Stages of the business and economic cycle. Business and economic cycle. Now, the phrase business and economic cycle are used interchangeably and they're essentially the fluctuations found in the aggregate economic activity of countries. And they have four phases, an expansion and a contraction, obviously, an upward movement in economic and activity and a downward movement in economic activity and peaks and troughs. And the peaks and troughs represent turning points or inflection points in the cycle. Now, periods of expansion occur after the trough or the lowest points of the business cycle and before the peak which is the highest point. In contraction, comes after the peak and before the trough. The contraction you may hear often called as a recession or even for especially severe situations. A depression is a period in which aggregate economic activity is declining. Now, these fluctuations occur over time. But generally, they revolve around a long-term uptrend in economic activity. And the full business cycle is essentially the full sequence of all these events and it's recurrent, meaning it happens over and over again over time. But one keynote is that the duration and severity can vary widely. Now, historically, in terms of duration, business cycles can generally vary from just over a year to as long as 10 to 12 years. And in terms of severity, the recent financial crisis that we saw last decade is an example of a severe recession and in fact, the worst downturn in over 80 years. Now, why is the business cycle important? Why is it important to analyze? Well, you may have heard the phrase, history never repeats itself but it can rhyme. Well, this speaks to us along those same lines. It's certainly helpful for us to evaluate patterns that we can use to analyze not only the present, but also forecast a future. Some other key points around the business cycle. First, consumers and businesses can either lag or lead the trough or peak inflection points that we mentioned. For example, at the beginning of an expansion phase, companies may want to fully utilize their current workforce and wait to hire new employees until they're sure that the economy is indeed growing from the trough that they experienced. Also, if the central bank reduced interest rates to stimulate the economy during a recession, it may slowly start to increase rates, not right away, but slowly start to increase rates toward historical norms only once they confirm a transition of the economy off of a trough. The important point here is that it's very difficult to identify an inflection point at the time. It's only in retrospect can we truly determine when the economy turned either up or down. Next, and thankfully for us, contractions have generally been shorter than expansions historically here in the U.S., meaning that we've recovered relatively quickly from recessionary periods. Next, government securities and non-cyclical sectors like utilities and consumer stables tend to outperform during recessionary periods. During a recession, investors play a relatively high value on safe assets like government securities and companies with steady positive cash flow like utilities. And that's because the importance of a safer income stream increases in periods of unemployment or when employment is declining. On the other hand, when asset markets expect the end of a recession or the beginning of an expansion phase, risky assets will be repriced upward and tend to outperform. The markets will start incorporating higher profit expectations into prices of corporate bonds and stocks particularly those of cyclical companies. Now, in often stated rule that you'll hear about recessionary periods is that recession is when a country sees two consecutive quarters of negative real GDP growth. Now, as you can see, this is very backward-looking. And typically, the equity markets will hit a trough or bottom three to six months before the economy bottoms or before we hit those two negative quarters of GDP growth. And that's why the equity stock market is classified as a leading indicator of the economy. Now, the equity markets aren't always right in their leading indication but there are always there attempting to forecast future economic growth. And lastly, signs of a late expansion or a potential inflection point or overheating of an economy which you may hear, comes with certain characteristics which include difficulty in corporations finding workers, increasing wages, higher inflation and prices, and higher leverage for individuals and corporations. Now, the latter part of an expansion phase is often called a boom. Now, the boom is when essentially, we are testing the limits of the economy. For example, companies may expand so much that they have difficulty finding qualified workers and they'll compete with other companies for these workers. And this would result in rising wages. And the rise in labor costs may then lead to a reduction in profits for the corporation overall. Now, central banks, investors, analysts, always looking for signs of that late expansion or that overheating type of inflection point. After all, just like an engine of a car that has been pushed to an excessive level, an economy can overheat also.