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Investor's Guide To The Business Cycle
Investor's Guide To The Business Cycle
Investor's Guide To The Business Cycle
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The rise and fall of the economy in America and elsewhere can generally be classified into a cyclical pattern
that repeats itself over and over. Although their timing can be hard to predict, those who are able to recognize
them when they occur can use this to their financial advantage in many cases. Learn the characteristics of each
major phase of the cycle and the possible ramifications that they may have on your investment portfolio.
The expansion phase begins when the economy finally begins to recover from a recession. During this phase,
the Fed will usually start to ease its monetary policy and thus allow credit to become more available. This
injects money and liquidity into the economy, which stimulates further growth and boosts the earnings of
corporations. As the economy solidifies, consumer discretionary income increases and leads to greater
spending. The stock market begins rising and economic numbers improve.
Peak
After a period of expansion, growth finally starts to taper off and corporate earnings reach their peak. Consumer
spending continues and interest rates bottom out. Stock prices level off and often begin to retrace the most
recent segment of their growth. This phase of the cycle usually lasts longer than any other.
Contraction
Economic growth eventually starts to slow and inflation begins to spiral upward. Consumer pessimism asserts
itself. Economic numbers start to wane and unemployment rises.
Trough
This is the period of recession where the economy bottoms out. The money supply has virtually dried up and the
Fed is raising interest rates in order to curb inflation. The markets are hitting a low as company profits recede
and consumer spending has slowed to a trickle. This phase will of course eventually give way to a new period
of growth that starts the cycle over again.
Market Indicators
One of the ways that economists determine where we are in the economic cycle is by watching various
economic indicators, such as Gross Domestic Product, interest rates, inflation, employment numbers and
productivity. Rising inflation indicates economic growth while falling GDP and employment figures reflect
periods of contraction.
during the various stages of the cycle. As mentioned previously, consumer cyclicals, transportation and
technology stocks can be good picks during a recession, as they tend to flourish when the economy starts to
recover. Then, when the economic recovery shifts into high gear, other sectors often experience periods of
strong growth, such as precious metals, healthcare, energy and capital goods. Commodities also typically peak
when the economy starts to cool off again.
If you are going to try a strategy that requires market timing, you should probably look to ETFs that invest in
each of these sectors in order to maximize your liquidity and minimize trading costs. Also remember that there
will not necessarily be a unanimous consensus on exactly when we enter or leave a particular phase in the cycle,
and you will ultimately have to decide for yourself when to shift your portfolio from one sector to another.
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