Last Friday’s Equity Monthly looked at where the global economy is in terms of the business cycle and how that translates into positioning within equity sectors. Basically, the global economic activity is below trend growth and still contracting, which is the critical phase for policy makers because it is in this phase of the business cycle that the economy can slip into recession. The current business cycle phase indicates that investors should be cautious on equities and tilted towards defensive sectors such Communication Services, Healthcare, Consumer Staples but also the cyclical Information Technology sector. South Korea is the lighthouse to watch
Extending the analysis, we follow up with a study of equity returns related to broader equity markets against the four phases of the business cycle. Our equity market universe consists of 18 developed equity markets and six emerging markets. The table below shows the average monthly return in USD across these 24 equity markets across the four different phases of the business cycle using data from 1995-2019. As with our sector breakdown it is not surprising to average negative returns when growth is easing/contracting compared to expanding. However, diving into the numbers the natural picture of defensive and cyclical equity markets related to the business cycle becomes obvious. We will cover that shortly.
But there is one equity market that stands out completely from the rest and that is South Korea. It is the only market that has a negative return in the above trend and expanding business cycle phase, also called the booming phase. Why is that? Well, it is a well-known fact that South Korean macro indicators are often used in global composite leading indicator models (because of its very cyclical industries such as autos and semiconductors), but this data also highlights that the South Korean equity market is ahead of everyone else.
The negative return in the booming phase shows that South Korean equities turns lower before everyone else. Likewise, in the below trend and contracting business cycle phase, also called the recessionary phase, South Korea stands out with high positive returns where other equity markets are declining. Again South Korean equities turn before the upswing. The conclusion is that South Korean equities are very important to monitor in terms of gauging where global equities are headed next.