Business Cycle by Rachel Bleich

The Business Cycle

What is the business cycle? How does it affect me? More and more, we hear about the business cycle in our ever-changing economy, but to fully understand just what we are hearing, we need to dig deeper. Once we comprehend what the business cycle is and what it does, then we can recognize the impact it has in daily life.

The business cycle, by its most common definition, is a period that extends from a peak in economic activity, through a following recession, recovery, and expansion until the next peak in economic activity is attained. The definition could also be looked at as a period extending from a trough in economic activity, through recovery, expansion, a peak, and recession until the next trough, or low point, in economic activity is reached. This cyclical movement is caused by changes in economic forces; one of the most common forces that affects business situations and the business cycle is aggregate demand, which can be looked at through the components of demand that make up the GDP. The relationship that represents aggregate demand is the sum of household expenditures (personal consumptions expenditures and residential investment), business expenditures (nonresidential investment), net exports, and government spending. All of these separate entities work together to create aggregate demand, whose fluctuations affect the macroeconomic forces that affect the business cycle, thus affecting each and every one of us.
The rise and fall in economic activity, also known as the business cycle, affects everyone in their daily life. As economic activity rises and the business cycle is expanding towards a peak, people make more money, invest more money, and feel more capable of spending more money. When the economic activity cycles towards a trough or recession, people make less money with some people losing jobs, and people feel less able to invest and spend money. How the economy is faring determines what we do with our money, which affects what we do, buy, wear, etc. This feeds into the household expenditures factor in aggregate demand, which is further proof of the relationship we have with the business cycle. When business expenditures, net exports, and government spending are thrown into the mix, it is easy to see how each part of demand works to influence the business cycle, and ultimately the average person.

The business cycle is an ever-changing rise and fall in economic activity that affects everyone, but it is also affected by everyone. It lives in a symbiotic relationship with household expenditures, business expenditures, net exports, and government spending as fluctuations occur. The important thing to remember is that no matter where the economy is in the business cycle, the cycle will continue and economic activity will change. So, although we maybe at a low point in economic activity, we will cycle into another expansion. The business cycle: it happens.

Congratulations, You Have Survived the Worst Business Cycle of Our Generation

From an investment viewpoint, you have survived the worst business cycle of our generation. It will be wonderful when the ecomony begins an upswing and we start the next business cycle. Congratulations, you have one more thing to be thankful for this Easter!

This week the US stock market recorded the best 5 week return, of about 30%, in the last 70 - 80 years. It is very doubtful that another 30% return will occur in the next 5 weeks. Since the economy is improving, is also very doubtful that the stock market will return to the low seen 5 weeks ago.

What is important to learn is that it is important to be a disciplined investor. Let's go back 5 weeks, most of the experts on TV talked about how bad things were and to avoid investing in the US stock market. As an investor, you were better off to maintain discipline and continue with your gameplan. Anyone who put money into the US stock market during the past 5 weeks had to have courage and overcome fear.

Now what does an investor do since the US Stock Market has rebounded? Follow your gameplan and maintain investing discipline. Noboby knows what will happen to the US Stock Market in the short term. In the longer term, the stock market increases as the economy improves.

Enjoy your Easter! Your Christian faith and relationships with Family and Friends are the most important things you have!

Index of Leading Economic Indicators

The last blog covered the current status of the United States Business Cycle based upon the most recent Gross Domestic Product, GDP, report. In the news, we hear doom and gloom and the discussion of the r word, recession. Based upon the GDP report, our economy is still expanding and not in a recession.

Previous blogs looked at three categories of economic indicators: leading, coincident and lagging indicators. Each category contain a grouping of individual indicators. These individual indicators within a category rarely if ever all are going in the same direction, up or down. Some very smart people figured out that you could give each individual indicator within a category a weight and a score. Once the score was tallied it could be called an index.

The end result is today we have an index of leading economic indicators, index of coincident indicators, and index of lagging indicators. Smart people figure this out every month and report it on a monthly basis.

