Page 3 - Equity Investing Through Business Cycles
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Understanding the Business Cycle
No business cycle looks the exact same. Because every business cycle is unique, there is
rarely consensus from experts about where we are in the cycle. However, certain patterns
tend to repeat themselves over time. Fluctuations in the business cycle are essentially
distinct changes in the rate of growth in economic activity, as well as changes in monetary
and fiscal policy. While unforeseen macroeconomic events or shocks can sometimes disrupt
a trend, changes in these key indicators historically have provided a relatively reliable guide
to recognizing the different phases of an economic cycle.
Specifically, there are four distinct phases of a typical business cycle:
Early-cycle phase: Generally a sharp Mid-cycle phase: Typically the longest
recovery from recession, marked by an phase of the business cycle. The mid
inflection from negative to positive growth cycle is characterized by a positive but
in economic activity (e.g., gross domestic more moderate rate of growth than that
product, industrial production), then an experienced during the early-cycle phase.
accelerating growth rate. Credit Economic activity gathers momentum,
conditions stop tightening amid easy credit growth becomes strong, and
monetary policy, creating a healthy profitability is healthy against an
environment for rapid margin expansion accommodative—though increasingly
and profit growth. Business inventories neutral— monetary policy backdrop.
Inventories and sales grow, reaching
are low, while sales growth improves equilibrium relative to each other.
significantly.
Late-cycle phase: Often coincides with peak Recession phase: Features a contraction
economic activity, implying that the rate of in economic activity. Corporate profits
growth remains positive but slows. A typical decline and credit is scarce. Monetary
late-cycle phase may be characterized as an policy becomes more accommodative
overheating stage for the economy when and inventories gradually fall despite low
capacity becomes constrained, which leads sales levels, setting up for the next
to rising inflationary pressures. While rates recovery.
of inflation are not always high, rising
inflationary pressures and a tight labor
market tend to crimp profit margins and
lead to tighter monetary policy.
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