Navigating the Business Cycle


min read

September 12, 2019

In the quest to become a savvy investor, one of the most important concepts you must understand is that of the business cycle. This periodic ebb and flow of our economy exerts tremendous influence not just on asset prices, but on everything from interest rates to the availability of jobs.

Recognizing where we are in a particular cycle will not only help you determine how to position your investments, it can help you with critical decisions such as whether it’s a good time to purchase a home, change jobs, or even start a business. In short, nearly every aspect of your financial life will be influenced in some way by the business cycle, so it pays to have a basic conceptual understanding.What’s the Business Cycle?


The business cycle refers to alternating periods of expansion and contraction within the economy. It’s sometimes referred to as the economic cycle or the boom-and-bust cycle. All free-market economies exhibit this type of behavior.

Whenever we talk about growth (expansion or contraction) of an economy, we’re referring to changes in the output of that economy. There are a variety of ways to measure output, but the metric that is most commonly used is real gross domestic product (GDP).Gross domestic product measures the total amount of goods and services produced within a particular country over a certain time frame. When an economy is expanding, the amount of goods and services being produced is rising. During a contraction (or recession), the amount of goods and services being produced is falling.

One key distinction to be aware of when talking about gross domestic product is the difference between nominal GDP and real GDP. Since GDP is measured in terms of dollars, its value is subject to the effects of inflation. Nominal GDP refers to the value of goods and services produced using today’s dollars. Real GDP, on the other hand, is calculated by taking nominal GDP and removing the effects of inflation.

Stripping out inflation allows for a more “apples to apples” comparison of the changes in output. It provides us with a much better read on whether the economy is truly expanding or contracting.


As a result of constantly rising populations and improvements in productivity (think technology), economies have a natural tendency to expand over time. However, they do not grow at a constant rate. Instead, we see periods of rapid economic growth that are interspersed with periods of both slowing growth, and times when the economy will actually shrink.

You can see how this all plays out in the chart below. The vertical axis measures output (the size of the economy) while the horizontal axis measures time. The “Growth Trend” line depicts the long-term average growth of the economy. As mentioned earlier, this line slopes up because nearly all economies expand over the long-run.

The gray dashed line represents the actual growth of the economy. As you can see, there are periods of rapid growth (expansion) followed by a peak at which output is at its highest. Subsequently, the economy begins to contract and output begins to fall.

The expansion phase of the business cycle is the entire period from one trough (the lowest level of economic output) to the following peak (highest level of output). The contraction phase is the period from one peak to the following trough. These alternating periods of expansion and contraction occur with relative frequency. Since 1854, the U.S. economy has experienced 33 cycles of expansions and contractions. It’s inevitable that we will experience many more.


Calling the business cycle a “cycle” is a bit of a misnomer because periods of expansion and contraction do not happen with any sense of regularity. We know that a period of rapid expansion will be followed by a contraction, but we do not know how long each expansion will last, or when the inevitable contraction will occur.

When a contraction, or recession, does hit, we also do not know long it will take for the economy to recover and begin growing again. Historically, expansions have lasted an average of 39 months, while recessions have lasted an average of 18 months. In recent times, the length of economic expansions has been increasing (averaging 58 months since 1945), while recessions have been falling in length (averaging just 11 months since 1945).

At this point, you may be wondering what criteria is used to make the determination that the economy is officially in a recession. The financial press and many others will tell you that we’re in a recession when the economy experiences two consecutive quarters of declining real Gross Domestic Product (GDP). In most cases, a recession will encompass two or more quarters of declining real GDP, but this definition is not entirely accurate.

In the US, the task of identifying and dating recessions falls on the National Bureau of Economic Research (NBER). The NBER is generally seen as the authority on dating recessions, and there is near universal reliance on the determinations made by the NBER. Businesses, policy makers, academics, economists and many others typically defer to the NBER for dating a recession’s onset and end. As a general rule, the NBER tries to identify a month when the economy reached a peak of economic activity, and then a subsequent month when the economy reached a trough – a bottoming of economic activity. The time period in between, during which economic activity is contracting, is defined as the recessionary period. After the trough, the economy moves back into a period of expansion. It’s important to realize from this approach that a recession, as defined by the NBER, is not a period of diminished economic activity, but a period of diminishing activity. Said differently, it’s the business cycle contraction that we discussed above.


Now that you understand the different phases of the business cycle, it helps to know how some of the major financial variables move during each phase.

During an Expansion:

  • Overall demand for goods and services increases
  • Interest rates move higher (borrowing costs rise)
  • Labor conditions improve (more jobs created than lost)
  • Wages rise
  • Stock prices generally rise
  • Bond prices generally fall
  • Real estate values rise

During a Contraction (Recession):

  • Overall demand for goods and services decreases
  • Interest rates move lower (borrowing costs fall)
  • Labor conditions deteriorate (more jobs destroyed than created)
  • Wages remain stagnant or fall
  • Stock prices generally fall
  • Bond prices generally rise
  • Real Estate values stagnate or fall

Based on these factors, it should be clear that the best time for most financial endeavors (buying a home, starting a business, finding a new job) is in the early or mid-stages of an economic expansion. Pursuing these goals near the peak (end) of an expansion, or during a recession, will lead to less than satisfactory results.


