Where are we in the current business cycle?

 

Where are we in the current business cycle?

Many people who failed to recognize the state of the business cycle did not get out of the stock market before the Great Recession hit. Making matters worse, they feared to get back into the stock market at the beginning of an expansion cycle. That's the right time to do so.

While you can't time the market perfectly, you can improve your returns by getting better at reading the business cycle. You then can adjust your asset allocation to take advantage of the phases.

4 Phases of the Business Cycle

The business cycle has four phases.

1. Expansion: The economy grows a healthy 2% to 3%. Stocks enter a bull market.
2. Peak: The economy grows by more than 3%. Inflation sends prices up. There are asset bubbles. The stock market is in a state of "irrational exuberance." Talking heads announce that we are in a "new normal."
3. Contraction: Economic growth slows but isn't negative. Stocks enter a bear market.
4. Trough: The economy contracts, which signals a recession.

5. Current Business Cycle

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

   In response to the COVID-19 pandemic, state governments closed non-essential businesses in March. By April, there were 23.1 million Americans unemployed, sending the unemployment rate to 14.8%.

   Prior to that, the economy had been in the expansion phase for 11 years. The last trough was in June 2009. We have probably reached the trough for the 2020 recession and the Federal Reserce projects that unemployment will return to 5% in 2021.

   The line chart below tracks the current business cycle according to the rise and fall of gross domestic product.

6. Expansion phases usually last five years or so.

    Even before the pandemic, many people were warning that a recession was just around the corner.

   There were no warning signs that expansion had reached its peak. Instead of inflation, there were asset bubbles. In 2015, it was in the U.S. dollar. The weak demand for the euro contributed to a strong dollar. There was an asset bubble in housing prices right before the 2008 recession. Sometimes the irrational exuberance of a peak takes place in asset prices without generating overall inflation.

7. Potential Indicators

   Economist John Kenneth Galbraith once said 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 indicate a recession even before it is officially declared.

   S&P 500

   This is a collection of 500 of the largest publicly traded stocks in the United States. The Dow Jones Industrial Average, by comparison, comprises only 30 stocks. As a result, the S&P 500 is a more thorough gauge of where the U.S. economy stands at any given time.

   Unemployment Claims

   The number of workers claiming unemployment benefits topped 10% in 2009, but it dropped to less than 4% as of 2018. In general, rising unemployment rates are often seen as an indicator of trouble for the economy, and falling unemployment rates can be viewed as the opposite.

   As with all potential indicators, though, look beyond the surface. For example, the unemployment rate measures only those people who either are working or are seeking work. Those who are not working by choice are not counted. According to the U.S. Bureau of Labor Statistics, the number of 16- to 24-year-olds who are not working because they are going to school has risen since 2009, while the unemployment rate has dropped.

   Consumer Confidence

   The consumer confidence index measures how willing people are to make purchases in any upcoming 12-month period. A rating higher than 100 means that people plan to spend money, while a rating lower than 100 indicates that people are more likely to add to their savings and hold off on major purchases. The less willing people are to spend their money, the worse that can be for the economy.

   Housing

   An increase in new construction or rising values for existing homes can be positive indicators for the economy and the business cycle. On the flip side, if new construction slows, or existing home prices plateau, that can be a sign of trouble.

   Remember that no single indicator should be viewed in a vacuum, and you should always look deeper than the headlines. For example, new construction might be slowing because tariffs made imported lumber more expensive. Other indicators might still project a strong economy. Some other potential indicators worth tracking include commodities prices, the consumer price index, and the producer price index.