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    The Business Cycle cover image

    The Business Cycle

    Table of Contents

    1) Explaining the Business cycle ūüĆĬ†2) Economic activity cycles¬†ūüĆĬ†‚Äč3) Policy cycles¬†ūüĆĬ†‚Äč


    Explaining the Business Cycle¬†ūüĆĬ†‚Äč

    The Business Cycle is a series of upswings and downswings in economic activity. Economic activity is measured through growth and inflation data while heavily influenced by policy. Policies are formed by two separate but cooperative entities: Elected Government officials (Fiscal Policy) and Central Banks (Monetary Policy). Fiscal and Monetary Policies aim to grow the economy while avoiding recessions and inflation. However, like a feedback loop, policy is highly correlated to inflation and recession. The Business Cycle illustrates the short-termand long-term cycles of growth, inflation, and policy changes. These changes impact market participants' sentiments, positioning, and the overall psychology that leads to upswings and downswings in prices. By learning the Business cycle process, you will be able to identify periods of acceleration & deceleration in growth and inflation, changes in policy, and market participant psychology. 

    The Cycle of Economic Activity¬†ūüĆĬ†‚Äč


    Cycles of growth¬†¬†ūüĆĬ†‚Äč

    The following growth metrics are taken monthly, quarterly, and yearly, creating three-cycle durations. Investors use past data points to confirm a trend. Analysts provide a forecast to signal what the market should expect. Actual data points either confirm or deny expectations. Market reactions are strongly correlated to missed expectations.

    • Monthly cycles
    • Quarterly cycles
    • Yearly cycles
    • Actual data points
    • Past data points
    • Forecasted data points

    Reading the Businesses Cycle
    To Investors. "What matters?"
    The size of the market's reaction is correlated to how close or far the forecasted data (expectation) is from the actual data.¬†‚Äč
    Surveys are typically Leading Indicators, while hard data is generally Lagging. Surveys are typically measures of sentiment, while Hard data is factual. Use leading indicators to anticipate a trend and lagging indicators to confirm a trend. Leads and Lags will help you to anticipate the direction of the business cycle.

    GDP growthGross Domestic Product is the total market value of all goods and services within a country's borders. The GDP growth rate (MoM & YoY) is critical in determining whether growth accelerates or decelerates. 
    • Annual GDP growth rate [GDP annual rate data]
    • GDP Growth Rate [GDP growth rate data]
    • GDP from Agriculture¬†
    • GDP From¬†Construction
    • GDP from¬†Manufacturing
    • GDP from¬†Mining
    • GDP from¬†Public Administration
    • GDP from¬†Services
    • GDP from¬†Transports
    • GDP from¬†Utilities
    Business growth (supply side)Business growth reflects the economic conditions of businesses on the supply side of goods and services. Consumer growth (demand side)Consumer growth data reflects the economic conditions of consumer behavior on the demand side of goods and services. It's important to note that services make up ~70% of the economy.‚Äč Labor Market growthLabor market data reflects the economic conditions of the supply and demand of labor measured by the BLS (Bureau of Labor Statistics). The stronger the labor market, the more productivity can keep prices affordable, giving workers and consumers more buying power.

    Takeaway

    • Headline growth data helps determine the current and future market conditions to which markets react.

    Example

    • In 2020, the $2.2 Trillion U.S. stimulus caused massive consumer spending in online retailers due to the pandemic. Although the Labor market was decimated, Amazon, the world's largest online retailer, appreciated 118% in just 5 months.


    Cycles of Inflation¬†¬†ūüĆĬ†‚Äč

    Inflation eats up consumer wages, spending, and business investment. Inflation accelerates when there's a supply shortage relative to growing demand. Investors fear inflation when it gets out of control.Consumer InflationConsumer inflation reflects the condition of inflation on consumers

    Producer InflationProducer inflation reflects the condition of inflation on businesses. 

    Takeaway

    • High inflation negatively impacts consumer spending, business investment, and, ultimately, markets.

    ‚Äč
    Example

    • In January 2022, inflation hit a 40-year high, causing extreme fear and sending many stocks to their 52-week lows.

    The Cycle of Policy¬†¬†ūüĆĬ†‚Äč


    While monetary policy dictates interest rates and money supply growth, fiscal policy determines the government's spending and tax policy.

    Monetary policy determining Interest rates [Fed Funds Rate data]


    ‚ÄčCentral banks directly control interest rates by increasing,¬†decreasing, or remaining neutral on the Federal Funds Rate.

    • Interest rate decisions are scheduled quarterly.
    • Decisions can happen in emergency announcements.
    • Fed officials give policy expectations through monthly & quarterly scheduled speeches. [FOMC meeting data]

    • Rate hikes are classified as¬†hawkish policy, while rate cuts are classified as dovish policy.

    Monetary policy controls the money supply. [Balance sheet data]Central Banks can increase or decrease the money supply on their balance sheet. 
    • Changes in the money supply are reached by a committee and proceeded by scheduled announcements and speeches.
    • Money supply increases represent periods of¬†Quantitative Easing¬†where the Fed's balance sheet expands and is called dovish policy.
    • Money supply decreases represent periods of Tapering¬†where the Fed's balance sheet is reduced and referred to as hawkish policy.


    Takeaway

    • Hawkish policies may hinder markets while dovish policies can stimulate markets.

    Example

    • Following the Covid crash of 2020, Fed officials responded with an emergency meeting to cut rates & accelerate QE. Within six months, the Stock market recovered to new all-time highs, making the event the fastest recovery from recession in all recorded history.

    Fiscal policy determines tax policy.  Elected gov officials vote on individual and corporate tax policy. 
    Fiscal policy determines government spending.Elected government officials vote on social, public, and private spending.
    • Social, public, and private spending stimulates growth in services, infrastructure, technology, and job creation.
    • ‚ÄčGov spending data‚Äč

    Takeaway 
    • Looser tax policies and government spending stimulate markets, while a lack of government spending and tighter tax policies may hinder markets.
    Example
    • ‚ÄčFollowing the COVID-19 crash of 2020, government elected officials decided to distribute stimulus checks to individuals and businesses, injecting a total of $3.5 trillion into the economy. Eighteen months after the bottom of the recession, the stock market doubled in value.


    ConclusionThe Business cycle is a series of short-term and long-term signals that investors use to speculate on the future path of markets. Each cycle's duration and velocity are never identical to the last, although they deliver a framework of what's to come. Economic growth is driven by spending and business investment, while monetary and fiscal policies work together to stabilize & improve economic conditions. Central banks and governments are subject to policy mistakes that can significantly impact economic growth and markets. Simply put, what goes up must come down, and vice versa. That's the Business cycle.

    Key Takeaway

    • Learning to utilize the Business cycle provides an edge to decision-making because it encompasses relevant data points & policy mechanics to foresee how the market could react.

    Example

    • The 2020 Covid Crash caused the fastest & deepest recession in all recorded history. The Fed responded with strong dovish Policy intervention, leading to the fastest recovery in history. As growth & markets soared in the following years, so did inflation, to levels not seen since the 80s. As inflation revealed itself in the headline data, markets violently corrected in anticipation of hawkish Policy.



    Here's where you can track the business cycle:¬†Economic Activity & Policy Calendar‚Äč
    Fed Beige Book: October release post photo
    economics

    Fed Beige Book: October release

    This Summarizes comments received from contacts outside the Federal Reserve System and is not a commentary on the views of Federal Reserve officials.