This decade has brought a long economic rebound to many parts of America. As 2017 ebbs into 2018, some of the statistics regarding this comeback are truly impressive:
*Payrolls have grown, month after month, for more than seven years.
*The jobless rate is lower than it has been for more than a decade.
*Business activity in the service sector has not contracted since the summer of 2009.
*The economy just grew 3% or more in back-to-back quarters, a feat unseen since 2014.
In the big picture, the American economy is booming. These statistics, and others, are so noteworthy that analysts are asking: when will the business cycle peak? Has it already peaked? Or are we experiencing a remarkably great exception to the norm?
Any investor must recognize two indisputable facts. One, expansions eventually give way to recessions. Two, bull markets are punctuated by bear markets. The question is when we will see the next recession, the next bear market, or both.
All business cycles have four phases. The first phase – expansion – is often the longest. It is characterized by two phenomena: a bull market and annualized GDP of 2% or greater. This expansion culminates at a peak, which is phase two. The peak is characterized by irrational exuberance on Wall Street, economic growth of 3% or more, a distinct acceleration of consumer prices, and the emergence of asset bubbles.
Then – perhaps, imperceptibly – supply begins to exceed demand. Fundamental indicators begin to weaken; yet, the economy still grows – just not at the pace it previously did. Then, the growth diminishes altogether, and the business cycle enters phase three – contraction. GDP goes negative for two or more successive quarters, which defines a recession. Corporate earnings take a major hit, depressing investors. Equities enter a bear market. Finally, things come to a trough – a bottom. On Wall Street, institutional investors reach a point of capitulation – a moment when they decide there is more potential upside than downside to stocks. Investors and consumers start to become less pessimistic. Suddenly, supply has to keep up with demand again. Things brighten, and a new business cycle begins.
How will we know precisely when the business cycle has peaked? Without seeing the future, we cannot know. We can make an educated guess based on fundamental economic indicators and earnings, but we will really only know looking back.
How can we prepare for the later phases of this current business cycle? Some healthy skepticism and some diversification may help. Investors who tend to get burned the most in an economic downturn (or bear market) are those who have fallen in love with one sector or one asset class. Their portfolios have become unbalanced, perhaps just because of the gains seen in the bull market.
Some investors opt for active portfolio management in recognition of business cycles, and their heavy influence on stock market cycles. Others choose to buy and hold, feeling that it is all too easy to mistime cycles while getting in and out of this or that investment class.
We have enjoyed a great bull run, and a new wave of prosperity has pulled many metro areas out of economic doldrums. At some point, times will get tougher. Whether you decide the appropriate response is to ride a downturn out or react quickly to it, a discussion with your trusted financial professional is a wise move.