No bull market lasts forever, and time appears to be running out on the historic economic expansion that began in 2009. Explore late-cycle indicators, what investment strategies have proved most effective in prior late cycles, and how advisors are positioning client portfolios today.
The months leading up to the end of an economic cycle and associated bull market are typically characterized by tightening monetary policy, a flat or inverted U.S. Treasury yield curve, and a more challenging earnings environment.
Today's higher interest rates and balance sheet reductions should have the opposite effect of quantitative easing: increasing the supply of bonds and lowering prices.
Higher short-term rates and a shrinking Fed balance sheet could cut the cycle short
A flattening yield curve
While the economy still appears to be on sturdy footing based on leading economic indicators, a flattening or inversion of the yield curve suggests a market peak may not be that far away.
The yield curve may hold clues to the timing of the cycle
Slower earnings growth
As monetary conditions tighten and borrowing costs increase, many companies lose earnings momentum. Companies with varying degrees of free cash flow and levels of indebtedness are having different earnings outcomes, which is leading to a greater dispersion of stock returns.
Earnings growth forecasts for U.S. companies have begun to level off
Explore time-tested strategies
No one knows precisely when the 10-year-old bull market will breathe its last breath, or when the economy will fall into recession. What's clear from prior turns in the business cycle is that the strategies that have done the best on the way up often fare poorly on the way down.
Relative to high-yield bonds, investment-grade bonds have held up much better in periods of market stress and slowing economic growth, and have traditionally provided important ballast that can help offset volatility in equities.
Investment grade has done better than high yield when economic growth has slowedHigh-yield and investment-grade bond credit spreads and price drawdowns (%)
Higher volatility regimes have preceded each of the past three recessions. Investors should consider emphasizing sectors less tied to the economic cycle, along with strategies that balance return potential with risk management.
Today’s rise in volatility has echoes of past late-cycle environments
Real assets and long/short strategies
The risk/reward trade-off for real assets can strike a favorable balance during late-cycle environments. Additionally, strategies that combine selective shorting of some areas of the market while maintaining long exposure to others have tended to gain a performance edge in late-cycle market environments.
Long/short equity has outperformed long-only in late-stage environmentsTotal returns by phase of economic cycle (%), March 1998–December 2017
All-weather funds that can help navigate late-cycle risks
Our multimanager approach enables us to offer a diverse lineup of specialized offerings across a range of traditional and alternative asset categories.
|Ticker||Fund name||Managed by||Morningstar category||Use for|
|JEEIX||Infrastructure Fund1||Wellington Management||Infrastructure||Managing downside risk and a potential inflation hedge|
|TIUSX||Investment Grade Bond Fund||Manulife Investment Management||Intermediate-Term Bond||High-quality income opportunities|
|JVLIX||Disciplined Value Fund||Boston Partners||Large Value||Core large-cap holding|
|JHBIX||Bond Fund||Manulife Investment Management||Intermediate-Term Bond||Diversifying income holdings|
|JSFDX||Seaport Long/Short Fund2||Wellington Management||Long-Short Equity||Alternative equity holding|
Are advisors playing enough defense in client portfolios?
Since 2015, our Portfolio Consulting Group has analyzed more than 2,000 model portfolios, providing fixed-income and equity audits, and evaluating each portfolio’s potential resilience in adverse market conditions. The group’s findings led us to three areas where advisors may be overlooking late-cycle indicators and exposing clients to unwarranted risk.
Little or no alternatives exposure
It's been said that the time to repair the roof is when the sun is shining. The risk of abandoning alternatives late in any business cycle is that doing so deprives clients of access to strategies that are less dependent on the cycle.
Use of alternatives in advisor portfolios has declined sharply
Still short duration and long on credit market exposure
The mix of fixed-income securities in model portfolios featured a growing allocation to short duration in 2018. The question going forward is whether a shorter duration posture will enable clients to take advantage of the Fed's recent pause in the direction of monetary policy.
Financial advisor portfolios have closed the gap, but still carry less duration than institutional portfoliosDuration (years)
A growth bias in equity positions
By looking through to the underlying holdings of each fund, we found that nearly a third of all the portfolios we analyzed had an extreme growth bias—weightings at least 10 percentage points higher than the overall market.