The Business Cycle Has Not Been Repealed
During the heady days in the late 1990s, people were saying that the Internet had permanently transformed business conditions in America. Serious analysts predicted that the business cycle had been repealed and, henceforward, the stock market would only go up.
That prediction lasted all of three months into the new millennium as the dotcom bubble burst and stocks declined with a vengeance. Soon after, the attacks on the World Trade Center and the Pentagon sent the U.S. economy into a downturn. And the mortgage crisis came along some six years later, dragging the economy into a painful 18-month recession.
Today, as a result, nobody doubts that the business cycle is alive and well.
What Exactly Is a Recession?
The technical definition of a recession is two consecutive quarters of decline in real gross domestic product (GDP). A private, non-profit research institution called the National Bureau of Economic Research (NBER) bears responsibility for announcing the official beginning and end of recessions in the United States. However, the NBER committee waits until all of the revised data on the economy has been reported before making the call. As a result, virtually everyone in the financial press and the business world is aware of the presence of recessionary conditions well before it’s actually declared official.
NBER also tracks the expansions that inevitably follow recessions. The length of time from peak to peak of consecutive expansions or from trough to trough of consecutive recessions is considered a business cycle. Since the end of World War II, there have been 11 business cycles in the U.S. The average length has been 5.75 years. The good news is that the length of the average expansion has been 58.4 months—almost five years—while the average length of contractions is only 11.1 months.
Cycles Within Cycles
As you can see, the labels “expansion” and “contraction” reflect average conditions across the entire $15.7 trillion U.S. economy. The averages often obscure a wide degree of variation in business conditions in different parts of the country and across different industries.
The economy can also be divided into sectors of businesses that are in the same industry or have other characteristics in common. There are many different ways to carve up the sector pie. But the best known is probably the segmentation scheme employed within the S&P 500® stock index. The 10 sectors are: Information Technology, Financials, Health Care, Consumer Discretionary, Energy, Industrials, Consumer Staples, Materials, Utilities, and Telecommunication Services.
Sectors that Drive Most Recoveries
Your own business experience should tell you which parts of the business cycle are the best and the worst for your company. Generally speaking, consumers lead the way out of recessions, buying clothes, traveling, and going to movies. As a result, companies in the consumer discretionary sector do well. Consumers may also be buying bigger ticket items that they’ve held off on acquiring during a recession, such as computers and cars. That gives a lift to companies in the IT and industrials sector, as well as material sector companies that provide steel, wood, and plastic building blocks for all these products. And of course, U.S. consumers are borrowing money from banks to pay for these purchases. As a result, banks and other financial sector companies will enjoy fast revenue growth.
Late in the cycle, demand will have pushed up prices for energy and raw materials, so those sectors are likely to do well. In addition, companies in so-called “recession-proof” industries are relatively well insulated from most economic slowdowns, as people have little choice about keeping the lights on in their homes, talking on the phone, seeing their doctors, and buying groceries. As such, defensive sectors include consumer staples, utilities, telecommunications, and health care.
Local Conditions and Specific Events Are Critical
That’s the theory, but in practice specific events can drive demand in more or less unpredictable directions. A rise in energy prices will benefit local gas stations, but hurt businesses connected to the airline industry as fuel costs squeeze profit margins.
Suppliers for large industrial companies will probably find a lag in the time it takes for their businesses to benefit, relative to that of their clients. It simply takes a while for the money to start flowing from the spigots.
Although health care is considered recession proof, doctors performing elective surgery may find revenues down during economic contractions, while oncologists should not be affected.
What about criminal defense attorneys? If anything, you’d expect crime to increase in a poor economy. In fact, anecdotally, a lawyer explained that his practice fell off during the last recession—he was losing business to public defenders.