Forget The Cycle. It’s the Regime That Matters
And When Sentiment Peaks, the Regime Is Already Shifting
Equities are back at all-time highs. Bond yields are falling. CNBC and the financial media are fixated on whether the Fed will cut rates and engineer a soft landing.
But for long-term investors, the cycle is a distraction. The real driver of returns is the regime—whether it’s a disinflationary boom or a period of stagflation.
The challenge is that, throughout history, each regime tends to sow the seeds of its own destruction. Yet investors are often wrong-footed at the turn—because sentiment is usually at its most extreme just as the shift begins.
Clocks and quadrants
The temptation to time the cycle is understandable. Models like the “investment clock” or investment quadrants suggest a predictable progression from recovery to expansion, overheating, and eventually recession. Each phase has an associated playbook for asset allocation. Buy equities during the recovery and expansion, switch to bonds as the economy cools, and repeat.
The reality is messier. For one, pinpointing the economy in real time is difficult. Although the economy was in recession during COVID and recovery thereafter, identifying where it is in the cycle has been difficult since then.
Markets zig-zag even more. Investors priced stagflation in 2022, then a possible recession after the demise of SVB in March 2023 and again as the Sahm rule was triggered in 2024. This year started with optimism about growth, which was followed by pessimism about stagflation. Now, the hope is for a disinflationary expansion.
One reason for the volatility is that investors are forward-looking. It’s not just where the economy is now that matters—it’s where it is heading that really counts. Famed macro investor Stanley Druckenmiller likes to form his view on markets based on where the economy will be in six months’ time.
And perception matters too. It’s not just about understanding the economic data—it’s about anticipating how others will interpret it. As Keynes observed, it’s like the newspaper beauty contest where readers pick the prettiest face—not based on personal preference, but on what they thought others would choose. Success came not from your own opinion of the prettiest face, but from guessing “what average opinion expects average opinion to be.”
For sure, some traders have successfully used the cycle and quadrants to inform their investments, but for most investors, an appreciation of the market regime rather than the market cycle matters more.
Defining the Regime
Over the past century, decade-long stretches have been shaped by structural forces—what we refer to as regimes—that drive returns across asset classes. Successful investing has often meant aligning with the dominant trend of the prevailing regime.
In the post-WWII era, the use of active fiscal demand management supported economic growth and sustained equity gains, while bonds underperformed amid rising inflation expectations.
The optimism of the 1960s gave way to supply shocks and persistent inflation in the 1970s. From 1966 to 1982, investors who didn’t see the shift in the regime reaped low or negative real returns in equities and bonds. Meanwhile, commodities and gold outperformed.
The Volcker shock in 1979 marked a regime change. His inflation-fighting success, combined with deregulation and the early waves of globalisation, ushered in falling inflation and a multi-decade bull market for equities and bonds. Commodities lagged.
The 2000s were characterised by a reset and two savage bear markets: the dotcom bust and the Global Financial Crisis. Bonds held up well in a disinflationary environment, while gold once again delivered strong returns as investors questioned fiat stability.
The deleveraging and austerity that followed the Global Financial Crisis contributed to the secular stagnation of the 2010s. Monetary policy became the only game in town. Growth was sluggish, but low rates and corporate profit expansion supported strong equity returns. Bonds rallied too, with trillions of dollars in government debt having negative yields, while commodities remained under pressure.
How Regimes Shape Markets—and End
What can we learn from past regimes to inform current investments?
For one, markets still exhibit cycles—but it’s the regime that drives returns. There were equity rallies during the inflationary 1970s and again in the early 2000s, but they proved fleeting. In both cases, the prevailing macro regime ultimately reasserted itself and reversed those gains.
Second, what works in one regime often reverses when the market transitions into the next regime. But investor sentiment can often be at an extreme just as the regime changes.
In fact, regimes often sow the seeds of their own destruction.
