The rise in central banks’ funds rates in the US and Europe, which began in 2022, is having a dampening effect on economic growth. The rate cuts will, in turn, give it an electroshock. As a result, the macroeconomic cycle, presumed dead since the Great Financial Crisis, will beat again. It will remind firms and investors of the good old times when ‘timing the cycle’ was everything.
Cyclical patterns were well-established and provided a modest sense of predictability. About two years after interest rates peaked, the economy would trough. In their infinite wisdom, investors would anticipate the inflection point by about six months, relying on lead economic indicators such as purchasing managers’ indices (PMIs). Equities would be risk-off when PMIs decline. They would enter an unpleasant risk-aversion phase when PMIs fall below 50 and continue to decline, causing both multiples and earnings to contract. Eventually, PMIs would trough, and a risk-on phase would kick off.
Applied to the current situation in the US, a peak in rates in July 2023 suggests that the US economy will trough in the summer of 2025. Lead indicators should allow the stock market to enter a bullish phase in the first quarter of 2025. Until then, according to past cycles, market sentiment will remain bearish until the PMIs, currently below 50, trough. This time may be different. Or not.
Unfortunately, macro cyclicality re-emerges along with a new monetary regime – one that will be much less forgiving than its immediate predecessor. In ‘Financial Immortality’ (2020), it was argued that ‘monetary policy at the zero-bound produces some sort of financial immortality since future cash flows never die. […] Without the constraint of time, there is no incentive for excellence.’ Under this extreme regime, financial success is cheap, and every day is like ‘L’école des fans’ where everybody can win.*
Those days are over. Global resource constraints recently discussed in ‘Keeping Degrowth At Bay’ associated with previously unaccounted-for climate change-related costs are restraining aggregate supply. The result is persistent inflationary pressure to be countered by higher (real) interest rate levels.
Combined with an industrial transition (digitization, decarbonization, and electrification), the higher cost of capital will create a growing chasm between winners and losers in the marketplace – a term broadly defined to include goods, services, labor, and capital.
Like any change, this trend will face resistance from various parties (industry lobbies, governments) benefiting from the status quo. However, resistance will only hinder innovation and productivity gains, giving rise to competitive disadvantages with damaging economic and geopolitical implications.
Instead of succumbing to the Sirens' songs of resistance, firms can position themselves to win by creating a ‘corporate control center’ responsible for gathering and consolidating business-relevant data. A dashboard would benchmark the firm’s relative performance on both financial and non-financial metrics, including through the eyes of influential data providers feeding the investment community and other stakeholders. An analytical tool would also help Management identify cycles (e.g., macro, micro, AI, sustainability, politics) to time well-informed decisions based on plausible scenarios.
Reality is an acquired taste. Regular, holistic, and unedulcorated reality checks help make the best of it.
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