MacroResearchBoard

The Beginning Or End: The Capital Markets Versus The Economic Cycle – January 11, 2021

The investment landscape is very different than in the past, as the business and capital market cycles are not in-sync. The economic expansion phase is in its early stages, but the capital market cycle is comparatively much more advanced, as strong returns in equities and credit have been compressed into a much shorter time frame than in past recovery phases.

A report last Friday noted that over the past five decades, the global stock/bond (S/B) ratio has exhibited a fairly consistent profile of peaking just ahead of economic recessions and rising sharply from depressed levels during economic expansion phases. The sharp decline in the global S/B ratio in February-March was pronounced, but more modest in magnitude than in past recessions. Moreover, the global S/B ratio has now fully recovered much more rapidly than in past cycles. This reinforces that the starting point for the capital market cycle is much less favorable than at such an early stage of an economic expansion.

The report concluded that an overbought global S/B ratio indicates increasing risk of a near-term correction or consolidation phase. Macro prospects point to a subsequent further outperformance of equities versus bonds, but current valuations indicate that returns on a 6-12 month horizon will likely be more moderate than many investors anticipate. We have a moderate tilt in favor of equities over bonds, but caution against augmenting equity exposure from current elevated levels.