Beware the Business Cycle

About 30 years ago, I came to the USA and had great difficulty finding a job as Civil Engineer. Most of my applications resulted in polite regret letters citing one reason or the other for the refusal. When I spoke to a friend (who had come here many years earlier), he told me that the reasons given in the letters were all nonsense. The real reason was that the companies had no jobs. I had committed the cardinal sin of arriving here during a business down cycle or economic contraction.  

At the time, I did not understand the full implications of what he said. Now however, after many years in the USA, I have lived through several ups and downs of the Economy and have a healthy respect for the Business Cycle. Further, I often hear about some acquaintances who have suffered heavy losses in their business start ups. These are hard working and intelligent people, but they started their business near the peak of a business cycle; consequently they paid almost the maximum price for purchasing their business, just before it was ready to go into a slump. Buying a business near an Economic cycle peak is a very risky move.

Different stages of the business cycle exhibit different characteristics-

Near the peak of a business cycle, you may observe the following:

Your commute takes longer (if you drive).

You have to park further and further from the train, (if you commute by rail).

You often have to stand in the train, bus or subway.

At the mall, parking may take several minutes to find.

Prices of groceries and gasoline go up almost on a weekly basis.

All your neighbors have purchased new, often bigger and luxury autos.

Your friends are putting up additions to their houses or remodeling their kitchens.

Handymen need 30 days notice for the smallest repair job.

People are very confident about the future.

Near the bottom (or trough) of a business cycle:

You often reach work early, because the commute is easier (if you still have a job).

You get comfortable seats in the train and good parking.

At the Mall, you park in under two minutes and the checkout is very quick.

The newspaper has many coupons for things you can actually use.

Repairmen are happy to come and give you a free Estimate for work.

People are gloomy about the future.       

So much for subjective observations. For more objective readings, an excellent source is the website of the National Bureau of Economic Research (NBER) at www.nber.org/cycles/. According to their studies, the last ten business cycles had an average duration of 67 months, with 57 months up and 10 months down. So roughly, we can say that we have 5 years of expansion followed by 1 year of contraction. Incidentally, the Economy last peaked in December 2007 and this was formally recognized in December 2008.

While the NBER readings are an excellent and authoritative source of information, their determinations are made several months after the peak or trough is over. If you are interested in anticipating a recession or recovery before it begins, the Stock market is an early predictor of a turn in the economy. For this, you can look at a chart of the stock market as represented by the S&P 500 index and superimpose the 150 day and 200 day averages. The averages are useful in smoothing out the day to day gyrations of the market and show the general direction, or trend of the market, as smooth lines. These lines serve as advance indicators. In an expanding economy, these lines have an upward slope. As the economy begins to weaken, these trend lines flatten out and gradually turn down. This is a fairly reliable sign that economic growth will soon turn negative. Several months later (say 9 to 18), these lines again turn up, signaling that the economy will soon be improving.

These trend lines can also be used as stock market entry and exit signals. In the 2000-2001, as well as the 2008 market meltdown, these signals could have saved the stock market investor from considerable losses, roughly 30-35% in each instance. So it pays to be aware of the Business Cycle.

Let me quote from the 1969 hit song “Spinning Wheel” by the pop group “Blood Sweat and Tears.”

“What goes up

must come down

spinning wheel

got to go around

talkin’ ’bout your troubles

it’s a cryin’ sin

Ride a painted pony

let the spinning wheel spin”

(Blood, Sweat & Tears, 1969)

In general, anybody who buys an economy-sensitive business or makes a large investment in the late stages of a business cycle, risks undergoing an experience involving “Blood, Sweat and Tears”, when the Economy does its next swan dive.