Four quadrants business cycle narrative thinking

 

I am an advocate of the simple phrase, "you cannot know where you are going unless you know where you are". This especially applies to thinking about investing with respect to the macroeconomic environment. As a simple approach to describing the economic environment, a 2x2 matrix can be employed based on level and trend for variables that proxy for economic growth, liquidity, and risk. 

The four quadrants represent position in the business cycle: early and rebounding, mid-growth and peaks, late and moderation, and recession and contracting. The PMI can serve as a simple example. The diffusion index can either be above or below 50 which is either strong or weak, and the index may either be rising or falling. A combination of below 50 and falling is a recession and contracting regime. A low PMI but positive change would be a recovery while a high PMI and negative change would be a slowdown. This methodology can be applied to any variable tracking growth and can also be applied to liquidity and risk measures. It provides a simple narrative framework for reviewing the environment and what may be expected with returns for major asset classes.

Narrative framing with data is an effective tool for structuring investment discussions.