What is the value of a monthly index of leading economic indicators? To Warren Buffet, it means very little as he stated during his annual meeting last weekend. Warren has a very long term view that goes beyond the timeframe of a single business cycle. To me, it gives me a sense of direction. It would mean a great deal if I was investing in options, which I do not.

It feels like things were better the middle of last year. Then things got worse last year until early this year, Not it feels like things are getting better again. This is what the stock market told me. The GDP numbers do not indicate this as the number has always been positive. Something else must be a better indicator than GDP.

If you look at the index of leading economic indicators, from September 2007 through March 2008, we see where the economy went down and in March is now positive once again. This makes me feel good about the direction of our economy and the US stock markets.

If you could choose between watching news reports or the index of leading economic indicators for investment advice which one is best? The answer is the index of leading economic indicators.

Current Status Business Cycle

Yesterday, April 30th, GDP was reported to have increased by 0.6% for the 1st Quarter of 2008. This period is from January - March 2008. I saw President Bush on TV giving a speech talking about how the economy had slowed and did not mention anything about a recession. I did not see any of the Democratic Party candidates talk about this economic data.

When GDP is negative for 6 months it indicates that our economy is in a recession. If the Quarterly GDP had been negative, the Democratic Party candidates would have been much more vocal. The data means that our economy is not in recession.

An excellent websites on economic data is www.bea.gov. This the website for the U.S. Department of Commerce, Bureau of Economic Analysis. GDP is reported 2 ways, in current dollars and inflation adjusted dollars. The below table shows Current GDP, in both current dollars, and Real GDP based upon 2000 dollars. Real GDP based on 2000 dollars is less than current dollars due to inflation.

Quarter/ Current GDP/ Real GDP (2000 Dollars)
2007Q1/ $13,551.9 Billion/ $11,412.6 Billion
2007Q2/ $13,768.8 Billion/ $11,520.1 Billion
2007Q3/ $13,970.5 Billion/ $11,658.9 Billion
2007Q4/ $14,074.2 Billion/ $11,675.7 Billion
2008Q1/ $14,185.2 Billion/ $11,693.1 Billion

This data shows that in current dollars GDP increased by $101 Billion or about 0.8%. Real GDP, taking out the impact of inflation, GDP increased only $17.4 Billion or about 0.1%. For the last 4 Quarters, GDP has increased in each Quarter with the last 2 Quarters having less growth.

Where are we in the Business Cycle? We are still in an expansion. We are not yet at the peak. We are not in a contraction. Does the news reports indicate that we are still in an expansion stage of the business cycle? No, it sounds like we are in a recession. Leading economic indicators suggest that we are not headed for a recession.

Bottom Line: If you invest by the news reports instead of real economic data, you will make very poor choices. Keep the faith in your investments.

Business Cycle Lagging Indicators

The previous blog gave information on the coincident indicators for a business cycle. This blog gives the lagging indicators or the indicators that will change in the future after a change in the Gross Domestic Product, GDP.

These lagging economic indicators include:

• Average Duration of Unemployment
• Labor Costs
• Corporate Profits or Earnings
• Consumer Debt Levels
• Commercial & Industrial Loans
• Business Loans

As GDP increases, Unemployment goes down (more people working), labor costs go up (more people working), earnings go up (higher revenue), debt levels go down (more money available)and the amount of loans should go down (less loans are required).If GDP decreases these indicators should act in a reverse fashion. As you watch the performance of these indicators, do not believe that they predict future performance of GDP.

While this is good economic data, using it as an investor is like driving a car while looking in the rear view mirror. I follow the 4 leading economic indicators more closely for making investment decisions rather than any lagging indicator. Do not confuse a lagging indicator with a leading indicator.

Note that corporate earnings are a lagging indicator instead of a leading indicator. This the one indicator that gives investors the most problem. Why? A good earnings report leads people to believe that good things are going to happen in the future so that an increase in earnings will increase stock price because we have a Price to Earnings number for a stock.

The key learning point is to pay much more attention to future revenue & earnings rather than earnings for a previous quarter. This is why a stock has a great earning report for a quarter and the stock goes down because of a comment about future revenue or profits.

