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Life in the cycle lane

Economic forecasters, by and large, have pretty poor track records but some have been more reliable than others.

The Economic Cycle Research Institute enjoys one of the more solid records in forecasting cyclical turning points. According to its co-founder, Lakshman Achuthan, its set of leading indicators submits “overwhelming evidence” that the US economy is tipping into a new recession. Its research speaks of “wild-fire” and “contagion” among forward-looking indicators across multiple sectors of the US economy.

This verdict, publicised towards the end of September, coincided with the end of the worst quarter for many risky markets since 2008.

Some weeks ago, we argued that a recession was largely compensated for in the price of a handful of assets – European equities being an example and rotated our portfolios accordingly.

So far this month, however, markets have shifted impressively back to risk-on mode as investor concerns about a recession have eased. This begs a tricky question, namely, are calls for a recession misguided or, with equity markets up substantially from their recent lows, are investors now being presented with the best opportunity to reduce risk we are likely to see for some while?

The S&P 500 hit its all-time-high ahead of the last recession in October of 2007. By March 2008, it had fallen 20 per cent from its peak. Yet even after Bear Stearns had failed, with the world on the cusp of recession, the market then rallied by close to 15 per cent, back to within 10 per cent of its October high. After briefly piercing its 200-day moving average to the upside, recession led the market to its ultimate low in early March 2009. This year, the S&P 500 recorded its cycle-high in early May, before dropping by a little over 20 per cent. From these lows, the market has moved strongly higher to once again within 10 per cent of its May peak, recently piercing its 200-day moving average. Sound familiar?

If ECRI proves prescient again, optically cheap equities will get even cheaper, core government bonds will get even more expensive and Albert Edwards will likely receive a knighthood.

OECD governments really cannot afford a new crisis. Nor can they afford a new recession. We continue to advocate treading carefully in these markets. We have been rewarded very quickly for tactically adding risk to our portfolios in late September. Today, we are again taking risk off the table.

Watch the leading indicators. Don’t confuse them with lagging ones. Not until the former turn upwards are we likely to turn structurally bullish.

Robin McDonald is fund manager of Cazenove’s multi-manager diversity range of funds



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