Business cycles investing clock images

This domino effect is key to the diffusion of recessionary weakness across the economy, driving the comovement among these coincident economic indicators and the persistence of the recession. On the flip side, a business cycle recovery begins when that recessionary vicious cycle reverses and becomes a virtuous cycle, with rising output triggering job gains, rising incomes, and increasing sales that feed back into a further rise in output.

The recovery can persist and result in a sustained economic expansion only if it becomes self-feeding, which is ensured by this domino effect driving the diffusion of the revival across the economy. Of course, the stock market is not the economy.

Therefore, the business cycle should not be confused with market cycles , which are measured using broad stock price indices. Measuring and Dating Business Cycles The severity of a recession is measured by the three D's: depth, diffusion, and duration.

A recession's depth is determined by the magnitude of the peak-to-trough decline in the broad measures of output, employment, income, and sales. Its diffusion is measured by the extent of its spread across economic activities, industries, and geographical regions. Its duration is determined by the time interval between the peak and the trough. In analogous fashion, the strength of an expansion is determined by how pronounced, pervasive, and persistent it turns out to be.

These three P's correspond to the three D's of recession. An expansion begins at the trough or bottom of a business cycle and continues until the next peak, while a recession starts at that peak and continues until the following trough. Accordingly, its Business Cycle Dating Committee considers a recession to be "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

For instance, after the end of the —09 recession, it "waited to make its decision until revisions in the National Income and Product Accounts [were] released on July 30 and Aug. Since the Committee's formation in , the average lags in the announcement of recession start and end dates have been eight months for peaks and 15 months for troughs.

Prior to the formation of the Committee, from to , recession start and end dates were determined on behalf of the NBER by Dr. Geoffrey H. He then served as the Committee's senior member from until his death in In analyses requiring international recession dates as benchmarks, the most widely used procedure is to reference NBER dates for the U.

The Great Recession was the longest one during this period, reaching 18 months. From —, they were almost equal in length, with recessions lasting 24 months and expansions lasting 27 months, on average. The average recession duration then fell to 18 months in the — period and to 11 months in the post-World War II period. Meanwhile, the average duration of expansions increased progressively, from 27 months in —, to 32 months in —, to 45 months in —, and to months in the — period.

The depth of recessions has changed over time. With cyclical volatility drastically downshifting after WWII, the depth of recessions decreased greatly. From the mids to the eve of the —09 Great Recession—a period sometimes dubbed the great moderation—there was a further reduction in cyclical volatility.

Also, since about the start of the great moderation, the average longevity of expansions appears to have roughly doubled. Business Cycle Graph. However, the post-WWII recoveries from the devastation wreaked on many major economies by the war resulted in strong trend growth spanning decades. When trend growth is strong—as China has demonstrated in recent decades—it is difficult for cyclical downswings to take economic growth below zero, and into recession. For the same reason, Germany and Italy did not see their first post-WII recession until the mids, and thus experienced two-decade expansions.

From the s to the s, France experienced a year expansion, the U. Canada saw a year expansion from the late s to the early s. Even the U. With business cycle recessions having apparently become less frequent, economists focused on growth cycles, which consist of alternating periods of above-trend and below-trend growth. But monitoring growth cycles requires a determination of the current trend, which is problematic for real-time economic cycle forecasting.

Targeted investing in stock sectors can be one potential tool in a capital preservation and income strategy. Yes, sector investing is often more exciting and inherently riskier than common ways of preserving capital, such as CDs, bonds, and other fixed-income securities. But for investors who want a different approach and are willing to accept a bit more risk without getting too aggressive, sector investing may be something to consider, if addressed with care.

Some sectors, such as Utilities, Consumer Staples, and Real Estate may provide dividend income, allowing an investor to potentially earn income in their portfolio through dividend issuance. These dividends may be used to purchase more shares, or may be taken as income. Of course, the payment of dividends is not guaranteed, and the issuing and payment of dividends may be discontinued by the company at any time.

Risks of Sector Investing Adjusting your portfolio to try to take advantage of sectors takes a bit more effort than just buying and holding stocks for the long term. We all know that past performance is not a guarantee of future performance. The problem with CDs and keeping your money in cash is that you might not be able to keep up with inflation. But like CDs, bonds do offer a bit more safety for those who want to protect their capital.

Bonds sometimes lose value—for instance, when interest rates rise—but they tend to be less volatile than stocks over the long term. Following a sector strategy can also mean paying more in transaction costs, as investors may make more adjustments to their portfolios. Even top money managers have a hard time hitting it right, so timing can be especially challenging for the retail investor. Do Your Research TD Ameritrade offers a variety of sector-specific research resources designed to help investors understand and implement sector investing strategies.

Learn where to start with sector investing by learning about tools such as top-down analysis, Market Monitor, and third-party analyst reports that can help you find investment ideas that align with your specific investing objectives. To access it, log on to tdameritrade. Image source: tdameritrade. For illustrative purposes only. Past performance does not guarantee future results. Looking for individual stocks within a sector? Select a sector and scroll down to see subsectors, industries, and some of the companies that drive the sectors.

