What Stage of the Business Cycle Are We in?

Whether it is the best of economic times or the worst of economic times, one thing is certain: change is coming. That’s because the economy is always in motion, passing through a four-stage expansion and contraction cycle marked by peaks and troughs. 

Of course, the timing of that cycle isn’t set in stone. In some cases, the economy thrives for a decade or more before declining into a recession. Since 1969, the average recession has lasted 12 months, with the shortest at just six months and the longest at a full 18 months. 

The business cycle functions in much the same way as the economic cycle due to forces like supply and demand, whether and how much capital is available, access to credit or lack thereof, and general expectations about the future.

In the early stage of expansion, it grows, expands, and gains strength. This is a period of recovery from the most recent recession. In the mid-stage, the business cycle reaches its peak before transitioning into the late stage when it begins to contract.

Finally, in the fourth stage, there is recession or contraction, and the cycle hits its lowest point—a trough. Businesses can expect a period of hardship before the cycle begins again. 

Over the past two years, the global economy has been in a constant state of flux, moving through the standard cycle in unusual ways. The COVID-19 pandemic created unprecedented challenges for businesses in every industry, but that hasn’t changed the underlying business cycle. 

So, what stage of the business cycle are we in today, and how long might this stage last before there is another change? More importantly, what is the best investment strategy for current conditions, and how can investors prepare for the next stage? 

What Stage of the Business Cycle Are We in Today? 

Determining what stage of the business cycle we are in today requires an understanding of the distinctions between each phase. The early stage, a period of expansion, is marked by consumer confidence. People are spending because they have a high degree of certainty that income will grow reliably and stock prices will go up. 

During this period, demand for various goods and services increases, which means businesses hire more workers. That contributes to demand, which keeps the trend moving in a positive direction. There is often some inflation during this early stage but no cause for concern. 

In the mid-stage, expansion hits a peak. Demand outstrips supply because there is too much money available to consumers. Inflation becomes problematic.

Certain assets see their values bubble—a situation in which prices rise so quickly, they become disconnected from the asset’s intrinsic value. Examples include the dot-com bubble that burst in 2001 and the real estate bubble that sparked a global financial crisis in 2008-2009. 

In the third phase, a period of contraction that leads to recession, the trend starts to point downward. This can be caused by excessive levels of inflation, a sudden increase in interest rates, or another type of financial crisis.

Consumer confidence begins to waver, and demand for goods and services starts to wane. Investors rethink their portfolios and move assets from stocks to bonds, gold, and other low-risk options, and businesses find themselves in the position of reducing their workforce and holding onto their cash. 

Finally, in the fourth stage, there is little or no demand as consumers focus their spending on necessities. Unemployment levels grow, and businesses falter if they do not have the cash to see them through to the next period of recovery. 

With all of that in mind, most experts agree that we are currently at the business cycle’s peak (or just over it) and starting to descend. It is unlikely that fiscal and monetary policies, which have been exceptionally supportive since the April 2020 trough, will continue to provide the same level of support in the coming months. 

Meanwhile, businesses cannot find enough workers, and the supply chain is under immense strain. That means demand is currently far higher than supply, as consumers still have plenty of cash on hand due to slowed spending during the pandemic. 

Inflation is picking up, and some suggest it is (or is about to become) a serious issue. All of these elements suggest that we are currently in the mid-stage of the business cycle—and that fact has investors asking what they should do next.

Will The Stock Market Crash? 

The April 2020 trough was preceded by a shocking stock market crash. On March 16th  alone, the Dow Jones Industrial Average declined by nearly 3,000 points, breaking records for the largest single-day drop in history.

From a percentage perspective, it was the third-worst drop ever experienced in the United States. However, the market made a speedy recovery, reaching record highs by the end of the year. 

The good news is that a contraction in the business cycle doesn’t mean the market will crash right away at least; it does mean however a period of recession, and experts are still debating exactly how serious the next contraction and subsequent recession will be. Fortunately, there is a strategy for riding out the ups and downs of business, market, and economic cycles with minimal stress. 

What Is the Best Investment Strategy for the Recession Stage of the Business Cycle? 

When a downturn is expected, many investors panic. That leads them to sell stocks in favor of safer assets, which in turn hastens the onset of a contraction and the depth of the related trough.

This panicked selling disrupts carefully planned investment strategies, which often leads to unnecessary losses. However, there is an alternative that typically offers more reliable results. 

Assuming the timing of investment goals allows some flexibility, the best strategy for riding out all stages of the business cycle is this: buy quality stocks and hold them for the long-term. 

Even better, add shares when contractions force stock prices down through dollar cost averaging. As the business cycle enters the early/recovery stage, quality stocks regain their value and often go on to achieve new highs. 

While this seems counterintuitive, to buy as stocks fall, it’s precisely the strategy Warren Buffett has advocated and practiced for enormous success. In his words, be greedy when others are fearful.

Best Stocks for Each Stage of the Business Cycle 

Investors interested in a tailored strategy for specific stages of the business cycle typically find themselves buying the following: 

• Early/Expansion Stage – In the early stage of the business cycle, the market is recovering from the most recent trough. Growth rates are high, and the most economically sensitive sectors see the biggest gains. Examples include consumer discretionary, industrials, and technology.  
• Mid-Cycle Stage/Peak – In the mid-cycle stage, the entire economy is thriving, and generally speaking, no single sector outperforms the others. With that said, individual companies can still outperform their peers, which is why careful research is a must before adding any stock to your portfolio. 
• Late Stage/Contraction – As the business cycle enters a downturn, consumer discretionary, industrials, and technology see slower growth. Investors show more interest in less economically sensitive stocks like utilities, energy, healthcare, and consumer staples, and that’s where most of the gains occur. It’s important to note that the gains in these types of stocks are modest during the contraction stage. 
• Recession – During the recession stage, it is unusual for any sector to do particularly well, though some individual companies may achieve higher-than-average gains. Investors tend to hold onto stocks in consumer staples and similar industries because they don’t have the same losses that consumer discretionary stocks experience during difficult economic times. 

What Are the Best Stocks for the Stage of the Business Cycle We Are in Now? 

Some companies are better positioned than others to withstand the downside of the business cycle.

Investors interested in preparing for a future contraction and recession may wish to consider companies like Amazon (AMZN), Duke Energy (DUK), and Visa (V).

Other options include Alphabet (GOOG), Bristol Myers Squibb (BMY), and Mastercard (MA). Each of these companies is in a market leadership position, and they provide what can only be described as recession-proof goods and services. 

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