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Economic Cycles

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U.S. Economic Cycles

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For information ab out the issues affecting the U.S. economy in 2008, see 2008 Financial TOP CONTRIBUTORS
Crisis and 2009 Financial Crisis.

The concept of Economic Cycles, which are sometimes referred to as Business Cycles, is Sean Hinton
a theory that attempts to explain changes in economic activity that vary from a long term
growth trend as observed in a developed market economy. Factors considered in defining
an economic cycle include growth of GDP, household income, employment rates, etc. Remi Cossart
Economic Cycles are divided into two main categories: b ooms and recessions. Booms
are associated with a strong economy, while recessions are characterized by below-trend
J.B. Schag
economic growth. The National Bureau of Economic Research (NBER) is considered the
authoritative source in the US that reports the dates of the peaks and troughs that quantify Economic Cycles. NBER
defines economic cycles a bit differently than Economic Cycle Theory.
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 more than just mere
fluctuations in economic activity and are
significant enough to be "widely diffused
Graphical representation of economic cycles
over the economy." [1]. A short term
decline in economic activity has
historically been observed to be followed by a short term gain in economic activity. Observed over longer periods, the
highs and lows average out to form the trend, or average, economic growth rate. The Economic Cycles Theory holds
that although this trend growth rate is subject to change, it has remained relatively steady in the past, thus theoretically
indicating the general rate of economic growth that we can expect to see in the mid-term future. No attempt is made by
Economic Cycles Theory to describe economic activity during extended periods of decline, only growth.

Booms and Expansions

Key features of an economic boom:
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Above-trend GDP growth

Higher disposable incomes
Less unemployment
Increased consumer spending

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.

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

General Motors (GM), Ford Motor Company (F), DAIMLERCHRYSLER AG (DCX), and other car companies can be
significantly impacted by recessions. During economic downturns, people often put off buying new cars until later, or
buy less expensive models.
United Airlines (UAUA), Air France ADS (AKH), and British Airways plc (LON:BAY) are three leading airlines, which
tend to suffer during recessions.
FedEx (FDX) and United Parcel Service (UPS) are the two leading package carriers. The volume of packages mailed
is highly correlated with macroeconomic conditions, subjecting FedEx and UPS to cyclical swings in revenues and
profits.
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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
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equipment purchases accordingly.
Construction

D.R. Horton (DHI), Lennar (LEN), Toll Brothers (TOL), and Pulte Homes (PHM) are large companies in the
residential construction industry. With the declining demand for durable goods, new home sales are likely to
decrease as well.
Foster Wheeler (FWLT) and CRH (CRH) are both involved in construction. FWLT provides construction services to
various industrial customers, and CRH manufactures and distributes building materials, like cement and premixed
concrete.
The performance of Home Depot (HD), Lowe's Companies (LOW), and other home improvement retailers is largely
correlated to the housing market. Any declines in new home construction or renovations would likely harm retailers
such as these.
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.
Commercial Real Estate Service Firms

Firms that earn revenues from Commercial Real Estate transactions such as Jones Lang LaSalle (JLL) and CB
Richard Ellis Group (CBG) are also negatively affected by recessions, and benefit from economic booms.
Hotels

Choice Hotels International (CHH) and other hotel/lodging companies serving middle income customers can be
negatively impacted by recessions.
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
Omnicom Group (OMC), Interpublic Group of Companies (IPG) and other advertising firms suffer during recessions
since advertising budgets are viewed as discretionary spending by many of their clients and are often one of the first
areas where firms cut costs during a slowdown.
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%.

Who's relatively less impacted by economic cycles?

On the other hand, certain goods are relatively insulated from the impact of economic cycles. Goods that have a
relatively inelastic demand with respect to income are generally shielded. For example, food has a very inelastic
demand. No matter how bad the economy gets, people have to eat and will continue to purchase food. This is particular
true for staple foods and goods like insulin and bread. In addition, when the economy improves, people rarely eat more
or buy more necessities.

