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A closer look at late-cycle performance

02 August 2019

3 minute read

By Gerald Moser, Chief Market Strategist

Risky assets tend to outperform safer ones in a late-cycle environment. As central banks ease monetary policy further deep into the cycle, will risky assets outperform this time?

When we launched our investment theme “investing in a late cycle” in April, we briefly described the typical performance of the main assets during a late-cycle phase. We now take a closer look at the pattern of cross-asset performance seen during that part of the cycle. We then relate those past results to our views in the context of a late cycle.

Don’t derisk too early

Performance data since the mid 1970s shows that risky assets tend to outperform safer assets in a late-cycle environment (see chart below). The median annual performance of emerging markets (EM) equities and commodities is particularly strong, with developed market (DM) equities also performing well. In addition to the strong performance of the above asset classes, the consistency of their returns also supports them over government bonds or credit.

Investment grade is actually the least likely to deliver a positive return, while high yield’s past performance is also lacklustre towards the end of the cycle. The median performance of those two asset classes is negative using historical data. Within fixed income, the clear outperformer is EM debt. Not only does it show historical positive returns, but is almost as likely to be positive as it is for equities or commodities.

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This time is unlikely to be much different: focus on equities and EM debt

In the current cycle, we prefer equities over fixed income. As central banks are pushing rates ever lower, we see more relative opportunities in the asset class. Although the upside to equity index levels may be more muted than in past late-cycle episodes, single-stock selections and active strategies could provide investors with double-digit returns.

With the dovish turn from the US Federal Reserve seen in recent months, our conviction towards emerging markets assets remains relatively strong. This also extends to the fixed income world. Similar to what has happened previously, we believe that EM sovereign debt should fare better than DM sovereign bonds. While EM debt looked less attractive when US yields were above 3.2% last year, levels of around 2% make a compelling case for the asset class for investors looking for yields.

The one area where it may be different this time around is for commodities. In a typical late-cycle environment, it is the best performing asset as demand far outstrips supply. But with the surge in shale oil output seen this decade, US oil production has been through a rebirth which limits the potential for upside in energy prices. That said, gold is one commodity that could be considered for diversification reasons, especially with the cost of holding it being very low.

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Market Perspectives August 2019

Find out our latest key investment themes. As expectations of more dovish central bank policy grow and early signs of a potential thaw in trade tensions, sentiment has turned for the better. However, with many geopolitical issues on the horizon and several financial markets close to record highs, is it time to de-risk portfolios?

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