Whether it’s the seasons changing, the earth revolving around the sun or business cycles chasing boom and bust, life as we know it occurs in similar repeating patterns. The financial markets are no exception to the forces of nature that we all submit to. Recently, I wrote a piece about low volatility and today I would like to analyze the effects of low volaitility on the financial markets in a more comprehensive way. First of all, let me return to my primary professional expertise, the FX market where we are approaching historical record low volatility(see below).
Low volatility in the largest market of the world(FX) points to a benevolent global economy where growth is consistent and risk is low. Of course, this very notion of low risk breeds complacency and typically leads to large counter swings as the business cycle turns and perceptions about the future change. So, where are we in the business cycle right now and what does it mean for asset classes?
Clearly, we are in between the early and late upswing Phase in the global business cycle that is accompanied by rising asset prices and contained inflation as shown above. If you take this chart and relate it to FX volatility you will also notice that there is still some room/time for letting this cycle play out, probably a year or so before this business cycle will reach its top and revert to the downside. The reason I think we have another positive year in the business cycle left is due to the fact that the general cycle described takes an average of about 8 years and 2007 was the peak of the previous one. As for assets, take a look at the length of major bull markets in asset classes over the past 60 years and you will notice a similar pattern once again.
As I have stated numerous times before, keep riding this business cycle but do realize that the sun eventually sets, and winter does eventually follow summer and fall, especially in places like Chicago. I will do my best to alert you to when I start to see the leaves fall off the tree and fall has arrived. Then, it will be time to harvest and take cover. For now, enjoy the sunny weather despite the occasional global political thunderstorm….