Content provided by Kostya Etus, CLS Research Analyst
At CLS, we tend to focus more on long term trends and ignore much of the short-term noise that can cloud investment decisions. In general, markets go up more than they go down, and over the long term, there is a positive risk premium for investments. A similar statement can be said about economic activity as financial markets are highly dependent on economic growth. Economic growth, as measured by Gross Domestic Product (GDP), has historically grown over the long run. But pieces of the economy, or the parts that make up GDP, do tend to move in trends. These trends are commonly referred to as cycles and there are two different types:
- Cyclical cycles tend to be short term and have quicker reversal periods.
- Secular cycles are the long term cycles that are more persistent and resistant to reversal and are therefore more important when looking at long term economic growth.
The following is a summary of an article from Ned Davis Research Group (NDR) that discusses their outlook for economic secular cycles:
NDR believes that there is a lot of evidence to support a brighter long-term economic outlook for the U.S. This in turn, gives fundamental rationale to support a new secular bull market in equities.
Monetary Policy is extremely accommodative. The FOMC already said it will not be selling its holdings in mortgage backed securities. NDR believes it will take years, well after 2020, before the Fed’s balance sheet returns to its pre-financial crisis size relative to GDP.
The economic recovery and expansion will be elongated. Post war (after 1949), average economic recoveries have lasted four to five years; we are currently in the 5th year. But housing construction, which usually leads recoveries, has been delayed by three years and furthermore, a recovery doesn’t just die of old age, it usually dies because of tighter policy, or an economic or financial shock. NDR expects the current recovery to last at least until 2017.
The credit cycle has turned. It began turning in Q4 of 2009 as delinquency and charge-off rates have been falling and loan volumes have been rising. Lending standards have eased and demand has increased for both business and consumer loans.
The automotive cycle is recovering. Sales dropped from a peak of almost 19 million units in 2000 to 9 million units in 2009, but sales have been recovering since then with an expected 15.5 million units this year. NDR believes the cycle is only halfway done and will reach 18 – 19 million by the end of the decade.
The housing cycle has turned. Housing formations have been picking up as the echo boom generation ramps up. NDR sees formations doubling over the next ten years.
The energy cycle has turned. We are in a U.S. shale revolution; the U.S. dry gas production grew from 1.5 trillion cubic feet in 2006 to 2.0 trillion today. As a result, the excess supply should put downward pressure on energy prices, thereby lowering the entire cost structure of the U.S. economy. This means lower inflation and faster real growth.
We believe all of these positives for the economy will likely happen because they make economic sense, the government can speed them up or slow them down, but most likely they cannot prevent them.
There is one negative…and that is if fiscal policy fails to recognize structural challenges. Although the structural deficit (U.S. debt) is currently narrowing, NDR sees it widening later in the decade mainly due to the aging baby-boomer generation.