Investing in Economic Cycles: Understanding Indicators, Phases, and Risks during a probably recession
We have put together the various stages of an economic cycle, and our most used macro economic indicators, the ones we are always watching. Furthermore, we are also highlighting risks of investing during a recession, and the opportunities that it comes next.
Understanding Economic Cycles: Indicators, Phases, and Risks
The economy is always changing, and investing in economic cycles can be a wise choice for investors looking to maximise their returns. To invest wisely, however, it is critical to understand the various economic indicators, phases, and risks involved in economic cycles.
Stages of Economic Cycles and How to Apply Into Your Investment
The fluctuation of macroeconomic indicators such as production, consumption, investment, jobs, and prices is referred to as an economic cycle. An economic cycle, according to the National Bureau of Economic Research (NBER), is a recurring pattern of expansion (growth) and contraction (recession) in the overall economy. The NBER uses changes in these indicators to identify different phases of the economic cycle, with a typical cycle consisting of four stages: expansion, peak, contraction, and trough.
During the expansion phase, the economy grows and businesses thrive. The peak phase is the top of the economic cycle and is often characterised by high levels of economic activity and an overheated market. The contraction phase, also known as a recession, is when the economy begins to contract and businesses begin to fail. The trough phase is the bottom of the economic cycle, and it is characterised by a slowing economy that is beginning to recover.
Investors can tailor their investment strategies to the various stages of the economic cycle. During the expansion phase, investors can concentrate on growth stocks to capitalise on the market’s momentum. Investors can begin to adjust their portfolios to prepare for the impending recession during the peak phase. Investors should concentrate on value stocks and exercise caution when investing in the market during the contraction phase. Finally, as the economy begins to recover during the trough phase, investors can begin to look for opportunities to invest in the market. (Note that in the picture above, we have highlighted the sectors that ten to outperform in each stage of the cycle, obviously, you need to identify when each cycle is ending to take advantage of the stocks set to outperform in the following stage).
Why we believe we are likely to go into recession?
Because this week. 2/10 part of the curve inverted, implying that 2-year Treasury yields were actually higher than 10-year Treasury yields. This is a red flag for investors that a recession is on the way.
We are going into more details about what exactly this macro-economic indicator is so important, so keep reading and learn!
Unsustainable Growth and Liquidity Deterioration
Investing in economic cycles is not without risks. One of the main risks is unsustainable growth, which often results from credit expansion without real funds in deposit. This can lead to a wave of negligence that can have a direct impact on the economy, as we have seen with the collapse of the subprime mortgage market in 2008.
Another risk is liquidity deterioration, which is often influenced by Reserve Banks. This can occur when banks, companies, and investors build unsustainable projections based on past economic scenarios, assuming that demand would stay high and interest rates would stay low forever. When this does not happen, it can cause a cascade effect and chain reaction that can be detrimental to the economy.
Economic Indicators to Understand the Stages of Economic Cycles and How to Apply Into Your Investment
As economies grow and develop, various economic indicators fluctuate. While some changes can be predicted and controlled, others are unexpected and can have a significant impact on the economy. The recent COVID-19 pandemic is a prime example of how unexpected events can have far-reaching economic consequences.
As a result, it is critical to monitor economic indicators in order to identify trends, forecast future outcomes, and make sound macroeconomic decisions. In this tutorial, we will look at some of the most important economic indicators to keep an eye on.
Rates of Unemployment Unemployment rates are an important indicator to keep an eye on. After a recession has already begun, unemployment rates tend to rise. A significant rise in unemployment rates indicates a slowing of economic activity, which can lead to a recession. This indicator is especially useful for policymakers and businesses because it provides information about the overall health of the labour market.
US Yield Curve
🚩 In March US Yield Curve Inversion Deepens, Increasing Likelihood Of 2023 Recession
The yield curve has now completely inverted. Three-month rates are significantly higher than ten-year yields on US government debt. The current inversion is deeper than before the financial crisis and the 1990 recession, but it is not yet at the level seen before the 2000 dot-com crash.
