Page 4 - Equity Investing Through Business Cycles
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Our Flags
While certainly not exhaustive, here are a few variables that we attribute flags to in order to
determine where we are in the business cycle:
Inflationary Pressures: When inflation increases, central banks raise interest rates to
slow the economy with the goal of bringing down inflation. With higher interest rates, the
probability of a recession increases, leading to layoffs, fewer jobs, and decreased
consumer and corporate spending, among other effects found in a slowing economy.
GDP: GDP represents the value of all goods and services produced over a specific time
period within a country's borders. Economists can use GDP to determine whether an
economy is growing or experiencing a recession. Investors can use GDP to make
investment decisions—a bad economy often means lower earnings and stock prices. GDP
is important because it gives information about the size of the economy and how an
economy is performing.
Yield Curve: A normal yield curve implies stable economic conditions and should prevail
throughout a normal economic cycle. A steep yield curve implies strong economic
growth in the future—conditions that are often accompanied by higher inflation, which
can result in higher interest rates. A yield curve inversion, when rates for two-year US
Treasury notes rise above those for 10-year notes, has preceded every recession since
the 1960s.
Changes in unemployment: Unemployment increases during business cycle recessions
and decreases during business cycle expansions.
Corporate Earnings: Business cycles and corporate earnings are closely related.
Understanding the business cycles should help to make projections of earnings.
Fiscal Policy - Government Spending and Tax policies: Fiscal Policy greatly impacts the
business cycle. It mostly consists of adjustments to tax and spending rates. Taxes are
decreased and spending is increased to promote growth. This frequently entails
borrowing through the issuance of public debt as bonds.
Monetary Policy - Fed dovish or hawkish: The money supply in an economy is impacted
by monetary policy, which in turn affects discount rates and inflation. Additionally,
Monetary Policy affects employment, business expansion, debt costs, and the relative
costs of saving vs spending, all of which affect aggregate demand. A Hawkish fed
concentrates on inflation. They favor increasing interest rates to limit the money supply.
A Dovish Fed strives to attain maximum employment while supporting economic
development.
Other Flags: We also use other flags including income, rising or falling sales, rising or
falling inventories, credit growth, and others.
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