Business Cycle


DEFINITION of 'Business Cycle'

The fluctuations in economic activity that an economy experiences over a period of time. A business cycle is basically defined in terms of periods of expansion or recession. During expansions, the economy is growing in real terms (i.e. excluding inflation), as evidenced by increases in indicators like employment, industrial production, sales and personal incomes. During recessions, the economy is contracting, as measured by decreases in the above indicators. Expansion is measured from the trough (or bottom) of the previous business cycle to the peak of the current cycle, while recession is measured from the peak to the trough. In the United States, the National Bureau of Economic Research (NBER) determines the official dates for business cycles.

BREAKING DOWN 'Business Cycle'

According to the NBER, there have been 11 business cycles from 1945 to 2009, with the average length of a cycle lasting about 69 months, or a little less than six years. The average expansion during this period has lasted 58.4 months, while the average contraction has lasted only 11.1 months.

The business cycle can be effectively used to position one’s investment portfolio. For instance, during the early expansion phase, cyclical stocks in sectors such as commodities and technology tend to outperform. In the recession period, the defensive groups like health care, consumer staples and utilities outperform because of their stable cash flows and dividend yields.

As of January 2014, the last expansion was determined to have commenced in June 2009, the period when the Great Recession of 2007-09 reached its trough (technically, that recession began in December 2007).

Expansion is the default mode of the economy, with recessions being much shorter and less common. So why do recessions occur at all? While economists’ views differ on this subject, there is a clear pattern of excessive speculative activity evident in the latter stages of expansion in many business cycles. The 2001 recession was preceded by an absolute mania in dot-com and technology stocks, while the 2007-09 recession followed a period of unprecedented speculation in the U.S. housing market.

The average length of an expansion has increased significantly since the 1990s. The three business cycles from July 1990 to June 2009 had an average expansion phase of 95 months – or almost 8 years – compared with the average recession length of 11 months over this period. While some economists were hopeful that this development marked the end of the business cycle, the 2007-09 put paid to those hopes.

Recessions can extract a tremendous toll on stock markets. Most major equity indexes around the world endured declines of over 50% in the 18-month period of the Great Recession, which was the worst global contraction since the 1930s Depression. Global equities also underwent a significant correction in the 2001 recession, with the Nasdaq Composite among the worst-hit as it plunged almost 80% from its 2001 peak to 2002 low.

  1. Lagging Indicator

    1. A measurable economic factor that changes after the economy ...
  2. Boom

    A period of time during which sales of a product or business ...
  3. Trough

    The stage of the economy's business cycle that marks the end ...
  4. Contraction

    A phase of the business cycle in which the economy as a whole ...
  5. Cyclical Industry

    A type of an industry that is sensitive to the business cycle, ...
  6. Sector Rotation

    The action of a mutual fund or portfolio manager shifting investment ...
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  1. How does the stock market react to changes in the Federal Funds Rate?

    The stock market reacts to changes in the federal funds rate in various ways depending on where it is in the business cycle. ... Read Full Answer >>
  2. What is the average length of the boom and bust cycle in the U.S. economy?

    The boom and bust, better defined as expansion and contraction, business cycles of the U.S. economy averaged 38.7 months ... Read Full Answer >>
  3. What economic indicators should an investor in the aerospace sector consider?

    The economic indicators that investors in the aerospace sector should consider are economic growth, interest rates and inflation. ... Read Full Answer >>
  4. What economic indicators are important to consider when investing in the chemicals ...

    The most important economic indicators to consider when investing in the chemicals sector are economic growth, interest rates, ... Read Full Answer >>
  5. What makes the chemicals sector attractive to value investors?

    The chemicals sector is attractive to value investors because it is a capital-intensive sector that can become grossly undervalued ... Read Full Answer >>
  6. What are the benefits of investing in a cyclical stock?

    Cyclical stocks tend to be highly correlated with the overall business cycle, so an investor can invest in a cyclical stock ... Read Full Answer >>
  7. Should I buy and hold a cyclical stock for long-term gains?

    Cyclical stocks should be avoided for long-term gains. They tend to be in competitive industries in which companies do not ... Read Full Answer >>
  8. How does an economic downturn affect a cyclical stock?

    An economic downturn negatively affects a cyclical stock. Its stock price declines as earnings and revenues tumble. Cyclical ... Read Full Answer >>
  9. What economic indicators are important to monitor when investing in the electronics ...

    The most important economic indicators to monitor when investing in the electronics sector are global gross domestic product ... Read Full Answer >>
  10. What are the key metrics used to measure the business cycle?

    Gross domestic product (GDP), investments, consumer spending, unemployment and inflation are the key metrics used to measure ... Read Full Answer >>
  11. Is cyclical unemployment always due to recessions?

    Cyclical unemployment is always due to a downturn in the business cycle, but it may not be due to a recession. By definition, ... Read Full Answer >>
  12. When does cyclical unemployment become structural unemployment?

    Cyclical unemployment becomes structural unemployment when workers remain unemployed long enough that they need to acquire ... Read Full Answer >>
  13. What does the gearing ratio say about risk?

    Technically speaking, there are many different gearing ratios, the most popular of which is the debt to equity ratio. Gearing ... Read Full Answer >>

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