Updated: Apr 2, 2022
During the inflationary era of the 1970s, investors scrambled to find an investment decision-making model that could not only help with asset allocation, but also provide guidance regarding the stages and phases of past, present, and future economic [business] cycles.
In essence, business cycles are marked by the alternation of the phases of recovery, expansion, contraction and recession in aggregate economic activity, and the concerted movement among economic variables in each phase of the cycle.
Aggregate economic activity is represented by not only real (i.e., inflation-adjusted) Gross Domestic Product (GDP), but also the aggregate measures of industrial production (output), employment, income, and sales, which are key coincident economic indicators that work within a feedback loop mechanism to suggest a persistent phase of increase or decrease in activities.
The Economic Growth and Inflation Matrix
Notwithstanding the complexity of an economic system and the phases of cycles, a simple yet powerful framework involving only the GDP and inflation indicators, emerged as a viable option to assess the stages of the economic cycle, also known as the “Economic Growth and Inflation Matrix” or simply, the GI matrix.
Popularized by Ray Dalio from Bridgewater Capital, but first found in books written by Harry Browne and Jay Schabacker, or on research papers from Geoffrey Moore of the National Bureau of Economics Research and Sam Stovall from Standard and Poor’s, the basic idea is that as the stages of the business cycle phase evolves, different asset classes should do better and worse. In other words, some assets do well with high inflation, and other assets do horribly. Some do well with strong growth, and others do well with declining growth.
“Modern” GI Matrix and Other Quantitative Tools
Today, with the advent of faster computing power and data analytics, the work that started during the last inflationary peak has been augmented by companies like GAVEKAL, Hedgeye and 42Macro, among others.
With indicators with sexy names like the “Volatility-Adjusted Momentum Signals (VAMs)” and the “Cross-Asset Correction Indicator (CACRI)" by Darius Dale from 42Macro, the investment decision-making process has been enhanced by quantitative analysis and now provides close to instantaneous guidance on the current stage of the phase of the economic cycle and fairly accurate guidance of future stages.
In its essence, the basic ideas still the same, as the economic phases cycles through its peak, contraction, recession, trough, recovery and expansion, GDP and inflation measures rotate through four different quadrants, grids, or regimes found on the GI matrix.
Interpreting the scatterplot chart
The scatterplot, a mathematical diagram using Cartesian coordinates typically used to display values from a data set with usually two variables , in this case Economic Growth measured by GDP and Inflation Rate, is a great tool that can not only help us understand correlation and causation (if any), but also assist in measuring and mapping the stages within the phases of the business cycle.
Using 42Macro’s “GRID Framework” below, we can follow how the stages (regimes) of the business cycle evolve as it moves through its phases. Starting at the top left part of the diagram, the “goldilocks”, “lowflation”, or “quadrant 1” is marked by accelerating economic growth and decelerating inflation rate. To the right, on “quadrant 2” is the “reflation” stage, where economic growth and inflation rate are both accelerating. The bottom right “quadrant 3” is called “inflation” or “stagflation” and is characterized by decelerating economic growth and persistent accelerating inflation rate. Lastly, on the bottom left part of the diagram the “quadrant 4” is called “deflation”, which is marked by decelerating economic growth and inflation rate.
The Growth and Inflation Matrix are global
The global economy has shown a steady increase in business cycle synchronization over the past 125 years . In recent decades, with increased interdependence through trade and financial linkages, the rapid transmission of shocks among countries – also defined as global shocks, have become a more important source of business cycle fluctuations, overshadowing the effects of long-term trends.
In this economically and financially interconnected world, the GI Matrix provides a robust backbone to the framework needed to assess economic conditions on a o local, regional, and global level.
How Brazen Capital Uses 42Macro Research
One of the value-added services we provide to our clients is the ability to position portfolios ahead of changes in business cycle. We use 42Macro together with other proprietary data to help us formulate our capital markets expectations and portfolio positions.
42Macro is an independent research company that provides timely, data-driven signals tied to detailed asset allocation and portfolio construction frameworks. 42 Macro data will help you identify and navigate the stages of economic cycle phases through dynamic macroeconomic forecasts that will allow you to take advantage of changing market narratives.
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