Investors' Holy Grail - The Business/Economic Cycle

Money_Dictators Updated   
The business cycle describes how the economy expands and contracts over time. It is an upward and downward movement of the gross domestic product along with its long-term growth rate.

The business cycle consists of 6 phases/stages:
1. Expansion
2. Peak
3. Recession
4. Depression
5. Trough
6. Recovery

1) Expansion:

Sectors Affected: Technology, Consumer discretion

Expansion is the first stage of the business cycle. The economy moves slowly upward, and the cycle begins.
The government strengthens the economy:

  • Lowering taxes
  • Boost in spending.

- When the growth slows, the central bank reduces rates to encourage businesses to borrow.

- As the economy expands, economic indicators are likely to show positive signals, such as employment, income, wages, profits, demand, and supply.

- A rise in employment increases consumer confidence increasing activity in the housing markets, and growth turns positive. A high level of demand and insufficient supply lead to an increase in the price of production. Investors take a loan with high rates to fill the demand pressure. This process continues until the economy becomes favorable for expansion.

2) Peak:

Sector Affected: Financial, energy, materials

- The second stage of the business cycle is the peak which shows the maximum growth of the economy. Identifying the end point of an expansion is the most complex task because it can last for serval years.

- This phase shows a reduction in unemployment rates. The market continues its positive outlook. During expansion, the central bank looks for signs of building price pressures, and increased rates can contribute to this peak. The central bank also tries to protect the economy against inflation in this stage.

- Since employment rates, income, wages, profits, demand & supply are already high, there is no further increase.

- The investor will produce more and more to fill the demand pressure. Thus, the investment and product will become expensive. At this time point, the investor will not get a return due to inflation. Prices are way higher for buyers to buy. From this situation, a recession takes place. The economy reverses from this stage.

3) Recession:
Sector Affected: Utilities, healthcare, consumer staples

- Two consecutive quarters of back-to-back declines in gross domestic product constitute a recession.

- The recession is followed by a peak phase. In this phase economic indicators start melting down. The demand for the goods decreased due to expensive prices. Supply will keep increasing, and on the other hand, demand will begin to decline. That causes an "excess of supply" and will lead to falling in prices.

4) Depression:
- In more prolonged downturns, the economy enters into a depression phase. The period of malaise is called depression. Depression doesn't happen often, but when they do, there seems to be no amount of policy stimulus that can lift consumers and businesses out of their slumps. When The economy is declining and falling below steady growth, this stage is called depression.

- Consumers don't borrow or spend because they are pessimistic about the economic outlook. As the central bank cuts interest rates, loans become cheap, but businesses fail to take advantage of loans because they can't see a clear picture of when demand will start picking up. There will be less demand for loans. The business ends up sitting on inventories & pare back production, which they already produced.

- Companies lay off more and more employees, and the unemployment rate soars and confidence flatters.

5) Trough:
- When economic growth becomes negative, the outlook looks hopeless. Further decline in demand and supply of goods and services will lead to more fall in prices.

- It shows the maximum negative situation as the economy reached its lowest point. All economic indicators will be worse. Ex. The highest rate of unemployment, and No demand for goods and services(lowest), etc. After the completion, good time starts with the recovery phase.

6) Recovery:
Affected sectors: Industrials, materials, real estate

- As a result of low prices, the economy begins to rebound from a negative growth rate, and demand and production are both starting to increase.

- Companies stop shedding employees and start finding to meet the current level of demand. As a result, they are compelled to hire. As the months pass, the economy is once in expansion.

- The business cycle is important because investors attempt to concentrate their investments on those that are expected to do well at a certain time of the cycle.

- Government and the central bank also take action to establish a healthy economy. The government will increase expenditure and also take steps to increase production.

After the recovery phases, the economy again enters the expansion phase.

Safe heaven/Defensive Stocks - It maintains or anticipates its values over the crisis, then does well. We can even expect good returns in these asset classes. Ex. utilities, health care, consumer staples, etc. ("WE WILL DISCUSS MORE IN OUR UPCOMING ARTICLE DUE TO ARTICLE LENGTH.")

It's a depression condition for me that I couldn't complete my discussion after spending many days in writing this article. However, I will upload the second part of this article that will help investors and traders in real life. This article took me a long time to write. I'm not expecting likes or followers, but I hope you will read it.

Have a great day :)

Thank you for reading this idea.
Update 1: Relationship Between Business cycle & Sentiment cycle
Update 2:
What is Recession?


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