The debate over the past year is whether the U.S. economy has transitioned toward the late stage of its expansion cycle in what has been an extended business cycle (over 10-years). A normal U.S. business cycle is comprised of four phases or stages – early, middle, late-expansion, and contraction/recession. During mid-cycle expansions U.S. economic conditions are characterized by growth peaking, profit growth peaking, credit growth strong, interest rates rising slowly or steady, favorable consumer confidence, and rate of inflation moderating. During late-cycle expansions growth tends to moderate, corporate earnings contract, credit tightens, interest rates begin to rise higher, consumer confidence peaks, and rate of inflation turns decisively higher.
Since the 2009 market bottom, the U.S. equity market has climbed higher setting new records without much of a major setback or an extensive pause. History showed major bull rallies do not end suddenly and without warning. Major bulls almost always exceed even the most bullish of forecasts and can sustain far longer than expected. In another words, bull markets tend to end with a euphoric rally via a “blow-off” market top.
The stock market and business cycle are highly correlated, with the stock market peaking and bottoming months and quarters ahead of a major economic top or trough. Investors may be considering if it is time to reduce their equity holdings. Our long-term research studies show the final stages of a bull rally can be explosive and very profitable for investors and traders as the stock market returns are the greatest one-year before the start of a bear market decline.
One way to address an ageing and maturing bull market is to focus on the areas that perform the best during the latter phase of its expansion cycle. Historically, Financials, Consumer Discretionary and economically sensitive sectors relatively outperform peers at this stage of the cycle. In addition, liquid, large-cap and well-known growth stocks also attract investment interests as investors turn to stocks that can grow faster than the economy.
So, what stage is the current economic expansion cycle and the stock market bull rally? We suspect that we are between the mid-cycle and the late-stage cycle based on the current S&P 500 sector rotations, and the recent shifting of money back into growth style investing.
A brief review of the attached RRG charts support the thesis of a very strong rotation taking place into U.S. growth style indexes and growth style ETFs. This often occurs as large-cap growth stocks outperform into an ageing bull market rally. Another RRG study focusing on S&P 500 sectors convey a mixed reading. Technology, Financials and Healthcare continue to lead their S&P 500 peers. However, Healthcare sector, which is a classic defensive sector is relatively outperforming the marketplace. This phenomenon occurs when the economy has slipped into a contraction or recession stage. In addition, Consumer Discretionary, Industrial sectors, and Materials have yet to emerge as market leaders. This hint of a sustainable bull rally and suggests that we are not yet at its late-stage. This would also imply economically sensitive sectors will soon emerge as market leaders into the late-expansion cycle.