Key Points

  • The massive growth in central bank balance sheets via quantitative easing, debt monetization, and firing of “big bazooka” stimulus packages gives the business cycle a renewed level of importance for understanding how changes in growth and inflation impact future shifts in global asset markets.

  • We demonstrate the varying sensitivities of 15 asset classes to changes in growth and inflation. We show that a strategy employing these two metrics and currently available market data (i.e., no forecasting) can outperform a simple equally weighted portfolio.

  • Based on the leading indicators of our simple TAA strategy, we are in a period of below-trend growth and inflation, which implies that an overweight to nominal bonds and reduction in commodities exposure would be appropriate. Markets, however, have been supportive of the “reflation” trade. Our model indicates it may be too early to adopt the reflation trade, and some reversal may occur.

Jim Masturzo is the corresponding author.

The business cycle is one of the most important concepts an investor should consider when constructing a portfolio of assets. Although we all have an intuitive awareness of the business cycle, economists and strategists use a wide variety of indicators to describe where the economy is in the cycle at any given time. For the purpose of this article, we extrapolate the business cycle in two dimensions: growth and inflation,1 and more specifically by increasing or decreasing rates of each metric.

The business cycle has always been an important force in investment decision making, but the massive growth in central bank balance sheets via quantitative easing, debt monetization, and firing of “big bazooka” stimulus packages may give the business cycle a renewed level of importance in the years ahead. Revisiting this topic now provides a basis for thinking about potential future shifts in global asset markets.

We show in a multi-asset context that different asset classes have varying sensitivities to changes in growth and inflation. We also show that a strategy that employs these two metrics and currently available market data (i.e., no forecasting) can outperform a simple equally weighted portfolio. We find that a great deal of information about future asset returns is available just by knowing the current stage of the business cycle. Our results help illustrate why growth and inflation are informative to asset returns and open the door to more-advanced forecasting techniques that can capture the additional theoretical benefits in knowing which business-cycle stage is up next.

After presenting evidence on how our macroeconomic-regime approach performs, we will review the stage of the business cycle we are in today and what it implies for portfolio positioning. We recommend an overall awareness of the effect of potential macroeconomic “shocks” in the road ahead as an important input to guide investors’ tactical asset-allocation decisions toward better long-term outcomes.