How Do Economic Cycles Impact Investment Strategies?

In business administration, understanding the economic cycle is essential. At both the macro and micro levels, the economic cycle influences the strategic and operational decisions of companies.

Strategic planning is about taking into account the developments and trends of the economic cycle to exploit growth opportunities and minimize risks. At the operational level, companies can adjust their production, prices, and personnel policies according to the economic cycle.

An economic cycles, also known as a business cycle, can be understood as a series of regular fluctuations in a country’s economic activity over some time. That is, it is a natural sequence of periods of growth and decline in the economy that has a predictable pattern. In general, the economic cycle consists of four phases.

Regardless of its duration, every economic cycle typically goes through four phases. The first phase is expansion, also called upswing or recovery. In this section, demand is slowly increasing again and production is ramping up.

The main characteristics of this phase of the economy are rising wages, increasing employment levels, low-interest rates, and a low inflation rate.

The upswing is followed by the boom, which can also be referred to as a boom or prosperity. Production capacities here are at full capacity and there is almost one full employment. The high level of employment increases prices and the risk of inflation grows.

What Are Economic Cycles And Their Phases, And How Do They Affect Investments?

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An economic cycle describes the regular ups and downs in the economic performance of a country or region. These cyclical movements are a fundamental part of every free market economy.

Types of economic cycles can be counted as differentiated by duration and causes, e.g. short-term cycles (1-3 years) and long-term cycles (also called Kondratieff cycles).

The duration of such a cycle can range from a few years to several decades. Different economic factors and developments are relevant here, which influence the interplay between supply and demand in the markets.

Expansion: In this phase, the economy experiences high growth rates, increasing employment figures, and often rising prices.

Boom: Economic performance reaches its peak. Unemployment is low and prices continue to rise.

Recession: Economic performance declines and growth slows. Companies are hiring fewer and unemployment is rising.

Crisis: Economic performance is at its lowest level. Unemployment is high and many companies can no longer operate profitably.

How Can Investors Tailor Their Strategies To Different Economic Environments?

A short-term cycle could be caused by the effects of a natural disaster. The resulting destruction could slow production and increase prices, eventually leading to a downturn. However, once the damage is repaired, the economy can quickly return to its previous path.

Long-term cycles, also known as Kondratieff cycles, last several decades. They are often the result of fundamental changes in technology and economic structure.

An example of a Kondratieff cycle could be the Industrial Revolution, which caused a long-term boom, followed by a downturn as the original engines of growth lost momentum and were replaced by new technologies and industries.

What Are The Investment Opportunities And Risks In Various Economic Phases?

Each phase of the economic cycle has specific characteristics and impacts on economic activity.

Recession: During this period, the economy shrinks, jobs are lost, consumer confidence declines, and inflation slows.

An example of a recession phase could be the financial crisis of 2008. Economic activity fell, unemployment rose, and many countries experienced a period of deflation.

Crisis: This is the bottom of the cycle. Economic activity is stabilized at a low level and there may be a sharp decline in the GDP come.

How Does Monetary And Fiscal Policy Respond To Economic Cycles?

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Monetary and Fiscal Policies in different countries enable the implementation of different strategies for economic cycles. They produce different solutions for different conditions, such as increasing or limiting the money supply and interest rates.

Their main motivation is to protect the value of the local currency by solving local problems faster. In addition to money supply and interest rates, political practices such as public expenditures or tax regulations are mechanisms that ensure that solutions become more widespread and useful.

An economic cycle usually becomes noticeable in such a way that the demand for various goods and services decreases. People are buying less (holding back on consumption), the gross domestic product (GDP) is falling and economic performance is deteriorating. Companies offer more than consumers want to buy. 

Scientists believe that the origin of an economic cycle lies in structural changes. For example, as soon as companies are forced to put employees on short-time work or to lay them off completely, an economic cycle is possible. 

But financial factors can also contribute. For example, when companies overestimate demand during an economic peak, invest too much in setting up production, and then have to reduce capacity again – or when companies do not have enough money available for more growth.

What Can History Teach Us About Navigating Investments Across Economic Cycles?

The current shape and duration of the economic cycle vary greatly depending on how quickly the economy recovers from setbacks and how robust growth is during periods of recovery. As a rule, the duration of a cycle is somewhere between two and twelve years.

A historical example of a crisis could be the Great Depression of the 1930s. During this time, GDP fell sharply, unemployment reached record levels, and many companies went bankrupt. During this phase of the economic cycle, unemployment is often at its peak and GDP is at its lowest point. Inflation can be very low or even turn into deflation.

Many economies are currently being observed in the recession or recovery phase due to the global economic crisis caused by the COVID-19 pandemic. How economies will perform will depend on many factors, including the success of vaccination campaigns, the effectiveness of government stimulus programs, and the strength of consumer demand.

See you in the next post,

Anil UZUN