High Yield and the Business Cycle - Hotchkis & Wiley Commentary
While history may not repeat itself verbatim, visceral human behavior often produces distinct cycles. We may learn from past mistakes, but collectively we exhibit the same instinctual traits as preceding generations. Many have attributed various social, cultural, and even military cycles to perpetual behavioral tendencies that society exhibits through time. Nowhere is this phenomenon more apparent than in economics, where cycles reign supreme. This newsletter's objective is to evaluate the business cycle and its influence on the high yield market. We will explore various economic, fundamental, and policy-related metrics to assess where we stand in the business cycle currently, and the underlying implications for high yield investors.
I. Business Cycles Historically
The National Bureau of Economic Research ("NBER") provides the most widely-accepted data regarding business cycles. NBER is a nonprofit research organization led by economic practitioners and academics with résumés that would make the most prominent world leaders blush. The organization forms a Business Cycle Dating Committee that determines periods of expansion and periods of contraction by defining the peaks and troughs of business cycles. Chart 1 depicts NBER-defined business cycles over the past 50 years.
A full business cycle encompasses a period of expansion followed by a period of contraction (i.e. trough-to-trough)1 . Chart 2 highlights the duration of full business cycles over the past 50 years. History warrants several observations. First, expansions dominate the duration of business cycles. Second, contemporary business cycles are punctuated by Federal Reserve actions. Third, short cycles have coincided with periods of volatile inflation expectations (e.g. late 1960s, early 1980s) while long cycles have coincided with stable inflation expectations (e.g. mid 1980s to today, and maybe further).
Naively applying the 50-year historical average suggests we are roughly two-thirds of the way into the current cycle. While this is an interesting observation, is hardly evidence on which high yield investment decisions should be based. Instead, after we evaluate the relationship between the high yield market and business cycles (Section II), we will explore various fundamental factors in an attempt to identify metrics that have been successful predictors of contraction periods historically (Section III).
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