From there, you can check analyst ratings and company fundamentals.

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Key takeaways Economic conditions may affect investment performance. Measures of economic activity have historically risen and fallen in a pattern known as the business cycle. The business cycle contains 4 distinct phases: early, mid, late, and recession. History offers guidance as to how various types of investments might perform during each phase. Corporate earnings, interest rates, inflation, and other factors that change as economies expand and contract can affect the performance of investments.

Understanding how various types of stocks, bonds, and other assets have historically performed at various points in the business cycle may help investors identify opportunities as well as risks. Knowing the cycle may also help investors evaluate and adjust their exposure to different types of investments, as the likelihood of a shift from one phase of the cycle to the next increases.

This business-cycle investing approach differs from both short- and long-term approaches because shifts from one phase of the business cycle to the next have historically taken place every few months or years on average. Fidelity's Asset Allocation Research Team believes long-term historical average returns provide reasonable guidance for allocating assets in portfolios.

However, over periods of 30 years or less, short-, intermediate-, and long-term factors may cause performance to deviate significantly from those averages, so analyzing factors and trends over shorter time periods can also be an effective approach to asset allocation. Investment performance is driven by short-, intermediate-, and long-term factors For illustrative purposes only.

Understanding business cycle phases Every business cycle is different, but certain patterns have tended to repeat over time. Changes in the cycle reflect changes in corporate profits, credit availability, inventories of unsold goods, employment, and monetary policy. While unforeseen macroeconomic, political, or environmental events can sometimes disrupt a trend, these key indicators have historically provided a relatively reliable guide to recognizing the phases of the cycle.

Bear in mind, though, that the length of each phase has varied widely. A typical business cycle contains 4 distinct phases. Early cycle: Generally, a sharp recovery from recession, as economic indicators such as gross domestic product and industrial production move from negative to positive and growth accelerates.

More credit and low interest rates aid profit growth. Business inventories are low, and sales grow significantly. Mid-cycle: Typically the longest phase with moderate growth. Economic activity gathers momentum, credit growth is strong, and profitability is healthy as monetary policy turns increasingly neutral. Late cycle: Economic activity often reaches its peak, implying that growth remains positive but slowing.

Rising inflation and a tight labor market may crimp profits and lead to higher interest rates. Recession: Economic activity contracts, profits decline, and credit is scarce for businesses and consumers. Rising growth and low inflation is the goldilocks phase of every cycle. Stocks are the best asset class in this phase. Phase 3 — Overheat phase: Productivity growth slows and the GDP gap closes causing the economy to bump up against supply constraints. This causes inflation to rise.

Rising inflation spurs the central bank to hikes rates. As a result, the yield curve begins flattening. With high growth and high inflation stocks still perform but not as well as in phase 2. Volatility returns as bond yields rise and stocks compete with higher yields for capital flows. In this phase, commodities are the best asset class. Productivity dives and a wage-price spiral develops as companies raise prices to protect compressing margins.

Central banks keep rates high until they reign in inflation. This causes the yield curve to invert. During this phase, cash is the best asset. Below is a chart that illustrates this process. The investment clock helps with understanding the progression of the economic cycle. As well as help you think about preferable asset allocation for each relative phase. Cyclical sectors like Tech or Steel out-perform. When growth is slowing South , Bonds, Cash and defensives outperform. Duration: When inflation is falling West , discount rates drop and financial assets do well.

Investors pay up for long duration Growth stocks. When inflation is rising East , real assets like Commodities and Cash do best. Pricing power is plentiful and short-duration Value stocks outperform. Asset Plays: Some sectors are linked to the performance of an underlying asset. Insurance stocks and Investment Banks are often bond or equity price sensitive, doing well in the Reflation or Recovery phases. Mining stocks are metal price-sensitive, doing well during an Overheat.

Pretty simple, right? A good place to start is by looking at the GDP gap. The zero line represents full economic capacity, or a closed GDP gap. When the reading is positive above the zero line , it means the economy is producing at above trend capacity. This causes inflation to rise and drives the central bank to hike rates. This is why a recession marked by the vertical grey bands follows after each subsequent period of above capacity production.

A look at GDP shows that growth remains firm and is trending up. So we have one part of our equation. We know that growth is trending up and GDP gap is tight but not yet above capacity. Now we have to figure out the other variable; inflation. Depending on the measure, inflation is currently between 1. One tool we can use for that is capacity utilization.

Capacity utilization is another way to measure GDP gap. The chart below shows the relationship. Both capacity utilization and CPI are smoothed over 12 months to shake out the noise. Capacity utilization leads inflation by months. As the business cycle advances, capacity utilization will continue to rise, pulling inflation up with it.

One of the best leading indicators of inflation is the relative change in the dollar. Most international trade is done in dollars. And commodities are priced in dollars.