The Impact of the Business Cycle on Interest Rates and Stock Investing

By Stock Research Pro • March 30th, 2009

The business or economic cycle refers to the changes in economic activity or production experienced by the economy as a whole over several months or years. The fluctuations are measured by the growth rate in gross domestic product (GDP) and these shorter business cycles are what make up the longer-term growth trend. Many investors try to time the market according to the current phase of the business cycle and while the fluctuations in output do not follow a predictable pattern, identifying the current phase of the cycle can be useful for stock investors.

The Stages of the Business Cycle

The business cycle refers to the periods of growth and decline in the economy. There are four stages in the cycle:

Recession: A recession or “trough” occurs when employment and output are diminished. In severe cases, the recession may become a depression.

Recovery: Recovery occurs when a recession or depression turn-around with improved levels of employment and economic output.

Growth: The growth phase of the business cycle is typically the most welcome for both businesses and consumers as both consumer confidence and business activity continue to rise. The downside to the growth phase is that it is often accompanied by higher levels of inflation.

Decline: Also referred to as an economic downturn or a “contraction”, the decline marks the end of the growth phase as consumer purchasing decreases and business production falls.

Stock Investing and the Business Cycle

Many investors believe that “beating the market” through proper timing is dependent on understanding the current phase of the business cycle as this is a primary contributor to stock prices. Interest rates, in particular, play an important role in the performance of the stock market. Higher interest rates (often seen as the growth phase reaches its peak) mean companies must pay more to borrow for capital investments and other business expenses, negatively impacting the company’s bottom line. On the consumer side, higher interest rates mean that individuals pay more for mortgages and other loans they might take out for to purchase products.

The higher interest rates seen at the peak of the growth phase can also initiate a shift in investing away from stock investing and into bonds.

More about business cycles


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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