At this point, it should go without saying that how you manage your investment portfolio with respect to the business cycle is extremely important. However, this is not nearly as difficult as it may seem. There’s really just one main overarching concept to grasp: Invest primarily in stocks during expansions, and bonds during contractions.

When the economy is expanding, it means that companies are able to produce and sell more goods and services. This drives increases in both revenues and earnings, and as a result, makes each share of stock more valuable.

During these periods, however, the increases in overall demand often cause interest rates to rise. Since bond prices are inversely related to interest rates, this means that bond prices typically fall when the economy is growing. As a result, bonds tend to act as a performance drag during economic expansions.

When the economy inevitably rolls over and begins to contract (we go into recession), this dynamic reverses. During these unruly periods, stocks generally lose a lot of value while bond prices rise.

As a result, the best thing you can do from an investment perspective is to invest primarily in stocks during economic expansions, and transition your portfolio towards bonds as the economy begins to roll over. Once the recession is over and the economy begins to expand, stocks once again become the preferred asset class.

Shifting your portfolio in this manner will allow you to take advantage of whichever way the economic winds are blowing, and maximize returns throughout each portion of the business cycle.

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Investment Model Disclosures


Sigma Point Capital, LLC (“SPC”) is a Registered Investment Advisor. All information provided herein is for educational purposes only and does not constitute investment, legal or tax advice, an offer to buy or sell any security or insurance product; or an endorsement of any third party or such third party’s views.

Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.

All examples are hypothetical and designed solely to convey information about our investment philosophy and strategies. Investing involves a great deal of risk including the loss of some or all of your investment. Past performance is not an indication or guarantee of future performance and Sigma Point Capital does not warrant or guarantee any minimum level of investment performance. No representation is being made that any SPC client account will or is likely to achieve profits or losses similar to those shown in the hypothetical back tested performance.

Backtested Performance Disclosure Statement

Hypothetical performance shown on the Sigma Point Capital website (the “Site”) is backtested and does not represent the performance of any account managed by Sigma Point Capital. The hypothetical performance depicted was achieved by means of the retroactive application of investment strategies that were designed with the benefit of hindsight.

Backtested performance is NOT an indicator of future actual results. Hypothetical results have inherent limitations, particularly that the performance results do not reflect the results of actual trading using client assets. Additional limitations of backtested performance include, but are not limited to, the effects of material economic and market factors on the decision-making process, and the ability for the security selection methodology to be adjusted until past returns are maximized.

The performance of any account managed by Sigma Point Capital will differ from the backtested performance shown on the Site for a variety of reasons, including without limitation the following:

  • Sigma Point Capital may consider from time to time one or more factors that are not accounted for in the models, or it may not consider any or all of such factors. The inclusion or exclusion of such factors may cause Sigma Point Capital to override the model’s recommendations, which could result in performance that is higher or lower than shown.
  • The hypothetical backtested performance results assume full investment, whereas an account managed by SPC may have a positive cash balance upon rebalance. Had the backtested performance results included a positive cash position, the results would have been different and generally would have been lower.
  • The backtested performance results for each strategy are based on the daily closing prices of each security. Accounts managed by SPC will rarely, if ever, be able to transact at the exact daily closing prices, and as a result, security purchases and sales may be at higher or lower prices than those depicted in the model’s returns. This could result in performance that is higher or lower than what is depicted on the Site.
  • The timing of trades and transactions in an account managed by SPC may differ from the timing of trades and transactions shown in the backtested performance. This could result in performance that is higher or lower than what is depicted on the Site.
  • Hypothetical performance includes the reinvestment of dividends and interest, but no management fees or transaction costs are included. If management fees and transaction costs were included, the results would have been different and generally would have been lower.
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Performance results have been compiled solely by Sigma Point Capital, LLC and have not been independently verified.

3rd Party Data

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Neither Sigma Point Capital nor any third-party data provider are responsible for any damages or losses arising from any use of this information.

Fund Ticker Symbols and Definitions

In order to help existing and prospective clients understand the performance characteristics of the SPC Tactical Investment Models, backtested performance on the Site is shown in relation to three benchmarks: The S&P 500 Index, The U.S. Aggregate Bond Index, and a 60/40 blend of those two indexes (benchmarks are shown using Exchange-Traded Funds which track each index).

Sigma Point Capital Tactical Models use a combination of equity and fixed-income ETFs to achieve their results; therefore, these benchmarks provide a reasonable example of the performance that one would achieve from a buy-and-hold approach using a similar set of securities.

SPY represents the SPDR S&P 500 ETF. It is an exchange-traded fund designed to track the performance of the S&P 500 Index. It does not represent the index itself.

AGG represents the iShares Core U.S. Aggregate Bond ETF. It is an exchange-traded fund designed to track the performance of the Bloomberg Barclays U.S. Aggregate Bond Index. It does not represent the index itself. The inception date for AGG is 9-22-2003. As a result, in our analysis and backtested performance, we use price data for VBMFX (the Vanguard Total Bond Market Index) as a proxy for AGG price data for all dates prior to 10-01-2003, at which point we switch to using actual AGG price data.

"60/40 Stocks/Bonds" refers to a hypothetical portfolio that would have kept 60% of its assets invested in SPY - the SPDR S&P 500 ETF and 40% of its assets invested in AGG - the iShares Core U.S. Aggregate Bond ETF.



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