Talking Money: Business Cycle
By Peter May
Economic history is marked by reoccurring cycles of expansions and contractions. That pattern is called “the business cycle.” The U.S. has had 33 business cycles since 1854, all characterized by a transition from the good times – when gross domestic product is expanding, businesses are growing, unemployment is low and consumers are spending – to the tough times when businesses are slowing, unemployment ticks up and consumers tighten their belts until the next upturn.
Most students are introduced to a business cycle shown as a simple, level, symmetrical wave. The truth is, the business cycle is more complex.
The current cycle, including the Great Recession, shows the traditional curve, though it is a little harder to see. Instead of being horizontal, the trend line is up, indicating that despite the short-term ups and downs, our economy continues to grow.
Also, the expansion and contraction phases of the cycle are not symmetrical. That’s typical. Since 1945, the average expansion has lasted 58 months, more than five times longer than the average contraction. The longest period of prosperity on record is 10 years.
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History has taught us, though, that at some point, something will go wrong and another contraction will begin. A contracting economy can drive down portfolio values. Ten of the 11 bear markets since 1929 came during economic contractions. Knowing that, investors certainly would prefer to avoid the contraction part of the business cycle. That ambition to track business cycles keeps economists studying economic indicators to try to spot our position on the curve.
Investors should not rely on predictions of the future. However, some economic indicators can help determine more or less where we are in a business cycle.
Though it’s unwise to time the market, it’s not unreasonable to take advantage of demonstrated truths. Typically, value stocks perform well in the recovery phase following a recession – often seen as two consecutive quarters of declining GDP. Then growth stocks take the baton as GDP expands again but fall fast during contractions.
- Early in a recovery, the financial sector can expect a bump from increased activity and rising interest rates.
- Later, the consumer discretionary sector benefits from optimistic buyers making purchases they had delayed.
- Midway through the cycle, businesses flush with cash expand to meet demand, helping industrials.
- Late in the business cycle, investors get defensive and start buying into sectors where purchases can’t be postponed like healthcare and energy.
Not all the same: At the Autumn 2016 Investment Outlook Seminar, Marc Amateis and Brian Kilb discussed ways in which the current business cycle may be atypical. Please click here to view a Money Talk Video of their presentations.
Knowing what types of assets win and when can help prudent investors boost their returns by making minor changes. But remember: No one really knows what the future holds. The best advice is to stay in the market, think long-term, lean into opportunities when prudent – but never overreact. Stay focused on your goals, and maintain a balanced portfolio.
Peter May is a registered representative at Landaas & Company.
(initially posted Oct. 27, 2016)