Introduction:

There is a saying that goes like this, “what goes up must come down”.  In reference to gravity, there are precise laws and formulas that can help you figure out how long an object will be airborne.

In the markets and in the economy, when something goes up we know it must come down, but there is no way to tell when.

The economy moves in boom and bust cycles in three phases:

  1. Expansion – economic growth and wealth expansion, higher stock company earnings
  2. Contraction – decreasing economic growth, job cuts, lower interest rates and lower earnings
  3. Recover – this stage is from the bottom of the contraction (the trough) up to the previous high of the expansion (peak) – above this level is net new growth

These cycles repeat and have rotated in sequence since the business has existed.

 

A complete break down:

Stock markets have been around for what seems like centuries. Each cycle extending over a longer period of time, from years to decades. Such as we have seen over the past boom cycle which has been extended for over a decade. There was a slight slip into the bear market territory in late 2018, which was quickly recovered.

Why do the they exist? It’s a part of a healthy economy. The cycles are due to monetary policy shifts. This circles back to the Fed and the Central banks across the world. They are in charge of the money supply and circulation.

In an expansionary market, everyone is euphoric and all rejoice in gains. This prompts Central banks to continue the joyous days ahead and make it easier to obtain money. They do this by making credit easier to obtain and lend money at a low cost. Or low-interest rates. This is done by cutting the central bank rate which was recently experienced in 2019 by the US Fed as equities traded at all-time highs.

When its easy to borrow money, investors take advantage of that and borrow to invest in the markets or in real estate. This is done to take advantage of the potentially higher returns. Flooding more money into the markets makes the market rise. They invest in high growth assets, maybe real estate or tech industries.

However, this comes at a price. Leading to exceeding demand and overinvesting in the markets. As companies growth is not as exponential as the investment growth in the markets. The overinvestment leads to mal-investments and eventually the bust.

Remember markets drop from all-time highs, not lows. When the market becomes overbought and the retail traders finally decide its time to buy after missing out on the major move, that’s when the selling begins.

This is the beginning of a domino effect. The domino effect being, loss of investor money, from panic selling. Which leads to cutting consumer spending and job cuts. This leads to harder to get credit, more expensive credit. Due to the difficulty of the previous boom investors being able to pay back the cheap money they borrowed. They’ve lost it!

That’s when the r-word comes in, RECESSION.

Panic Selling begets the Recession:

Panic selling begins when markets are overextended and investors notice the first sign of a dip, whether its 5% or 10%, just knocking on door of sell stops into the 20% and 40% drop levels.

This is when confidence in the market starts to wane and retail traders start buying the tops and the smart money begins to experience fear. The first indication is near correction territory, such as 10% drop. Money begins to flow out of the risk-on equity markets and into the risk-off safe havens. The risk-off assets include bonds, gold and the yen for example. When you see a risk-off increase on high volume, the smart money is rebalancing and flowing cash into the “worry assets”.

When buying starts to stall, and everything ceases other than necessities and job layoffs increase panic selling begins. There can be a cataclysmic event that catches up to us and starts the sell off, but that may not always be evident.

How does the recovery happen from the bust?

The bust cycle eventually comes to a halt, and the buying props in. Buy the dip, right? The investor, big money buying comes in at a price they deem is cheap enough. Or a “low” and that is where the boom begins. This is when the big money has enough money to start investing again, which does not happen overnight but its the start.

This is where central banks come into the market and change monetary policy, again making it cheaper to borrow and then invest. Yet again. It’s a cycle.

The government can step in as well and provide subsidies to companies to get them out of the recession and enforce growth business opportunities. Leading to job hirings again and investing.

U.S. Boom and Bust Cycles Since 1929

We found a very useful chart that rehashes the history of the economy since 1929, which shows every single boom and bust cycle since 1929, and the comments show what cause these cycles.  It is particularly interesting to go back in time and observe the chart of the SP500 index as you study this table.

The best way to anticipate the future is to learn about the past, because history, as they say, may not repeat – but it certainly does rhyme. The most recent boom and bust cycle is the current boom that has extended over a decade. There was a slight bear market move into the end of 2018, not to the degree of previous busts.

Cycle   Duration                     Comments
BustAug 1929 – Mar 1933Stock market crash, higher taxes, Dust Bowl.
BoomApr 1933 – Apr 1937FDR passed New Deal.
BustMay 1937 – Jun 1938FDR tried to balance budget.
BoomJul 1938 – Jan 1945World War II mobilization.
BustFeb 1945 – Oct 1945Peacetime demobilization.
BoomNov 1945 – Oct 1948Employment Act. Marshall Plan.
BustNov 1948 – Oct 1949Postwar adjustment
BoomNov 1949 – Jun 1953Korean War mobilization.
BustJul 1953 – May 1954Peacetime demoblization.
BoomJun 1954 – Jul 1957Fed reduced rate to 1.0%.
BustAug 1957 – Apr 1958Fed raised rate to 3.0%.
BoomMay 1958 – Mar 1960Fed lowered rate to 0.63%.
BustApr 1960 – Feb 1961Fed raised rate to 4.0%.
BoomMar 1961 – Nov 1969JFK stimulus spending. Fed lowered rate to 1.17%.
BustDec 1969 – Nov 1970Fed raised rate to 9.19%.
BoomDec 1970 – Oct 1973Fed lowered rate to 3.5%.
BustNov 1973 – Mar 1975Nixon added wage-price controls. Ended gold standard. OPEC oil embargoStagflation.
BoomApr 1975 – Dec 1979Fed lowered rate to 4.75%
BustJan 1980 – Jul 1980Fed raised rate to 20% to end inflation.
BoomAug 1980 – Jun 1981Fed lowered rates. For more, see Historical Fed Funds Rates.
BustJul 1981 – Nov 1982Resumption of 1980 recession.
BoomDec 1982 – Jun 1990Reagan lowered tax rate and boosted defense budget.
BustJul 1990 – Mar 1991Caused by 1989 Savings and Loan Crisis.
BoomApr 1991 – Feb 2001Ended with bubble in internet investments
BustMar 2001 – Nov 20012001 Recession caused by stock market crash, high-interest rates
BoomDec 2001 – Nov 2007Derivatives created housing bubble in 2006
BustDec 2007 – Jun 2009Subprime Mortgage Crisis, 2008 Financial Crisis, the Great Recession
BoomJul 2009 – NowAmerican Recovery and Reinvestment Act and Quantitative Easing

SOURCE: the balance.

 

Take a look at what the cycles look like to date. This is a visual representation of what the market looks like to date and all of the drops and recoveries. As you may notice, the current boom is extremely overextended based on past moves.

 

 

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The information contained in this post is solely for educational purposes, and does not constitute investment advice.  The risk of trading in securities markets can be substantial.  You should carefully consider  if engaging in such activity is suitable to your own financial situation.  TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.