The next blog will review the GDP for the 1st Quarter 2008 and see what it tells us about our current business cycle.

Business Cycle Coincident Indicators

The previous blog gave information on the leading indicators for a business cycle. This blog gives the coincident indicators or the indicators that coincide with performance of Gross Domestic Product, GDP.

These indicators give confirmation of where we are in a business cycle. While these indicators are important from a confirmation perspective they are not as useful to an investor as the leading economic indicators.These coincident economic indicators include:

• Industrial Production
• Personal Income
• Employment
• Average Number of Hours Worked
• Manufacturing and Trade Sales
• Non Agricultural Employment
  

As GDP increases, these indicators should also increase. Conversely, if GDP decreases these indicators should also decrease. As you watch the performance of these indicators, you should see confirmation with GDP.

While this is good economic data. I follow the 4 leading economic indicators more closely for making investment decisions. Do not confuse a coincident indicator with a leading indicator.

Business Cycle Leading Indicators

Previous blogs have given information on the business cycle for our U.S. economy. Gross Domestic Product, GDP, is measured to see where we are in the business cycle.

Wouldn't it be nice to know where we are in the business cycle ahead of time? If we did we could make better investing decisions. We can get a picture by looking at something call leading economic indicators or the things that move ahead of the GDP measurement.

The leading economic indicators include:

• Building Permits
• Stock Market Prices
• Money Supply (M2)
• New orders for consumer goods
• Average Weekly Initial Claims in Unemployment
• Changes in Raw Material Prices
• Changes in Consumer or Business Borrowing
• Average Work Week for Manufacturing
• Changes in Orders for Durable Goods

The things I watch are:

1. Stock Market Prices - going up now after a decline
2. Money Supply (M2) - going up, increasing by about $200 Billion in the 1st Qtr 2008 alone. A few data points to illustrate the trend. (January 2007 = $7.1 Trillion, January 2008 = $7.5 Trillion, March 2008 = $7.7 Trillion)
3. Changes in Raw Material Prices - going up (I think that is more of a global indicator rther than just a U.S. indicator now)
4. Average work week for manufacturing - this should be going up due to value of the dollar relative to other currencies.

To me this indicates that our economy is not in a contraction mode. It appears to be in a trough or early expansion mode.

Bottom Line: Do not let the news get you down.

Understanding Business Cycle

The measure of the health of our economy is the Gross Domestic Product, GDP. It measures the value of all goods and services produced in the United States including consumption, investments, government spending, and exports minus imports. The GDP is reported by the government on a quarterly basis.

GDP goes through periods of time where it gets bigger and smaller. When GDP gets bigger it means that businesses are expanding and is called business expansion. When GDP gets smaller it means that business is shrinking and is called contraction. The business cycle has 4 stages: expansion, peak, contraction, & trough.

Since data is reported historically, we only know the health of the economy for the previous quarter and not how healthy we are in the current quarter. GDP is not a leading indicator for an investor because it takes the measure of economic health in the past. Do not invest using a GDP report.

In an expansion, business is growing and can be measured by the following being higher: GDP, consumer demand, corporate sales, manufacturing output, wages, savings, real estate prices, and stock market. Along with these going higher, the Federal Reserve, Fed, is raising interest rates and slowing the money supply to fight inflation.

At a peak, these things stop growing and the Fed is holding interest rates and the supply of money.

In a contraction, everything flips and we have lower: GDP, consumer demand, corporate sales, manufacturing output, wages, savings, real estate prices and stock market. The Fed is lowering interest rates and increasing the money supply to stimulate the economy to avoid a recession or depression. A recession is 6 months of contraction while a depression is 18 months of contraction. Another definition is a recession is when your neighbor loses their job and a depression is when you lose your job.

At a bottom things stop falling and the Fed is holding interest rates and the supply of money.

Watching stock prices, interest rates and commodity prices tell us where we are in a business cycle.

The next blog will be on where the United States economy and global ecomony are in the current business cycle.