Cycles are everywhere—seasons, the moon, your laundry… and yes, in business too! Just like you can predict when winter is coming (thanks, Game of Thrones), you can also predict that the economy will experience periods of growth and periods of slowdown. This ebb and flow is known as the business cycle, and understanding it can be one of the most valuable tools in your personal finance toolkit.
The business cycle is basically the natural rise and fall of economic growth over time. Think of it like the seasons—there are periods when the economy is booming (like the summer, when everything is warm and flourishing), and there are times when things cool off (like fall and winter). While you might think this only matters to economists and big companies, the truth is that knowing where we are in the business cycle can actually help you make better financial decisions—whether you’re investing in stocks, buying a home, or just trying to figure out if now is a good time to take on some debt.
Understanding this cycle, and more importantly, knowing where we are in it, will help you figure out what to invest in and when. This is especially important right now because a major component of the business cycle—interest rates—has shifted.
Where Are We Now in the Business Cycle?
Before we dive deeper, let’s address the million-dollar question: where exactly are we in the business cycle right now?
I hate to break it to you, but pinpointing exactly where we are in the business cycle is like trying to call the exact moment when winter turns into spring—it’s something you often only recognize in hindsight. However, we can still make some educated guesses based on a few key indicators.
Here’s what we know:
Interest rates are dropping around the world.
They’ve been at their highest levels since 2001 for the past few years.
Global economies are growing, with global GDP projected to rise around 3% for the next few years.
Unemployment is low, but has started creeping up slightly, reaching 4.2% in the U.S. after a recent low of 3.4%.
This data suggests that things are looking pretty solid at the moment. But to figure out where we are in the cycle, let’s break down the different phases of the business cycle and what they mean for you.
1. Expansion: The Good Times
This is the phase when things feel great! During an expansion, the economy is growing steadily. Businesses are thriving, hiring more workers, producing more products, and overall optimism is high. People are spending more money, buying homes, cars, gadgets, and maybe even splurging on that long-awaited vacation. This is the “summer” of the business cycle—warm, sunny, and full of opportunity.
Interest Rates:
To keep the good times rolling, central banks (like the Federal Reserve in the U.S.) typically keep interest rates low. Lower interest rates make it easier for people to borrow money and spend, which keeps fueling the economy. Businesses can take out loans to expand, hire more staff, and innovate. Consumers, like you and me, are also more likely to take out loans for big purchases like houses and cars.
Why It Matters:
Low interest rates mean cheaper borrowing, which encourages spending and investment. This, in turn, keeps the economy growing. However, if the economy grows too quickly, we can run into a problem—rising prices, also known as inflation.
Where to Invest:
Stocks perform well during expansions, particularly in industries that thrive when people are spending more. Think banks, technology companies, luxury goods, and consumer discretionary items. This is the time when people are buying the latest iPhone, upgrading their wardrobe, or booking flights for exotic vacations. Companies that sell these kinds of products often see their stock prices rise in an expansion.
2. Peak: The High Point
The peak is exactly what it sounds like—the point when the economy is at its strongest, but also when things start to look a bit too good. Demand for products is sky-high, but companies may start to struggle to keep up. This is where inflation becomes a big concern. Prices rise too fast, and people begin to feel the pinch of higher costs of living. It’s like the dog days of summer when the heat becomes unbearable, and everyone is just a little too hot to handle.
Interest Rates:
To prevent the economy from overheating, central banks typically raise interest rates at this stage. Higher interest rates make borrowing more expensive, which is meant to cool things down. When it costs more to borrow money, people and businesses will start spending less.
Why It Matters:
When interest rates rise, everything from mortgages to car loans to credit cards becomes more expensive. This can be a real buzzkill if you’re thinking about buying a house or financing a big purchase. The goal of raising rates is to slow down spending to avoid runaway inflation, but it also means that borrowing becomes a lot less attractive.
Where to Invest:
During the peak, the riskiest investments tend to perform the best—think small company stocks or cryptocurrencies. Everyone gets greedy, and this is when risky assets seem to skyrocket. However, as with all things, what goes up must come down, and these risky investments can crash just as fast as they rose. So while it might be tempting to jump in, be cautious—this is when the market can be at its most volatile.
3. Contraction: The Slowdown
After the peak comes the inevitable cooldown. In the contraction phase, the economy starts to shrink. Companies cut back on production, some people lose their jobs, and consumer spending slows. This is the dreaded “recession” phase, where the economy feels like it’s in reverse, and optimism is replaced by a sense of caution.
Interest Rates:
To help the economy recover from this slowdown, central banks usually lower interest rates again. By making borrowing cheaper, they hope to encourage businesses and consumers to start spending and investing again, which can help restart the engine of economic growth.
Why It Matters:
Lower interest rates during a contraction mean that it’s cheaper for you to borrow money, which can be good news if you’re looking to buy a home or start a business. The goal here is to shorten the recession and get the economy growing again as quickly as possible.
Where to Invest:
Bonds and other low-risk investments tend to perform better during this phase. As people pull money out of riskier investments like stocks, they flock to safer havens. Gold, which is often seen as a store of value, also tends to do well during contractions as investors seek stability.
4. Trough: The Turning Point
Finally, we reach the trough—the low point of the business cycle. But here’s the good news: the trough means that the worst is over, and things are about to get better. It’s the point where the economy stabilizes, and the cycle is ready to start again with a new expansion phase. Think of it as the first signs of spring after a long winter.
Interest Rates:
Interest rates usually remain low during the trough to help give the economy a boost and encourage recovery. This phase is all about setting the stage for growth, so central banks will do what they can to make borrowing cheap and investment attractive.
Why It Matters:
With low interest rates, businesses are encouraged to invest in growth, and consumers are more likely to start spending again. This is when things begin to turn around, and confidence in the economy starts to rebuild.
Where to Invest:
This is the time to get back into stocks. Prices have likely fallen during the contraction, and while it might feel risky, this is often when you can find the best deals. Buying during the trough can be a smart long-term strategy if you believe the economy is about to enter a new expansion phase.
So... Where Are We Now?
I said earlier that it’s hard to know exactly where we are in the business cycle, and while I stand by that, here’s my best guess: we’re in the expansion phase.
Interest rates are starting to come down, which should stimulate growth. The economy is already growing at a decent clip, with global GDP projected to rise around 3%. Unemployment is still low, even though it’s ticking up slightly, and consumer spending remains strong.
All of this suggests that we’re in the middle of an expansion—interest rates are dropping, economic growth is solid, and inflation seems to be under control (for now). So, if you’re thinking about investing, it’s probably a good time to do so. But keep an eye on things—once the economy overheats, we’ll be heading toward the peak, and that’s when things start to get dicey.
The Business Cycle and You
In the end, the business cycle is like a roller coaster with its ups and downs, and interest rates are the brakes or gas pedal that control the speed of the ride. When rates are low, the economy speeds up; when they’re high, things slow down. Understanding these phases can help you make smarter decisions about your finances—whether it’s borrowing money, investing, or just keeping an eye on what’s happening in the broader economy.
So the next time you hear the word "recession" or "expansion" on the news, you'll know what it means—and you'll have a better idea of how to navigate your finances accordingly.
Happy investing!