Food manufacturers and retailers

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Safeway (SWY), Wal-Mart Stores (WMT), Sysco (SYY), and other food retailers are somewhat protected from
recessions. For health reasons, the demand for food is unlikely to decrease below a certain level, giving food
retailers some degree of insulation from poor economic conditions. However, foods which are considered more
luxurious or expensive will fluctuate during economic cycles.
Pepsico (PEP), Kraft Foods (KFT), and H.J. Heinz Company (HNZ), as well as other food manufacturers, generally
see a smaller decline in sales resulting from a recession.
Addictive Substances

Altria Group (MO), Lorillard (LO), and REYNOLDS AMERICAN (RAI) and other large tobacco companies in the U.S
are protected from recession. Though cigarettes are not generally considered necessities, they still have steeply
inelastic demand. In addition, other illegal addictive drugs like heroin and cocaine are almost totally protected from
cycles. Because of the inherent nature of addictive substances, consumption becomes a necessity to the user
regardless of cost.
Required Medicine and Medical Equipment

Many required medicines like insulin and key equipment are not impacted by economic cycles. This is because
patients must buy or use medicine and equipment that is necessary for their survival regardless of the prevailing
economic condition. Thus, suppliers of such goods are also insulated since hospitals and patients must buy as
necessary.

Utilities

Exelon (EXC), Entergy (ETR), and other providers of key utilities are unlikely to suffer greatly during a recession.
Commercial and residential buildings must be powered and have access to sewage and water. These necessities
are somewhat protect from shifts in the general economy.

Economic Theory "Schools" of Thought

Classical Economic Theory - 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.

The Chicago School, which is often seen as neo-classical or monetarists, emphasizes the correlation between the
"credit cycle" and the business cycle. These economists argue that interest rates act as the general price level for
money and that the monetary causes the shifts in the business cycle. This school of thought believes that correct
manipulation of monetary policy, mostly through the Federal Reserve can eliminate the business cycles. The thinking
goes that by correctly increasing and decreasing the supply of money at the right time, the toughs and bubbles can be
avoided.[2]

Keynesian Economic Theory

Keynesian Theory argues that because price levels and wages (price of labor) are relatively rigid in the short run,
expansion in spending will alter real output. This is in contrast to classical economic theory which states that changes
in government spending will not alter economic conditions since such spending must be offset by equally large, albeit
future, taxes. However, Keynes argued that all actions do occur in the short run, where prices are rigid and so
government spending can effectively stimulate the economy. Thus, Keynesian Theory advocates for extensive deficit
spending which, aided by a "money multiplier" can reverse economic downturns which have occurred due to a fall in
consumer consumption. In this way, Keynes saw the government as temporarily stimulating the economy by replacing
the drop in spending from consumers. According to this theory, the government spending must be deficit and not
balanced by equivalent taxing.[3]

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Complexity Economics
This school of thought disagrees with traditional economics in that there is no linear equilibrium that the economy
trends towards. Instead, society is filled with a series of individuals who use rule of thumb judgments based on
incomplete information sets. The result is a dynamic, chaotic system with no clear distinction between micro and macro
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 discrete beginning and end.

Growth Curve and Life Cycle

The exponential growth of an economic bubble is unsustainable and results in synchronized wealth destruction when
the bubble collapses. On a global scale this reinforces the periodicity of the cycle because the entire world economy
must go through the recovery at the same time. Individual savings and investment behaviors become synchronized.

Shapes of Economy
Recessions of the economy come in many shapes and sizes. However, economists tend to refer to the following four
shapes the most[4]:

V-shaped recession
U-shaped recession
W-shaped recession
L-shaped recession

References
1. ↑ Wikipedia: Business Cycles
2. ↑ Ludwig Von Mises Institute "Why the Business Cycle Happens" 16 July 2004
3. ↑ Library of Liberty and Economics - The Concise Encyclopedia on Economics "Keynesian Economics" by Alan
S. Blinder
4. ↑ "Understanding V, U, W, and L-Shaped Recessions" article from Learning Markets

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