maintaining a diversified and economically-balance portfolio is a good idea, just again review the unemployment rate graph and make your own decision as to where we might be within this current economic expansion. Do you know what time it is?