Where are we in the current business cycle?

In this article, we will discuss our position in the current business cycle and how to protect your investments at any stage of it. We will divide the article into subheadings covering the four stages of the economic cycle, potential indicators, and how to safeguard yourself in each phase. We will also provide answers to some frequently asked questions about the business cycle.

The Four Stages of the Business Cycle

The business cycle consists of four stages:

1. Expansion: The economy grows by 2% to 3% and stocks enter a bull market.
2. Peak: The economy grows by more than 3% and inflation rates rise. Asset bubbles occur, and the stock market is in a state of “irrational exuberance.” Experts declare that we are in a “new normal.”
3. Contraction: Economic growth slows but is not negative, and employment decreases. Stocks enter a bear market.
4. Trough: This is the lowest point of contraction before the next recovery begins.

The Current Economic Cycle

The U.S. economy entered a contraction phase in the business cycle in February 2020.

In response to the COVID-19 pandemic, U.S. state governments closed non-essential businesses in March. By April, the number of unemployed Americans reached 23.1 million, causing the unemployment rate to rise to 14.8%.

Prior to that, the economy was in an expansion phase for 11 years. The last trough was in June 2009. We may have reached the trough of the recession in 2020, and the Federal Reserve expects the unemployment rate to return to 5% in 2021.

The stages of expansion typically last around five years. Even before the pandemic, many people were warning of an impending recession. There were no warning signs indicating that the expansion had peaked. Instead of inflation, there were asset bubbles. In 2015, the bubble was in the U.S. dollar. Weak demand for the euro contributed to the strength of the dollar. There was a bubble in housing prices before the 2008 recession. Sometimes, irrational exuberance occurs at asset peaks without causing general inflation.

Potential Indicators

Economist John Kenneth Galbraith once said that there are two types of economic forecasters: “those who don’t know, and those who don’t know they don’t know.” Here are some common indicators that suggest a recession even before it is officially announced:

• S&P 500 Index: This is a collection of 500 of the largest publicly traded companies in the United States. In comparison, the Dow Jones Industrial Average consists of only 30 stocks. Therefore, the S&P 500 is considered a more comprehensive indicator of the U.S. economy’s condition at any given time.
• Unemployment Claims: The number of workers filing for unemployment benefits exceeded 10% in 2009, but it dropped to under 4% by 2018. Generally, rising unemployment rates are seen as a sign of trouble in the economy, while declining unemployment rates are the opposite.
• Consumer Confidence: The Consumer Confidence Index measures how willing people are to make purchases in the coming 12 months. A score above 100 means that people plan to spend money, while a score below 100 indicates that people are more likely to add to their savings and postpone large purchases. The less likely people are to spend their money, the worse it is for the economy.
• Housing: An increase in new construction or rising values of existing homes can be positive indicators for the economy and the business cycle. Conversely, if new construction slows or current home prices stagnate, it may signal a problem.

How to Protect Yourself in Each Phase

Consult a certified financial planner when you wish to buy specific funds or stocks. Here are some guidelines on what tends to be best in each stage of the business cycle:

• In

Contraction Phase: Stay calm. If you haven’t sold stocks by the time of economic contraction, it’s likely too late. You can move some assets into bonds or cash, but keep some stocks. You want to capture the rebound when it happens. Most investors sell stocks when the contraction has already begun. They don’t buy again until it’s too late. Recessions or bear markets typically last from six to 18 months.

• Bottom Phase: Start adding stocks and commodities like gold, oil, and real estate. They should be cheaper during a recession.
• Expansion Phase: In the early stages of expansion, small-cap stocks grow at the fastest pace. Small companies are able to take advantage of market shifts. You can get additional income from high-yield bonds. Add stocks and bonds from emerging and developed foreign markets. They protect against a declining dollar. Emerging markets grow faster in the early stages of recovery. For example, Brazilian banks did not buy subprime mortgages. The country’s economy grew while the U.S. economy was in recession. Emerging markets have risks, but as the global economy improves, they are worth that risk.
• Peak Phase: Sell stocks, commodities, and unwanted bonds. Increase the cash and fixed income allocation. The safest bonds are U.S. treasury bonds, savings bonds, and municipal bonds. When interest rates are high, buy short-term bond funds and money market funds. As interest rates decrease, shifting to corporate bonds provides higher returns with greater risks. Add gold until it makes up about 10% of your portfolio. It’s a good hedge against inflation. It’s also the best protection during a stock market crash.

As you can imagine, selling stocks when others are bragging about how much money they’re making is very difficult. Timing the market is almost impossible. Instead, be conservative. Don’t allocate 100% of your investments into one asset class. Instead, ensure that you diversify your investments. Gradually shift the proportion to align with the business cycle. Always work with a financial planner to ensure that the distribution aligns with your personal goals.

Frequently Asked Questions (FAQs)

How many months have passed since the latest phase in the business cycle began?

The latest recession reached its bottom in April 2020. This means that by June 2021, 14 months had passed since the start of the expansion phase.

How often do business cycles occur in the United States?

Between 1945 and 2019, expansions lasted an average of 65 months and recessions lasted an average of 11 months. This means that a full business cycle takes about six years on average.

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Sources:

– Congressional Research Service. “Introduction to U.S. Economy: The Business Cycle and Growth,” Page 1.

– National Bureau of Economic Research. “Determination of the February 2020 Peak in US Economic Activity.”

– U.S. Bureau of Labor Statistics. “Unemployment Rate,” Select “Unemployment Rate.”

– National Bureau of Economic Research. “Business Cycle Dating Committee, National Bureau of Economic Research.”

– Board of Governors of the Federal Reserve System. “Dec. 16, 2020: FOMC Projections Materials, Accessible Version.”

– Legislative Analyst’s Office. “Sagging Global Economy May Affect California.”

– U.S. Bureau of Labor Statistics. “Housing and Expenditures: Before, During, and After the Bubble.”

– U.S. National
Source: https://www.thebalancemoney.com/where-are-we-in-the-current-business-cycle-3305593