It is a critical indicator to monitor is the US yield curve. The yield curve shows the relationship between short-term and long-term interest rates for US Treasury bonds. A normal yield curve is upward-sloping, which means that long-term interest rates are higher than short-term interest rates. However, an inverted yield curve, where short-term interest rates are higher than long-term interest rates, is a predictor of a recession.
US Yield Curve and Financial Crises The US yield curve has also been found to be a reliable predictor of financial crises. In particular, when the yield curve is flat or inverted, it suggests that the market believes that interest rates will fall in the future. This, in turn, can lead to excessive borrowing and risk-taking, which can result in a financial crisis.
The Purchase Management Index (PMI)
🚩 The ISM Manufacturing PMI edged higher to 47.7 in February of 2023 from 47.4 in January, which was the lowest since May 2020, but fell short of expectations of 48. The reading pointed to a fourth consecutive month of falling factory activity with companies continuing to slow outputs to better match demand for the first half of 2023 and prepare for growth in the second half of the year.Â
PMI – is another crucial economic indicator that measures the activity of procurement managers. The PMI is used to gauge the health of the manufacturing sector and can provide insight into the overall state of the economy. A PMI reading above 50 suggests that the manufacturing sector is expanding, while a reading below 50 indicates contraction.
Consumer Confidence Consumer
🚩 U.S. Consumer Confidence Fell Sharply in February
Confidence is a measure of how optimistic or pessimistic consumers are about the economy’s future. When consumers are confident, they tend to spend more, which can boost economic growth. Conversely, when consumer confidence is low, they tend to save more, which can lead to a decrease in economic activity.
Yields Spread US High Yield Corporate Less 10 Years US Treasury Bonds The Yields Spread
🚩 This week. 2/10 part of the curve inverted, implying that 2-year Treasury yields were actually higher than 10-year Treasury yields. This is a red flag for investors that a recession is on the way.
US High Yield Corporate Less 10 Years US Treasury Bonds is another important indicator to monitor. It measures the difference between the yields of high-yield corporate bonds and US Treasury bonds with a maturity of less than ten years. When the spread is high, it suggests that investors are willing to take on more risk, which can lead to higher economic growth. Conversely, a low spread suggests that investors are more risk-averse, which can lead to lower economic growth.
New US Corporate Security Issues
New US Corporate Security Issues is a macroeconomic indicator that measures the credit risk associated with investing in corporate bonds issued by US corporations.
This indicator tracks the number of corporate bond issues that have had their credit ratings lowered by credit rating agencies like Moody’s, Standard & Poor’s, or Fitch. A credit rating downgrade indicates that the issuer’s creditworthiness has deteriorated, indicating an increased likelihood of bond default.
🚩 As we can see, there is significant decrease in the number of new US corporate security issues can be a warning sign for a possible economic downturn or recession. However, it’s important to understand that we are also combining it with other key indicators.
The Proportion of Growth Indicator providing Bearish Signal
The proportion of growth indicators providing a bearish signal is an economic indicator that measures the number of economic indicators in a given economy that are indicating weakness or decline.
A bearish signal is an indicator that the economy is slowing or contracting, indicating that economic growth is slowing or contracting. Reduced consumer spending, slowing GDP growth, rising unemployment rates, and other negative trends are examples of these signals.
The proportion of growth indicators that provide bearish signals is calculated by dividing the number of growth indicators that provide bearish signals by the total number of growth indicators. A high proportion of bearish signals indicates that the economy is facing major challenges, whereas a low proportion of bearish signals indicates that the economy is doing well.
When is the next big rally?
Because the Federal Reserve’s monetary policy has been the tightest since the 1980s, the majority of the world economy is in severe contraction, far worse than most analysts have anticipated back in 2022. During severe economic contractions, the stock market tends to underperform and remain in a bear mode;
🚩 In the 1980s and during the GFC, we saw a significant decline in equities during the pivot of interest rate hikes, and it is not until the first interest rate decline that markets begin to respond, eventually shifting from contraction to the next recover stage.
It is critical to detect such as shift, which is yet to be seen, potentially by mid-year.
We hope it helped you to understand a bit more about the key macro-economic indicators and why we believe we are going into recession.
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