3 Economic Cycles: Explanation of Phases and Their Impact on Assets

The economy, much like a marathon runner, goes through cycles of growth and contraction. These cycles are known as economic cycles and consist of three main phases: economic expansion, recession, and recovery. Whether you're an investor, a trader, signal provider or even an everyday consumer, understanding these phases and how they affect different assets is crucial.
1. Economic Expansion Phase

The expansion phase is like a clear day after a period of rain. It's full of life and prosperity. During this phase, employment is high, unemployment is low, and economic activity is at its peak. Increasing demand leads to rising prices and interest rates, as the central bank aims to control economic growth.

Investors have a higher risk appetite during this phase. Think of it as a time when people are willing to invest in riskier assets to achieve higher returns. Stocks and certain commodities tend to perform well during this period. The market is confident in investing, aiming to earn a better return than what traditional savings accounts offer, which often fall behind inflation rates.

Companies show improved earnings and launch new projects, attracting more investors. Better company performance and increased risk appetite contribute to upward trends in the market. Similarly, commodities like oil experience high demand due to increased economic activity, such as manufacturing and travel.

Safer assets like bonds and safe-haven investments may see poorer performance during this phase. Since they're low-risk options, their returns tend to be lower, making them less attractive compared to higher-risk assets.

2. Recession Phase

Now, let's address the phase that often makes headlines with words like "slump" or "decline."

Yes, the stock market starts to tumble, and commodities follow suit. Other risk-based assets also come under pressure. But let's understand why this happens.

Imagine a typical family of four. Both parents are working, with $25,000 in savings and $25,000 invested in the stock market. During a recession, one parent loses their job, and the other faces a 20% pay cut. Stocks are considered riskier compared to savings accounts and bonds. Do you think they'll hold onto their stocks or sell them? Will they increase their savings and opt for safer assets?

During this period, investors have a low-risk appetite. They seek safety, often turning to savings accounts and bonds. This increased demand for bonds is evident. Moreover, economic activity decreases, leading to reduced demand for commodities like oil.

3. Recovery Phase

The recovery phase, or the "phew, that's over" phase for some, sees the economy and investment markets stabilizing. Unemployed individuals gradually find work, salaries start to rise, and economic activity picks up. All seems well, but what happens to tradable assets?

During this period, inflation tends to be high due to low interest rates and a lower supply of goods. This means that individuals need to earn substantial returns to preserve their wealth's value.

Let's revisit the same family example. They now have $30,000 in savings and $20,000 in bonds. Both parents are employed again, but their savings accounts offer only a 0.10% annual yield, and the bonds aren't performing much better.

The family might sell their bonds and reduce savings to seek higher returns. In this scenario, they could turn to the stock market, perhaps opting for $25,000 in stocks and $25,000 in a savings account.

This shift in demand toward stocks and an increase in commodity values due to higher demand for fuel and raw materials characterize the recovery phase.

In conclusion, while economic cycles may seem daunting, history has shown us that times of hardship are followed by recovery. By understanding how the market reacts to these cycles and current conditions, investors can make informed decisions based on their risk appetite and personal circumstances. Economic cycles are like a recurring pattern that, while challenging, ultimately leads to growth and renewal.