ClockWise: New Recovery phase good for stocks

Inflation and interest rates spiked after the Covid pandemic and global growth slowed, but fears of a full-blown recession look increasingly misplaced.

Global growth indicators are perking up again against a backdrop of falling inflation – the Recovery phase in the Investment Clock model that guides our asset allocation (Figure 1). This is historically the best time to be invested in stocks, but bond investors may be disappointed if rate cuts fail to materialise as expected. We’ve been positive on equities since the fourth quarter of 2022 and this development adds to our conviction.

Figure 1: The Investment Clock back in Recovery

Source: RLAM. Growth and inflation trail shows the last 12 monthly plots with the yellow dot representing the most recent month. As at February 2024.

The Investment Clock depicts the business cycle with four distinct phases, depending on the strength of global growth and the direction of inflation (Figure 2).

Figure 2: Stylised business cycle showing the four Investment Clock phases

Source: RLAM as at 01/01/2024.

Different asset classes tend to offer their best performance at different stages of the cycle (Figure 3):

• Government bonds tend to offer their best returns in Reflation, when global growth is weak and inflation is falling.
• Stocks usually do best in Recovery when growth is strong but inflation continues to fall.
• Commodities have posted strong returns in Overheat, when growth is strong and inflation is rising.
• Cash is the defensive choice during Stagflation (although commodities are usually still the best performing asset class at these times).

Figure 3: Historic asset class returns in Investment Clock phases

Past performance is not a guide to future performance.

Source: RLAM for illustrative purposes only. Data based on an analysis of business cycles since April 1973. As at 01/01/2024.

We tell the time on the Clock each month by processing the signals from around 40 economic indicators. In January, the Clock moved into the disinflationary slowdown phase, Reflation, in which central banks typically cut interest rates most aggressively. However, a run of stronger business confidence data this month, along with a very strong non-farm payrolls report in the US, paints a different picture.

While improvements are tentative, the strength of industrial new orders relative to inventories in the US and elsewhere (Figure 4) suggests a more sustained period of improvement. There’s good news and bad news. Stocks are likely to cheer any pick-up in corporate earnings, but an acceleration in growth against the backdrop of still-tight labour markets and high core inflation rates would cause a headache for central banks. We think interest rates will still come lower in 2024, but not to the degree currently factored into bond markets and this could limit returns.

Figure 4: US business confidence with New Orders minus Inventories balance

Source: LSEG Datastream as at 15/01/2024.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.