Business Cycle in capital markets

A typical business cycle has a number of phases. We split the cycle into five phases with
the following capital market implications:
o Initial Recovery. Short-term interest rates and bond yields are low. Bond yields
are likely to bottom. Stock markets may rise strongly. Cyclical/riskier assets such
as small stocks, high-yield bonds, and emerging market securities perform well.
o Early Expansion. Short rates are moving up. Longer-maturity bond yields are
stable or rising slightly. Stocks are trending up.
o Late Expansion. Interest rates rise, and the yield curve flattens. Stock markets
often rise but may be volatile. Cyclical assets may underperform while inflation
hedges outperform.
o Slowdown. Short-term interest rates are at or nearing a peak. Government bond
yields peak and may then decline sharply. The yield curve may invert. Credit
spreads widen, especially for weaker credits. Stocks may fall. Interest-sensitive
stocks and “quality” stocks with stable earnings perform best.
o Contraction. Interest rates and bond yields drop. The yield curve steepens. The
stock market drops initially but usually starts to rise well before the recovery
emerges. Credit spreads widen and remain elevated until clear signs of a cycle
trough emerge.