The 4 Phases of a Business Cycle
Transitions in the economic growth have a major impact on the prices of asset classes. Although every economic cycle is different, our historical analysis suggests that the rhythm of cyclical fluctuations in the economy has tended to follow similar patterns. The idealized pattern of economic growth cycle can be broken down into four distinctive phases below:
- Phase 1 (Early Cycle) – The economy slows down below its long-term trend. During these times, investors can expect inflation, bond yields, short-term interest rates, and commodities to decline. The bear market bottoms and stocks start a new bull market.
- Phase 2 (Mid Cycle) – The economy strengthens from a period of slow growth but its pace is still slow. During these times, investors can expect inflation, bond yields, short-term interest rates, and commodities to stop declining. The stock market is still strong, but its appreciation takes place at a much slower pace than in Phase 1.
- Phase 3 (Late Cycle) – The economy is strong and growing at well above potential. During these times, investors can expect inflation, bond yields, short-term interest rates, and commodities to start rising. The stock market is now growing at a slow pace and reaches a top toward the end of this phase.
- Phase 4 (Recession Phase) – The economy reaches the top in its growth rate and begins to slow down under the pressure (negative feedback) of rising interest rates, inflation, and overall business costs. During these times, investors can expect inflation, bond yields, and commodities to lose considerable momentum and eventually peak. Short-term interest rates usually peak toward the end of Phase 4. The stock market is now struggling with the majority of stocks making no progress.
If investors want to outperform the market in the short term, they need to identify the phase where the economy is in the business cycle, then select and invest in the sectors that will perform well in the current phase and be ready to transition to the next phase.
