Unlock Editor's Digest for free
FT editor Roula Khalaf has chosen her favorite stories in this weekly newsletter.
The author is Chief Global Equity Strategist and Head of European Macro Research at Goldman Sachs and author of Any Happy Returns.
Over the past few months, we have seen a significant shift in expectations regarding the business cycle. A year ago, many economists and investors expected the global economy to slip into recession as interest rates soared to counter soaring global inflation. By contrast, consensus expectations earlier this year were more benign, with inflation now slowing, paving the way for a series of interest rate cuts and a soft landing for the economy.
Financial markets tend to predict cycle changes before they materialize. For example, in the first half of 2022, global stock prices fell due to rising interest rates and fears of a recession. In contrast, global stock prices have risen nearly 20% since late October 2023, as investors began to reflect the improvement in the macroeconomic environment. As such, cycles are of great importance to investors.
That said, while many investors are focused on predicting these tipping points, most are focused on making profits over the long term. For these investors, short-term declines or gains should be relatively unimportant; what matters more is the trend.
Most cycles exist within these long-term trends or “super cycles”, which can vary widely but can be long-lasting. For example, after World War II, there were three supercycles that produced steep returns for investors, but there were also three supercycles where overall returns were low.
From 1949 to 1968, U.S. stock prices rose 14% annually, accounting for inflation and dividends. Postwar reconstruction, the establishment of international organizations, the rise of world trade, and the baby boom all combined to bring about rapid economic growth. However, by the late 1960s, inflation began to rise, and from 1968 to 1973, real total returns on U.S. stocks declined by 4% per year. Amid geopolitical tensions, a series of oil shocks, high inflation, and rising interest rates led to a recession and a slowdown in global trade.
Inflation and interest rates peaked in 1982, ushering in one of the strongest super cycles in history, which ended with the technology bubble of the early 2000s. During this period, consistently lower interest rates, economic reforms, tax cuts, and the acceleration of technology supported increased profitability. The collapse of the Soviet Union reduced geopolitical risks and facilitated an era of rapid globalization and increased world trade. These factors combined to produce an annual real return of 16% for U.S. stocks between 1982 and 2000.
The next super cycle lasted from the bursting of the tech bubble to the end of the 2009 financial crisis. The economy and markets are hit by a series of shocks, with real annual stock returns dropping to -9%, and a series of booms and busts. Finally, the period 2010-2020 once again produced strong stock returns of 16% annually after inflation and dividends. This is largely a function of record low interest rates, quantitative easing to support markets and the economy, and the growing influence of large financial institutions. Technology company.
New inflection points are emerging in both the cycle and the market's long-term trends. From a cyclical perspective, concerns about inflation and rising interest rates are receding. But as I write in my book, several developments are reshaping current secular trends that I call the postmodern cycle.
Major central banks may cut interest rates this year, but it is unlikely that they will return to post-crisis lows or continue to trend downward for several years. Meanwhile, geopolitical tensions are rising, globalization is being challenged, and more regionalized patterns of production are emerging. Tight labor and energy markets are raising costs and reducing profit margins for companies. These headwinds are intensifying as we face the twin impacts of his two powerful additional forces: AI and decarbonization.
Both are capital intensive and present opportunities as well as challenges. Over time, AI will likely improve productivity and create new jobs, products, and services. On the other hand, a decarbonized economy offers the prospect of a healthier, safer world, and one in which the marginal cost of energy collapses. Investors will become more patient and more willing to make bigger and harder choices between relative winners and losers.