A (slightly) different cycle

One of the most dangerous phrases in the investment world is “this time it’s different”. It usually gets wheeled out near the end of a bull market to explain why the bull market will continue forever due to a new era of permanent prosperity. Or near the end of a bear market to explain why the bear market will continue forever due to fundamentally negative forces such as a day of reckoning being upon us. And usually when it is uttered en masse it marks the turn in the cycle, and makes those who uttered it look foolish.

So the term needs to be used with caution. But while the fundamental drivers of the investment cycle – such as human psychology, the tendency for economic growth and asset prices to revert to a long run mean and the countervailing force of fiscal and monetary policy – remain alive and well, it does need to be recognised that there are subtle differences in each cycle that make them slightly different. At least enough to be of relevance to investors.

And there certainly are differences in the current economic and investment cycle that investors need to be aware of. This was already apparent through the downturn phase with a financial catastrophe the likes of which had not been seen before in the post war period combining with the impact of the earlier monetary tightening, an energy crisis and a normal inventory downturn to result in the first slump in global GDP in the post war period. Moreover, typical cyclical recoveries have seen the US drag the rest of the world out of recession. This time around it looks a little different.

Uninspiring conditions in developed countries…

While the financial constraints in the US don’t appear to be stopping a recovery, they will likely constrain it after an initial bounce. Following the financial crisis, US credit creation is likely to be impaired for some time and US households are likely to be more focussed than normal on reducing their debt levels following the slump in the value of their assets. So notwithstanding the potential for a solid initial bounce as pent up demand is unleashed, the result is likely to be relatively constrained economic growth in the US for the next few years. This is likely to be reinforced as the US moves towards a greater focus on regulation which will boost the cost of doing business in America.

At the same time, structural problems and poor demographics mean it is hard to see either Japan or Europe filling the void. And of course most advanced countries will need to deal with very high public debt to GDP ratios which will provide another constraint to growth and a potential source of volatility. So the overall picture for mainstream developed countries points to relatively sub-par and unexciting growth over the next five or so years. And given substantial amounts of excess capacity in the advanced world combined with subdued credit growth it’s hard to see inflation being a problem any time soon.