Economic cycles, sometimes referred to as business cycles, are the fluctuations in economic activity that occur in any developed economy. Theoretically, any deviation from average growth is considered an economic cycle, whether growth of GDP, household income, employment rates, etc. In practice, economic cycles are divided into two main categories:
booms and
recessions. Booms are associated with a strong economy, while recessions are characterized by below-trend economic growth. The National Bureau of Economic Research (NBER) defines economic cycles a bit differently.
Graphical representation of economic cycles
Rather than booms and recessions, it classifies the economy as being in
expansion or
contraction. Expansion is when several pieces of economic data are improving, and contraction is a decline in the same data. These definitions focus more on the movement of data, whereas the boom/recession definition only refers to the data's position relative to historical averages.
The basic idea behind economic cycles is that they're just that: cycles. Any steep decline in economic activity will likely be offset by future surges in the economy's growth. In the long term, the highs and lows average out to form the trend, or average, economic growth rate. This trend growth rate is subject to change, but it has remained relatively steady in the past, indicating the general rate of growth that we can expect to see in the future.
[edit] Booms and Expansions
Key features of an economic boom:
- Above-trend GDP growth
- Higher disposable incomes
- Less unemployment
- Increased consumer spending
[edit] Recessions and Contractions
Key features of a recession:
- Below-average GDP growth. The historical definition of a recession is when the economy has two consecutive quarters of negative growth. Usually by the time the official reports come available to identify a recession the market has already priced in the recession. Most recessions have a time span of 18-24 months.
- Lower disposable incomes
- Higher unemployment rates
- Decreased consumer spending is caused by the above mentioned conditions, lower disposable income from inflationary pressures, higher commodity prices such as oil, or food sources. The less spending can lead to higher unemployment. Many times this first shows in the retail sector. The three items mentioned, basically, will manifest itself on the other and snowball into a recessionary period.
[edit] Who's particularly impacted by economic cycles?
While the economy as a whole is negatively impacted by economic cycles, certain companies and industries are particularly sensitive to changes in the overall state of the economy. Manufacturers of durable goods like cars, appliances, and electronics are among the most impacted. When times are bad, people tend to cut back on the purchase of durables, as the ones they already have can generally last through the recession. At the same time, durables usually benefit the most from booms. As disposable income increases, consumers are likely to go out and buy that new car they've been holding out on. In addition to manufacturers, financial institutions are susceptible to declining demand for financial services and an overall decrease in the amount of money flowing through the economy.
Transportation
Manufacturing
- Whirlpool (WHR), and Sears Holdings (SHLD) are all leading manufacturers of home appliances, which are subject to declining demand for durable goods. In addition to people's tendency to avoid larger purchases during recessions, the demand for appliances is tightly linked to new home sales, which also tend to slow during recessions.
- Alcoa (AA) and US Steel (X) produce aluminum and steel, respectively. These two materials are used in a wide range of construction and manufacturing capacities, subjecting them to the performance of their end markets.
- Caterpillar (CAT) and Tractor Supply Company (TSCO) both manufacture farming equipment. As farmers feel the effects of economic fluctuations, they tend to adjust their large equipment purchases accordingly.
Construction
Investment services
- Bear Stearns Companies (BSC), Merrill Lynch (MER), Morgan Stanley (MS), Goldman Sachs Group (GS), Credit Suisse Group (CS), Lehman Brothers Fin SA (LEH), UBS AG (UBS), J P Morgan Chase (JPM), Lazard (LAZ), Jefferies Group (JEF), and other providers of investment services can be negatively impacted by recessions. On the other hand, these firms are likely to benefit from economic booms as customers' demand for financial services increases.
- Real Estate Investment Trusts (REITs) such as Vornado Realty Trust (VNO) also tend to be particularly affected, as demand for lease space and properties varies with the economic cycle.
Hotels
Other Areas of Discretionary Spending
- Brink's Company (BCO) and other home security service providers which primarily serve single family residential consumers
- Zale (ZLC) and other luxury commodity sellers
Education
- Apollo Group (APOL), Career Education (CECO), ITT Educational Services (ESI) and other education providers typically see enrollment increase during economic downturns as poorer job prospects cause prospective students to view continuing eduction more favorably. During the 2001 recession, enrollment growth at four-year for-profit education institutions doubled, and during the first years of recessions over the last four decades, enrollment growth in two-year education programs has increased by an average of 12%.
[edit] Who's relatively less impacted by economic cycles?
On the other hand, certain goods are relatively insulated from the impact of economic cycles. Food is an example of a good that has very inelastic demand. No matter how bad the economy gets, people have to eat. When the economy improves, we generally don't eat more, though the quality of our diet may improve.
Food manufacturers and retailers
Tobacco companies
- Altria Group (MO), Loews (CG), and REYNOLDS AMERICAN (RAI) are the three largest tobacco companies in the U.S. Though cigarettes are not generally considered necessities, they still have somewhat inelastic demand. The addictive nature of cigarettes affords tobacco companies some protection from recessions, up to a point.
Utilities
[edit] Economic Theory
[edit] Chicago School
Milton Friedman has said that economic cycles aren't really "cycles" that there is no clear beginning and end unlike the seasonal cycle for, among other economic activity, retail sales and seasonal credit cycle which peak before summer and trough after.
Most economists note the high correlation of the so-called "credit cycle", punctuated by monetary growth and decay, to the so-called "economic cycle", Keynes and Friedman included.
[edit] Complexity Economics
Eric Beinhocker views economic cycles from a network and game theory perspective. This view re-frames cycles in terms of evolutionary growth rather than having a discreet beginning and end.
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