Investment Clock insights

How can the Investment Clock go backwards?


Nersen Pillay, Investment Director

Our active asset allocation process aims to maximise exposure to assets which do best in different parts of the economic cycle and minimise exposure to those which do worst in any period.
Inflation lags growth in a typical economic cycle, allowing us to divide the cycle into four phases. A particular asset class tends to do best in each phase as shown in the diagram. 

Our active asset allocation process aims to maximise exposure to assets which do best in different parts of the economic cycle and minimise exposure to those which do worst in any period.

Inflation lags growth in a typical economic cycle, allowing us to divide the cycle into four phases. A particular asset class tends to do best in each phase as shown in the diagram. 

If we represent the same economic cycle in two dimensions we get the RLAM Investment Clock, with inflation increasing from left to right and growth increasing from the bottom to the top. If growth and inflation cycles progress as the theory suggests, then we should move around the clock in a clockwise direction; from Reflation to Recovery when loose monetary policy takes effect and growth picks up; then into Overheat and Stagflation as inflation eventually rises and triggers interest rate hikes that cause growth to slow again.

However, real life is more complicated. Economic cycles tend to take years to work themselves out but can contain mini-cycles in which growth may fade or reaccelerate. 

Inflation may also have unexpected short-term fluctuations, being heavily influenced by commodity prices, oil especially. Changes in demand from China is a major cause of volatility in commodity prices. The clock can, and does, go backwards if we see a short-term global slowdown with weaker Chinese growth pushing global inflation lower.

That's exactly what we're seeing now. We ‘tell the time’ on the clock using proprietary scorecard indicators for global growth and inflation, both of which peaked in March. While the global growth trend is positive with unemployment rates continuing to fall in all of the major economies, business confidence and lead indicators have started to roll over and economists have started to downgrade growth forecasts. Global inflation has been trending higher over the last year after a recovery in China boosted commodity prices, but base effects and falls in the oil price this year mean global inflation is peaking.

This means the RLAM Investment Clock has moved, left and down, away from the top right ‘Overheat’ and towards the ‘Reflation’ phase. Against this backdrop the recent rise in yields is odd and possibly triggered by central banks fighting the last war rather than looking forwards. We've bought bonds at higher yields to reduce our underweights. Weakness in stocks would probably see us buying as we don't think growth will slow for long.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.