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What is a business cycle?
It’s the ups and downs of the entire economy’s Real GDP as it follows its overall trend.
The overall trend is upwards
Note: Oddly enough the term business cycle does not apply to a business. Rather, it refers to the entire economy (keeping us all on our toes I guess).
As the US economy works its way upward it has its ups and down. The ups exceed the downs, and over time the economy (and the stock market) climb upwards.
This occurrence is typical of a good, and normal, economy. It represents that the US economy is healthy overall, so it grows and performs well (upward trend).
But the US economy also encounters challenges along the way (the downs markets and slowing or shrinking GDP periods).
Importantly, individuals, companies, organizations, and government responds to the declines in order to “fix” the economy by solving a present challenge.
The US has been very good at fixing its economy as it meets challenges, plus we have a huge collection of smart and hardworking businesses full of good people and resources to fix their business (their slice of the economic pie).
Economists measure business cycles
These macroeconomists measure many variables to paint a picture and understand the past, present, and future economy. An example of a variable that is measured is Unemployment. Another example of a variable that is measured is Real GDP. There are tons of variables measured. But these variables are measured at regular intervals (perhaps once per week, once per month, once per quarter, once per year, etc.) When you measure a variable at consistent intervals it’s called a time series.
When you look at the time series (collection of data for one variable taken at regular intervals), you can see trends. Real GDP, Prices, and Unemployment are three massively important trends for economists. When the Real GDP trend shows increases for two or more quarters (a quarter is a 3-month interval, or a quarter of a year) then the economy is in expansion. If that expansion lasts for a long, long time (years) it is considered a boom.
But when the Real GDP trend shows decreases for two (or more) quarters then the economy is in contraction. Historically, if the Real GDP is contracting then it was called a recession, but nowadays many economists look at more than just Real GDP before labeling the economy as being in a recession.
(They will look at income, unemployment/employment, etc for an overall feel before using the word recession.)
So expansion and contraction are not debatable: either your Real GDP continues to grow every quarter and you’re expanding (your economy), or your Real GDP continues to shrink every quarter and you’re contracting (your economy). Obviously, government is interested in having tools to end contraction, avoid recession, and restore expansion/growth — more on that later.
The NBER (National Bureau of Economic Research) can officially declare a recession, but as an improving investor gathering your data do you want to just move with the herd and wait for the NBER to declare a recession or end of a recession? Or do you want to be one step in front of it? And even if you do wait, just understanding that an expansion or a contraction is coming can keep you emotionally calm and rational (buying low and selling high takes emotional control and sound reasoning).
I saw that coming from a mile away” is a powerful feeling as an investor. It takes time to develop that — and you will still get surprised from time to time too. But since you’re winning more than you’re losing as you improve, you deal with it better.
Note: The NBER is typically full of Nobel Laureates and past members of the President’s Council of Economic Advisors. But, you know, good investors still ensure what they are reading and hearing makes sense to them.
Many economic factors correlate
For instance, Real GDP and Unemployment rates historically correlate (move together) very, very well. In other words, when Real GDP is going up then Unemployment is going down. When things move together but go in opposite directions that is called “an inverse relationship” or a “negative correlation.” They go in opposite directions, but at the same time; this can also be called countercyclical. And a direct relationship is when two things move in the same direction at the same time; this can also be called positive correlation, procyclical, or just cyclical.
An investor could look at it the opposite way too: when Unemployment is going down then Real GDP is going up.
The NBER looks at this closely when deciding if we are in a recession. If Real GDP is declining, but Unemployment is not changing then they may not call it a recession.
There are indeed times when things that are highly correlated (like Real GDP and Unemployment) do not move “correctly.” This is always odd for economists and investors, and you need to pursue the reason (or at least a theory) why.
Remember, the economy is very dynamic and complex, so there are many things that are usually true but not always true. Economists are just gathering information and painting pictures in order to understand the economy. Not every painting from economists is photo-realistic.
There are in-between periods too, such as 2024, when the painting looks more like a Monet. You can tell what it is, but there are not a lot of clean edges. What you don’t want is a Jackson Pollock painting (economically speaking), such as the lead-up to GFC (Great Financial Crisis of 2007-2008) that wasn’t understood and turned into a crash.
As an investor, you want procyclical investments when the economy is good (restaurants, airlines, auto-makers) and countercyclical investments (discount retail and alcohol) when the economy is bad.
So before the NBER declares a recession they look for: a decline in total GDP, a decline in income, a decline in employment, and a decline in trade. So they want to see that the economy is bad, or down in many regards — and we would tend to agree with this. The term recession should be reserved for when many bad things are happening within the economy. Otherwise, people might think every bit of bad news is a recession, which reduces their participation in the economy (less iPhones, restaurants, and Disney+) which then would lead to more problems — because they got spooked.
Note: What works really well is to have a teammate that can understand, stay the course, and make some basic pivots along the way. If you can’t do it yourself, we recommend Arena Investor investment management services.
You can be in a growth recession too
What does that mean? It means you were growing at 3% but are now growing at 2.5%. See how you are growing slower now? The growth (growth rate) contracted. But you are still growing. It is like the kid in middle school who hits a growth spurt and grows 12″ in a year versus the kid who grows 6″ in a year. Don’t worry, they are both healthy.
Look at the data for yourself, hear what is actually happening, and don’t just listen to panicky news. Growth rate contractions happen. Should we look at why? Yes. Should you panic? No. In fact, you should never panic.
The moral of the story
Continue to learn so you can decide for yourself what is good and bad. (Hint: there are opportunities in every market.)
What is an economic depression?
So we know what contraction is, and we know a recession is more than a Real GDP contraction, but what is a depression? Simply put, an economic depression is when you are in a recession for a long time (years and years).
Since The Great Depression economists have been steadfastly dedicated to preventing another depression! Heck, we already covered Keynes and his effort to develop macroeconomics because the world was suffering through The Great Depression. (There are other great contributions from others too in economics.)
Economies have momentum and inertia
The momentum is how much change is happening (a lot of upward or downward change in the Real GDP for instance) and inertia is the economy’s resistance to change. This does not mean that when government takes action it is useless; instead, it means that a train slows down slowly. You won’t get a barge to turn on a dime. You can put rudder inputs in, and a turn will start, but it might not respond like a fifth generation military fighter jet.
You may think you want quick changes, but you don’t. What you want is small inputs that are on-time from the government so you don’t get a runaway train in the first place — so you don’t need to do a 180 degree turn with an aircraft carrier — but instead a little left or a little right to stay on target.
As instructor pilots say, “small corrections sooner.” The US government has been pretty good at this compared to the rest of the world, especially when you consider how big, complex, and dynamic our economy is. But let’s stay vigilant.
Note: Economic inertia that is quite resistant to change is called persistence.
Thank you for your continued trust in Oberdorfer Financial.
Truly,
The Oberdorfer Financial Team
At Oberdorfer Financial, we help The Ones in The Arena — hardworking men, women, and owners of America. Together, we’ll keep your Money on a Mission.
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