Look for Silver Lining in Current Business Cycle
Stocks Make Biggest Gains During Recovery and Expansion Stages
Oct 12, 2009
But whether the recovery and expansion phase of the cycle comes quickly or gradually, the good news for stock market investors is that the expansion phase of any business cycle is a silver lining. During those months stocks go up more than at any other time.
Furthermore, the old canard, "Everybody talks about the weather but nobody does anything about it," certainly does not apply to business cycles. Those rolling ups and downs of economic activity- symbolized by significant changes in Gross Domestic Product (GDP) – are constantly discussed by those in charge of things.
Federal Reserve Chair Ben S. Bernanke and Treasury Secretary Timothy Geithner talk about them, possibly in their sleep. So do Chair Christina Romer of the Council of Economic Advisers, and Larry Sommers, Director of the White House National Economic Council. As for their boss, President Barack Obama, he listens.
Business Cycles Have Four Phases
A business cycle is the periodic but irregular up-and-down movements in economic activity, measured by fluctuations in real GDP as well as many other macroeconomic variables, according to the Internet economic guide About.com:Economics.
There are four stages to one of these wave-like economic adjustments:
- Peak – A point when an economic expansion slows, totters, then stops and begins sliding downward.
- Contraction – A period of indefinite length, when the general economy has slowed down and moves like a lazy snail.
- Trough – A bottom of the contraction, when economic activity sprouts like the first crocus in spring and growth resumes.
- Expansion - A period of indefinite length, when the general economy changes gears, from a clunker’s grinding crawl to an accelerating Ford or maybe even a Maserati.
NBER Business Cycles Measure Duration of Economic Activity Not Volumes
Economists Wesley C. Mitchell and Arthur F. Burns were pioneers in the research of business cycles. Mitchell was a founding member of the National Bureau of Economic Research (NBER). That is the group of professional economists who don referee’s stripes, yellow flags and lanyards to blow the whistle on the starts and stops of business cycles, in terms of its peaks, contractions, troughs and expansions.
However, rather than gauge the intensity of economic activity, NBER simply establishes the length of time consumed in each stage. Thus, there are are short cycles and long cycles, and they are measured in months.
Recovery and Expansion Wall Street's Other Season to be Jolly
Christina Romer, writing in The Concise Encyclopedia of Economics, indicates all modern industrial economies, including the US, undergo swings in economic activity. The spells of prosperity or expansions and periods of decline or recessions combine to form waves of economic activity, producing the phenomena called business cycles.
When the expansion phase commences, recovery is underway, a goal so eagerly anticipated by the brain trust that engineered the financial bailout and stimulus. It is the period most exciting for investors, for it is the springtime of corporate growth and Wall Street's other season to be jolly.
US Now in Its 12th Recession Since 1945
Since World War II, NBER has called 11 business cycles. The 12th one is in progress presently, one in which the economy is in the contraction or recession stage, after peaking in December 2007.
In October this year, besides another front door scramble of Halloween spooks, a new scary jack-o-lantern will haunt the US. The current recession will enter its 22nd month, the longest contraction since the Great Depression of the 1930s. That one went 43 months. Since 1945 the average recession has lasted ten months.
Best Investment Time Awaits Investors
For stock market investors the time for shine will be after the trough, when the eagerly-awaited expansion begins. Since WW II, the average expansion has lasted 57 months and the mean stock market growth during the expansion has been 57.6%, with a range -7.3 to 218.5%. On the other hand, stock performance from peaks to troughs during the same time period resulted in gains of only 3.5% per contraction.
Returning to the stock gains in the expansions, the minus growth of 7.3% was the only negative one occurring in the post WW II expansions. The political troubles brewing between North and South Korea before North Korea invaded South Korea in 1948, could explain the stock market weakness then.
If they have the option, the obvious conclusion for investors is to wait for the expansion stage to buy stocks, unless they are aware of special situations that are expected to move independently of the market; or, their funds are embedded in continuous investment programs, over which they have no control.
Expansions are the silver linings in the clouds, after a stormy stock market decline. They are the golden times, when bull markets mint new millionaires.
The writer is a Chartered Financial Analyst (CFA).
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