Understanding Economic Cycles and Investment Strategy
By Vaughn Woods, CFP, MBA
Knowing how the economic cycle works makes you a better investor. The economic cycle is defined as the fluctuation of the economy between periods of expansion (growth) and contraction (recession). Factors such as gross domestic product (GDP), interest rates, total employment, and consumer spending, can help to determine the current stage of the economic cycle.
So, when it comes to the economic cycle several crucial questions arise to aid your understanding of the securities markets. Here they are: How long do most economic cycles last? Which period of the economic cycle offers investors the best returns? Why is prudent asset allocation so connected to the economic cycle? Key factors to understanding economic cycles will be detailed here. Foremost among these factors is that keeping up with the economic cycle can make you money.
This keeping up is what we do for you. Each day brings new data requiring study. Each monetary and fiscal event requires valuation calculations. Each geopolitical and structural event can affect corporate earnings and future earnings estimates. understanding economic cyclicality.
All investment returns are economic cycle starting-point dependent. So, when you read or hear people talking about prudent investing being defined by a 3–5-year commitment it is largely due to the likelihood of participating in portions of the expansion and contraction cycles.
To maximize profits, it is necessary to invest ahead of a cycle. Thereafter, selling into the upside after, perhaps, years can be a good strategy. However, before selling for a profit both the next cycle and the effects of short and long-term capital gains must be considered. This too, is done for you. It is what we do. Unlike funds which are required to pass on trading gains annually no matter your tax situation, we account for your unique needs with your input. That is why we call it personal portfolio management.
Economic expansions can last 5 -10 years or longer. Recessions are historically shorter, though they can last several months to several years. The bad news is a recession follows each expansion. The good news is that each recession is followed by an expansion.
The Covid-19 shutdown recession is still ongoing according to some analysts. Their thinking is the U.S. is still in recession. Some 14 million workers are still unemployed. Millions more are underemployed.
As we reenter an expansionary phase in the economic cycle it may be of value to recall cycles over the last thirty years. Since the recession that started in July of 1990, 4 expansionary phases have occurred. The first expansion lasted 7 years and 8 months. The second lasted 10 years. The third lasted 6 years and 1 month. The fourth lasted 10 years and 8 months before being disrupted by a government lockdown. So, our current event-driven recession began in February of 2020 and ended some 14 months later, though no end date has been set in stone. Using the fourteen-month end date to our most recent recession, the average length of the last four recessions is 12 months.
Economic cycles teach us the best times to invest. During every economic cycle there are two best times to invest. They are (1) in the first twelve-months of a new cycle after the recession is over and (2) within the twelve-month period before you get your head handed to you as a new recession unfolds. Alan Greenspan famously called this second period before recession, Irrational Exuberance in that this final phase is marked by abundant and unsupportable enthusiasm.
Even as I write this to you, growth and income portfolios across the world are being adjusted to account for the potentiality of upcoming economic strength or weakness. On the weakness side we find growing fears of a possible new wave of contagion (SARs-CoV-2 Delta variant) and a heavily supported bond market, suggesting people want protection from an ongoing recession. On the strength side we find predictions that US GDP will grow at some 6% for 2021, 4% in 2022 and 2% in 2023. If these numbers are close to being accurate it suggests that the corporate profit cycle could become and remain expansionary for years to come.
Vaughn Woods, CFP, MBA
Vaughn Woods Financial Group, Inc.
2226 Avenida De La Playa
La Jolla, CA 92037
Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0263
Marketedge.com, Investopedia, Statista.com, Wikipedia