Many mainstream economists tend to shy away from discussing the economic cycle although it is important to have some idea as it provides some insight on the likelihood of a recession, stock market peaks and crashes. In the past, we witnessed five long-term cycles i.e. (1) Steam Engine (1780 -1830); (2) Railway & Steel (1830 – 1880); (3) Electrification & Chemicals (1880 – 1930); (4) Automobiles & Petrochemicals (1930 – 70); and (5) Information & Communication Technology (1970 – 2010).

In our view, the next long wave of cycle will be influenced by globalisation and demographic changes supported by the increasing pace of liberalisation of technological barriers through the internet. We expect the next long cycle to be shorter than the previous cycles (50 years for the first three cycles and 40 years for the last two cycles). In fact, we believe the cycle will be shortened to around 20-30 years through fast-moving technology and internet advancement, which means the next cycle should end around 2030 – 2040.

At the same time, we examine the potential likelihood of a next business cycle correction after the 2009 global financial crisis. Our focus is on the US, Europe, the UK, China and Malaysia. From our probability assessment, it shows: (1) the US’ risk of the next slowdown in 4Q2018 is at 12% and 15% in 2Q2019; (2) Europe is more likely to see a slowdown around 6.8% in 1Q2020 when the ECB starts raising its current negative policy rate; (3) the risk of the UK’s heading to a slowdown/recession could be in 1Q2018 at 15% and 19% in 2Q2018; (4) China will experience a debt-driven cycle; and (5) Malaysia may experience a slowdown around 1Q2019 with a probability of 10%.

A. Economic cycle

• Many mainstream economists tend to shy away from discussing the economic cycle. However, we feel it is important to have some idea as it provides some insight on the likelihood of a recession, stock market peaks and crashes.

• Looking back, we found five long-term cycles. They are: (1) Steam Engine (1780 -1830); (2) Railway & Steel (1830 – 1880); (3) Electrification & Chemicals (1880 – 1930); (4) Automobiles & Petrochemicals (1930 – 70); and (5) Information & Communication Technology (1970 – 2010).

• In our view, the next long wave of cycle will be influenced by globalisation and demographic changes. With the increasing liberalisation of technological barriers through the internet, it has accelerated globalisation to a new level with businesses being conducted anywhere, at any time of the day. One can expect more goods and services being traded over the internet.

• At the same time, the "Internet of Things" (IoT) is increasingly coming into play. The IoT has the potential of not only impacting how one lives but also how one works. On a broader scale, it helps reduce wastages and improve efficiency although we recognise that there are numerous complexities around the IoT. As the new networks link data from products, company assets, and the operating environment, they will generate better information and analysis. This will help speed up the process of decision making, making it more efficient and accurate. Also, we expect the IoT to significantly influence the lifestyle of the individual.

• Looking at the speed of technological progress, we think the next long cycle will be much shorter than the previous cycles. The first three cycles in the past lasted for about 50 years while the last two cycles stayed for about 40 years. Assuming a fastmoving technology and internet advancement, the possibility for the next cycle to be shortened to around 20 -30 years is high in the cards. It means the next cycle should end around 2030 – 2040.

• We also examine the likelihood of the business cycle slowdown after the 2009 global financial crisis focusing on worries of the US Fed overshooting its monetary and quantitative tightening cycle; the Euro region driven by the political noise and the risk of the ECB running out of ammunitions; the UK’s seemingly inevitable economic slowdown; China’s debt meltdown and the possibility of Malaysia experiencing a 10-year cycle.

B. Risk of Fed rate hike overshooting

• Our concern is on the US Fed risks overshooting its monetary and quantitative tightening cycle. Using the yield curve as a guide, any signs of inversion in the Treasury market suggests the economy could be heading for a bumpy ride, implying the risk of recession becomes higher.

• We found that in the past six recessions since 1970, these were preceded by a yield curve inversion – an unsettling precedence. However, there could be exception to this rule. Though in the past, an inverted yield curve was followed by a recession when both the short-term and long-term rates rose, this time around the short-term rates are climbing gradually while long-term rates remain fairly stable, suggesting the financial conditions are not as tight. Inflation is still below the Fed’s 2% target, with GDP growing at a stable pace. There is hardly any evidence to show rate hikes have sufficiently affected spending.

• Meanwhile, the FOMC began normalising its balance sheet from September 2017. The 3-month Treasury bill rate inched up to 1.29% on 22 November from end of August’s 1.00%. The 10-year rate rose to 2.32% on 22 November from 2.12% at the end August. The yield spread of 1.03 on 22 November was narrower compared to 1.13.at the end of August. Interestingly this level was consistently seen ahead of a slowdown.

• There could be some risk of an economic slowdown if the Fed raises short-term interest rates aggressively. The biggest risk is when the Fed is swayed by worries of inflation, and overshoots its rate hike regime. Some Fed members have turned hawkish in part because they want to offset the expected fiscal stimulus from Trump’s administration which has not been realised yet. Also, the Fed has waited too long to end QE and begin reducing its balance sheet.

• If Trump’s spending policies materialise, it will overheat the US economy and raise the risk of the US Fed overshooting, pushing the economy into recession. If the policies fail, it will dent the confidence of many market participants and in turn feed into a wider economy. From our business cycle analysis, we found the probability for the next slowdown/recession picking up in 4Q2018 to 12% and rose to 15% in 2Q2019.

Source: AmInvest Research - 28 Nov 2017