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In this episode, Chief Economist Eric Lascelles breaks down his analysis of the business cycle, including a look at how markets have historically performed across the different stages. Dave Richardson also discusses the importance of staying invested in the market through the cycles. [8 minutes, 07 seconds] (Recorded April 7, 2021)


Hello and welcome to the Download. I'm your host, Dave Richardson, and I am joined by Chief Economist at RBC Global Asset Management, Eric Lascelles. Eric, how are you today?

I'm just fine. Thanks so much for having me.

And as usual, because we say this every time you visit the podcast, you're the hardest working economist in Canada. And once again, you produced some serious work over the last couple of weeks. For those who follow you, they would have found it in your MacroMemo last week, I think you mentioned. And it's a work on the business cycle and the connection to markets. Could you lay out what you were trying to accomplish and what are some of the key findings that would be significant to investors listening to the podcast?

Absolutely, Dave. For quite some time, we've formally tracked the business cycle. We have a scorecard, all sorts of sophisticated inputs that go into that. And that's something, as you know, we've been sharing for years and years. And as you probably know, the most recent assessment is, this is probably an early phase of the business cycle. And so that has its own set of implications in terms of the economy getting to continue to grow and that kind of thing. But one thing we've been able to do recently is to stretch that business cycle analysis back for decades and decades, so we can now start to make interesting comments about, historically, what markets do at different points in the business cycle. And really quite interestingly. I should say that this is the US business cycle, though that really does rhyme with Canada and most of the world. It's also the US stock market I’m about to talk about, but again, it tends to rhyme with other markets. And what we found is that essentially stock markets grow and rise the most at the earliest possible point in the cycle and rise a little bit less— and a little bit less and a little bit less— progressively as you work your way through a business cycle. And so, for instance, our start of cycle definition tends to see the biggest, most incredible gains. Obviously, it's a tricky business at that point. You're debating, are we in the start of a cycle or is it still the recession? It's not always crystal clear. And so, it is hard to time that precisely, I’ll acknowledge. And the key is to get the right phase of the cycle when you're doing this kind of investing. But nevertheless, you then see, on average, quite good returns at the early point of the cycle, which is where we think we are right now. You tend to see pretty good returns mid-cycle, you tend to see OK returns late-cycle, and then you tend to shift negative as you get to end-of-cycle, and of course, into recession. Probably nothing mind shattering there, but I guess the main takeaway is that investors should be at their maximum level of aggressiveness fairly early in the going and should become incrementally a little bit less aggressive as time goes on. And to be clear, we're talking about business cycles that last five, ten years here. This is not about getting things right on the right day of the week or the right week of the month. But nevertheless, the idea would be that you want to be a little more aggressive in the early going. And indeed, we still think it's fairly early going. And so, it's yet another argument to be taking some risks and perhaps to be a higher than neutral allocation to things like stocks. So that's the main takeaway. Just to get into the weeds for a moment, we can also say some things about the bond market side and bond yields. And it's a little bit more nuanced there. It's more of a, I guess I'd call it a bimodal distribution. That is to say, you see yields experiencing the most upward pressure at the very start of the cycle, which is, by the way, what we've just seen, I think. And so, you see yields rising as you're emerging from a recession and then you kind of just don't do a whole lot for a number of years. And then you see more upward pressure at late-cycle. And so essentially people start to debate as you get towards the end of the cycle: gee, inflation is rising, are we going to overheat? To what extent is the central bank going to tighten and see another push higher in yields? But over the intervening years, you tend to see a fairly stable yield environment. And so conceivably, we are nearing that kind of situation, though I can't promise every cycle looks the same. Obviously, by the way, at the end of the cycle and into recession, you then see yields falling. And so, some interesting takeaways there, perhaps useful, I think, for investors. And maybe the other thought I'll share just on the business cycle in general is that there's been some chatter that this could be a really short business cycle. It's been moving so fast. We had this incredibly short recession, this incredibly quick start of cycle, and we're already early cycle. And now we're predicting, and many others are predicting, the US economy could now be back to its prior peak by the middle of this year. Canada could be back to a prior peak by the end of this year. Does that mean it's late-cycle before 2021 is done? Is this a two-year business cycle? I don't think so. I would acknowledge it might be a faster business cycle than usual. Maybe we're talking five years instead of ten, or something like that. But do note, when economies get back to their prior peak, that's not the same as saying they're starting to overheat. In fact, the economies should have been growing over the last few years. And so, it's going to take them longer to get to their full potential. That might be more of a 2022 or a 2023 proposition. And even when they get to the potential, we've seen historically, you can then spend several years at your potential, even overheating a little bit, before it all comes tumbling down. And so, I would say, even though this is moving more quickly, it should still be a multi-year business cycle. And we don't think the next few years are credibly going to bump up against any kind of natural business cycle restrictions. Obviously, any number of other things could happen or may not happen. And sometimes you get shocks out of the blue that can affect the way that the economy grows or doesn't grow— pandemic would be the classic case in point. But in terms of the normal ebb and flow of the business cycle, it should be quite a number of years to go, but maybe not a full ten-year cycle like last time.

Yes, and if you had any doubt that economics is a science, you just have to listen to your favorite economist dropping «bimodal» as a term in the middle of the podcast to know that economics is a science. But Eric, this is such important work and I've used it when I've been doing investor presentations for years. You work around the business cycle and that being a key in terms of how people want to position their portfolios at different points in the cycle. But I think the overriding message that comes out of it is particularly the work around the importance of being invested in the market early in the cycle. And if you think about it, let's say early-in-the-cycle is last April, and that's typical— or maybe a little bit atypical, maybe an extreme example—, but it's not uncommon that the very start of the business cycle is the most painful, stressful, panicky time to actually be investing in the stock market. And so, some people are reluctant to put more money to work. If you just stay invested and you focus on long term, you're there for that part of the market move. And that part of the market move is so critical for generating the performance that stocks generate for you over the long haul, in excess of other asset classes. So, this work is so important to highlight— really for me anyways and for most investors—, the idea of staying invested is so critical. Making subtle moves around in the business cycle, so that when that correction comes, you're probably watching your work, you're moving to a more conservative portfolio a little bit as you move towards the end of the business cycle, but you're there for that big pot at the beginning that's so important, and that you might not be if you were trying to time the markets.

It is enormously important and it never feels good at the time. You may even be introspective and look back and think, did you manage to invest during that period? Did you get the money back in? If not, maybe the best strategy is to just be invested at all times. That's, in fact, a pretty good winning strategy more often than not. And if you're extremely nimble, good for you. But as you say, you can't miss out on that start of cycle gains. It's where a disproportionate fraction of the return comes from.

Well Eric, as always fantastic work, important work, work that helps sophisticated investors and people who are just learning about investing. Both in stocks and bond market. Thank you again for joining us on the podcast.

My absolute pleasure. Till next time.


Recorded: April 7, 2021

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