The Economic Expansion Turns 10-Years Old - Five Things Institutional Investors Need to Know

The Economic Expansion Turns
10-Years Old

The current economic expansion turned 10-years old in July, becoming the longest period of sustained economic growth in U.S. history. During the current cycle, GDP of the U.S. economy has grown 22%. That number is sluggish, however, when compared to the 43% growth in GDP that took place from 1991-2001, a 10-year span that included a short recession in 1993.

Inflation has remained subdued despite the sustained period of economic growth, consistently languishing below the Fed’s 2% target. This is unlike past expansionary periods which ended with high inflation and the Fed raising interest rates to cool the economy.

The labor market has been strong in the past ten years, with unemployment consistently below 4% and new jobs being added every month. However, wage growth has grown at a slower pace than in past expansionary environments.

The U.S. stock market has quadrupled since bottoming out during the Great Financial Crisis, culminating in the all-time highs reached by the S&P 500 at 3,000 and the DJIA at 27,000 during July. Bond markets, however, have been somewhat mixed over the same period, as ultra-low interest rates and the impact of quantitative easing across the globe have reduced yields and impaired the overall attractiveness of bonds for many investors. In June of this year, the yield on three-month Treasury bills exceeded that of 10-year Treasury bonds by the widest margin since 2007, creating what is referred to as a yield curve inversion. A sustained inversion is said to point to an impending recession within the coming 12-18 months, though investors don’t yet seem stymied by this particular indicator.

As evidenced in the outcomes above, the unprecedented levels of quantitative easing implemented globally by central banks have resulted in a remarkably long period of stable but tepid economic growth. Throughout the last decade, central bank policy has largely dictated the significant outperformance of risky assets, such as stocks and high-yield bonds. As the current run of economic expansion extends into its eleventh year and central banks continue to evolve their policy, institutional investors should evaluate these five considerations for the years ahead.

Five Things Institutional Investors
Need to Know

Evaluate your comfort zone in taking on risk
All investments involve some degree of risk. The reward for taking on risk is the potential for a greater return. In the past 10 years, with bond yields historically low and stock market performance historically high, it is prudent to evaluate your risk profile often. Don’t let recent history lure you into a false sense of security.
Consider rebalancing portfolio methodically
When investment returns on one particular asset class outperform others, particularly looking back at the U.S. stock market performance of the past 10 years, it can be easy to “let your winners ride.” Setting rebalancing rules ahead of time can take the emotion out of this decision.
Consider an appropriate mix of investments
Diversification benefits portfolios in the long run by reducing risk. Can the domestic stock markets continue their run? It is time to re-examine whether your allocation is still appropriate. Even in the past 10 years, there have been times in which diversification has reduced risk and enhanced return.
Interest rates are low and should stay low
Bond yields have fallen precipitously in the past decade. Even in the past two years, global central banks have struggled to raise interest rates. It should continue to be difficult to raise rates as global growth struggles to regain solid footing.
Passive investments and quantitative algorithms dominate
A significant amount of investment dollars are now on “auto pilot”. JP Morgan estimates that up to 60% of investing dollars are invested in index funds or ETFs, while quantitative rules-based strategies account for an additional 20%. By definition, these approaches use historical data to build strategies without the benefit of human fundamental research. With so much money following the “herd”, be careful not to miss the catalyst that will upset history.