In the 2010 decade there have been three distinct business cycles based on several indicators such as growth in manufacturing employment, heavy truck sales, credit spreads, or purchasing managers surveys. The three cycles spanned 2009-2013, 2013-2016, and 2016-2020.
Their pattern is important because they had an impact on several asset prices. The last business cycle – the one going from 2016 to 2020 – provides, for instance, imported lessons on how long-dated Treasury yields behave.
Some investors focus on the direction of the economy. Is it going up or down? What happened between 2016 and 2020 should help to recognize the power of small changes in the growth of business activity on investment timing.
In 2019 Wall Street agreed the economy was expanding and bond prices were extremely overbought. Yields had to move higher and prices lower. Several major strategists embraced this view.
Wall Street did not recognize business activity was already in the midst of a slowdown which started in mid-2018. Yields on 10-year Treasury bonds had bottomed in 2016 at around 1.4% and then rose until they peaked at 3.0% in 2018 as growth in business activity was rising. They began to decline in 2018 as the economy slowed down to finish at about 1.4% in 2019.
These levels were excessively low – or so Wall Street kept saying at that time. They could not go much lower given the economic expansion. Analysts repeated bonds were overbought and yields had to rise because the economy was still growing and the easy monetary policy of the Fed implied only one outcome – rising inflation.
Of course, rising inflation would have been the kiss of death for bonds. Hence the conclusion yields had only one way to go – sharply higher. Instead yields kept trading around 1.4% (pre-pandemic) to fall