I’ve always marked the end of July as the unofficial end of summer- many families return home from their summer escape, children prepare for the next school year, businesses re-affirm their year-end targets, and so forth, we thought it would be timely to provide our Back to School Guide for macro investing. As we’ve discussed over previous cups of coffee, we believe understanding the macroeconomic environment aids the decision to what investments individuals should pursue. The most critical component of our investment management process is understanding & identifying where we are in the economic cycle.
Over coffee this morning we will chat about the importance of economic cycles and the methods we use to understand the direction of economic growth. So, grab your cup of coffee, or your iced vanilla lavender latte, and enjoy!
For the high-speed espresso drinkers, here is a quick bullet point synopsis:
- Economic cycles heavily influence asset prices
- There are four economic factors that most heavily influence the cycle
- We can track a cycle by monitoring real-time economic data like the ISM PMI
- We orient investment programs based on the direction of the economic cycle
We view the economic cycle, also known as the business cycle, as the progression of an economy through time with its direction being influenced by a multitude of economic factors- monetary policy, interest rates, inflation, and liquidity. These factors act as transmission mechanisms which allows us to assess the progression and current phase of the economic cycle and its influence on asset prices.
One of the economic indicators we use to monitor the phase of the economic cycle is the Institute for Supply Management’s PMI which tracks expectations for companies in the United States. We use this indicator because of its rich history spanning back to 1947 and its ability to accurately anticipate the direction of economic growth. In fact, every time this indicator falls below a reading of 50, there is an adverse economic event that occurs somewhere globally.
While we never know when a crisis will emerge or what that crisis will even be, we can prepare by tilting our investment programs to favor defensive oriented assets in the event of any unforeseen market drawdown or economic crisis. As most know, we’ve expressed our opinion that the economic cycle continues to decelerate which has caused investment assets to exhibit dramatic swings thus leading to low returns.
As always, these economic cycles ebb and flow which are natural occurrences just like the change in weather seasons. Our goal is to monitor the economic cycle and invest accordingly in assets that fare well in this environment.