Where Are We in the Current Business Cycle?

Why You Should Care

current business cycle
You need to always know where we are in the current business cycle. Illustration: Yenpitsu Nemoto/Getty Images

Do you share this reader's concern?

I don't recognize the business cycle well and consequently, I did not get out of the stock market early before the contraction hit. I feared putting too much money into the stock market in the beginning of the expansion cycle. I wonder whether you have articles that give clear indication of where we are now in terms of the business cycle,  and suggested stock picks (or mutual funds/ETFs) for the current moment?

Although you can't time the market, you can improve your returns by knowing where we are in the business cycle. You can adjust your asset allocation to take advantage of the phases.

The business cycle has the following four stages:

  1. Expansion. The economy grows a healthy 2-3%. Stocks enter a bull market.
  2. Peak. The economy grows more than 3%. Inflation sends prices up. There are asset bubbles. The stock market is in a state of "irrational exuberance." Talking heads announce we are in a "new normal." Authors publish books entitled "Dow 30,000."
  3. Contraction. Economic growth slows but isn't negative. Stocks enter a bear market.
  4. Trough. The economy contracts. That signals a recession. Economic experts predict it will continue for years.

Right now, we are in the expansion phase. We have been since June 2009. That's a long time. Historically, they last five years or so.

We don't appear to be at a peak because we don't have inflation.

But there are asset bubbles in the U.S. dollar. See Why Is the Dollar So Strong Right Now? The asset bubble was in housing prices right before the 2008 recession. Sometimes the irrational exuberance of a peak takes place in asset prices without generating inflation overall.

To answer the second part of the question, I'm not qualified to suggest specific funds or stocks.

You need to consult with a financial planner to do that. But I will give generally-accepted guidelines for what tends to do better in each phase of the business cycle:

  1. Contraction. Sit tight. A recession or bear market usually lasts six to eighteen months. Just wait it out. 
  2. Trough. Start adding stocks and commodities such as gold, oil, and real estate. They should be cheap during a recession. 
  3. Expansion. In the early stages of an expansion, small-cap stocks will grow the fastest. You can gain extra income with high-yield bonds. Add stocks and bonds from foreign developed and emerging markets. They hedge against a declining dollar. Emerging markets grow faster in the early stages of an upturn. They are risky, but as the global economy improves, that risk is worth it.

    Later on in the expansion, add mid-cap and large-cap stocks. Larger companies do better in the late stages of a recovery. 

  4. Peak. Sell stocks, commodities, and junk bonds. Increase the proportion of cash and fixed income. The safest are U.S. Treasuries, and savings bonds, and municipal bonds. When interest rates are high, buy short-term bond funds and money market funds.  As interest rates fall, switch to corporate bonds provide a higher return with greater risk. Add gold until it's about 10% of your portfolio. It's the best hedge against a stock market crash. That's because gold prices rise for 15 days after any crash. For more, see Why Invest in Gold?.

    As you can imagine, it's incredibly difficult to sell stocks when everyone else is bragging about how much they're making. That's why timing the market is impossible for most people. Instead, be conservative. Never have 100% of your investments be in any one asset class. Instead, make sure your investments are diversified. Just gradually shift the proportion to stay in tune with the business cycle. Always work with a financial planner to make sure the allocation also matches your personal goals. 

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