For those unfamiliar, here is a summary of the various phases of the business cycle clock:
- Phase 1: Debt Reduction – Buy Credit, Sell Equities
Our clock starts as the credit bear market ends. Spreads turn down as companies repair balance sheets, often through deeply discounted share issues. This dilution, along with continued pressure on profits, keeps equity prices falling. For the present cycle, this phase began in December 2008 and ended in March 2009. Global equities fell another 21% even as US spreads tightened.
- Phase 2: Profits Grow Faster Than Debt – Buy Credit, Buy Equities
The equity bull market begins as economic indicators stabilise and profits recover. The credit bull market continues as improving cashflows strengthen company balance sheets. It’s all-round risk-on. This is usually the longest phase of the cycle. This began in March 2009, and according to most Wall Street analysts, is the phase we find ourselves in right now. Equity and credit investors both do well in this phase.
- Phase 3: Debt Grows Faster Than Profits – Sell Credit, Buy Equities
This is when credit and equities decouple again. Spreads turn upwards as fixed income investors become increasingly worried about deteriorating balance sheets. But equity markets keep rallying as EPS rise. Share prices are also boosted by the effects of higher corporate leverage, often in the form of share buybacks or M&A. This is the time to favour equities over credit.
- Phase 4: Recession – Sell Credit, Sell Equities
In this phase, equities recouple with credit in a classic bear market. It is associated with a global recession, collapsing EPS and worsening balance sheets. Insolvency fears plague the credit market, profit warnings plague the equity market. It’s all-round risk-off. Cash and government bonds are usually the best-performing asset classes.