One of the most valuable mental models we use in our global macro research process is Merill Lynch’s Investment Clock. smart money dumb money chart
The merrill lynch investment clock splits the business cycle into four phases Learn more about how it works and why it s important.
It’s a simple yet useful framework for understanding the various stages of a business cycle and which asset classes perform best in each stage. A similar framework is used at Bridgewater Associates, one of the most successful hedge funds of all time.
We’ll break down the Investment Clock and apply it to the current market to see which assets are likely to perform best going forward.
The Investment Clock Phases Explained:
The Investment Clock splits the business cycle into four phases. Each phase is comprised of the direction of growth and inflation relative to their trends. You can see these four phases in the chart below via Merrill Lynch.
Four Phases of Investment Clock
Here’s a breakdown of the four phases:
Reading The Investment Clock:
Below is a chart that illustrates the four phases of the Investment Clock together: Here’s The Following From Merrill Lynch On Which Asset Classes Outperform During Each Investment Clock Phase:
Cyclicality: When growth is accelerating (North), Stocks and Commodities do well. Cyclical sectors like Tech or Steel out-perform. When growth is slowing (South), Bonds, Cash and defensives outperform.
Duration: When inflation is falling (West), discount rates drop and financial assets do well. Investors pay up for long duration Growth stocks. When inflation is rising (East), real assets like Commodities and Cash do best. Pricing power is plentiful and short-duration Value stocks outperform.
Interest Rate-Sensitives: Banks and Consumer Discretionary stocks are interest-rate sensitive “early cycle” performers, doing best in Reflation and Recovery when central banks are easing and growth is starting to recover.
Asset Plays: Some sectors are linked to the performance of an underlying asset. Insurance stocks and Investment Banks are often bond or equity price sensitive, doing well in the Reflation or Recovery phases. Mining stocks are metal price-sensitive, doing well during an Overheat.
Pretty simple, right?