In the mid 1960s, after two decades of strong equity returns, investors were bullish, with the Nifty Fifty—the darlings of the day—pushed to extreme valuations, much like today’s Magnificent Seven.
On 31 December 1965, Keynes featured on the front cover of Time magazine, in recognition of the widespread adoption and perceived success of Keynesianism. But excessive reliance on demand management laid the foundations for the inflation of the 1970s and disappointing returns for the high-flying Nifty Fifty.
The trauma of that inflation and the pessimism it created gave political cover for Volcker’s tightening in the early 1980s. Famously, BusinessWeek magazine heralded the death of equities in 1979, just as a major rally was about to begin.
Two decades of strong returns for equities then led to hubris and excessive optimism at the turn of the century. Stocks like Cisco or Sun Microsystems were seen as cornerstones of any portfolio. But overly optimistic investors were wrong-footed again as a lost decade for equity investors unfolded.
Again, in the 2010s, the regime shifted again with both the secular stagnation and the new equity rally, a by-product of the Global Financial Crisis and the QE that came thereafter.
Investing in a new macro regime
Fast forward to today, and we can see how the current regime is taking shape—again heavily influenced by the past.
The austerity of the 2010s, the belief that QE fuelled inequality, and the perception that globalisation failed to deliver broad-based gains have all contributed to the demise of the neoliberal free-market ideology.
But what is replacing it is still unclear. In the US, it was initially Biden’s progressive agenda, now replaced by a populist, mercantilist agenda under Trump. In Europe, the focus has shifted to industrial policy and defence spending. The common denominator: large fiscal deficits.
The willingness to embrace deficit spending also has its origins in the 2010s. A decade of ultra-low—even negative—bond yields enabled the fiscal lever to be pulled during COVID and again during the cost-of-living crisis.
But old habits die hard, and it will be difficult for governments to wean themselves off the fiscal addiction. The bond market has taken note, and global bond yields are now roughly 3% higher than in the previous decade.
Although yields have fallen in the past month on growing hopes that the Fed will ease, higher and more volatile bond yields could well become a defining feature of the regime.
The secular stagnation of the 2010s was a headwind for commodities. Falling prices led to reduced investment across the sector. In 2010, commodities featured in many asset allocation plans. But there’s nothing like sustained price weakness to change sentiment. A decade of poor performance has seen allocations steadily decline
Just as higher prices often cure inflation by dampening demand, lower prices tend to sow the seeds of future rallies—by constraining supply growth and delaying investment. Commodities may also see a secular trend change given the past underinvestment and rising defence and infrastructure related demand.
Equities are less clear-cut. With the S&P 500 back at record highs, there is no obvious regime shift—yet. Optimists might argue the regime has turned more positive amid continued AI-driven capital expenditure.
But fifteen years of double-digit US equity gains have left valuations stretched and sentiment bullish. Although central banks have shifted from asset purchases to asset sales, the QE era helped cement the prevailing psychology: buy the dip has been rewarded time and again.
Low borrowing costs, cheap assets, and rising valuations also created ideal conditions for private equity—and the money flowed in, by the trillion. But the landscape has shifted. Higher interest rates and inflated asset prices have stalled deal activity. Less capital is being returned to investors, and less is being recycled into new deals—perhaps an early warning sign for risk assets more broadly.
The equity rally and perception of US exceptionalism were key supports for the dollar in the 2010s, and a strong dollar weighed on gold. But the dynamics are shifting.
Dollar strength in the previous regime has contributed to widening US trade deficits, and the policy stance has quietly turned less dollar-friendly. Gold, previously constrained by dollar strength, is now trending higher—even with real yields still elevated -as concerns around fiat debasement emerge as a by product of QE and rising deficits.
Regime shifts don’t ring a bell. They build quietly—then become obvious in hindsight.
For investors, now is the time to look past the noise of rate cuts and soft landings—and focus instead on what excessive deficits, higher interest rates, and rising macro volatility mean for asset prices in the years ahead.