Glossary
Business cycle
The recurring rise and fall of economic activity through expansion, peak, contraction and trough.
The business cycle is the pattern of alternating expansion and contraction in overall economic activity: output, jobs, incomes and spending rise for a period, reach a peak, fall into a recession, hit a trough and then recover. The cycles are irregular in length and severity, not clockwork. They matter to investors because corporate profits, interest rates and the relative performance of different sectors all tend to shift as the economy moves through its phases.
The four phases
- Expansion: GDP grows, unemployment falls, and companies hire and invest.
- Peak: growth is at its strongest; inflation pressures and interest rates often rise.
- Contraction (recession): activity declines across much of the economy.
- Trough: the low point, after which recovery begins.
In the US, the official dates of peaks and troughs come from the National Bureau of Economic Research's Business Cycle Dating Committee. It looks at a broad set of indicators, not just the popular "two negative quarters of GDP" shorthand, and it usually announces dates many months after the fact.
Since World War II, US expansions have generally lasted much longer than contractions, typically several years against less than a year.
Why it matters for markets
Stock prices tend to anticipate the cycle, often falling before a recession begins and rising before it ends, so waiting for official confirmation usually means acting late. Investors also talk of sector rotation: cyclical industries such as industrials and consumer discretionary tend to do best early in recoveries, while defensive sectors such as utilities and consumer staples have tended to hold up better in downturns. These are tendencies with many exceptions.