Investment Decisions based on the Economic Cycle

Countries go through the business or economic cycle and the stage of the cycle at which a country has a direct impact both on industry and individual companies. It affects investment decisions, employment, demand and the profitability of companies. While some industries such as shipping or consumer durable goods are greatly affected by the business cycle, others such as the food or health industry are not affected to the same extent. This is because in regard to certain products consumers can postpone their purchase decisions, whereas in certain others they cannot.

The four stages of an economic cycle are:

  1. Depression: At the time of depression, demand is low and falling. Inflation is high and so are interest rates. Companies, crippled by high borrowing and falling sales, are forced to curtail production, close down plants built at times of higher demand, and let workers go.
  2. Recovery: During this phase, the economy begins to recover. Investment begins anew and the demand grows. Companies begin to post profits. Conspicuous spending begins once again. Once the recovery stage sets in fully, profits begin to grow at a higher proportionate rate. More and more new companies are floated to meet the increasing demand in the economy.
  3. Boom: In the boom phase, demand reaches an all-time high. Investment is also high. Interest rates are low. Gradually as time goes on, supply begins to exceed the demand. Prices that had been rising begin to stabilize and even fall. There is an increase in demand. Then as the boom period matures prices begin to rise again.
  4. Recession: The economy slowly begins to downturn. Demand starts falling. Interest rates and inflation are high. Companies start finding it difficult to sell their goods.

The Investment Decision

Investors should attempt to determine the stage of the economic cycle the country is in. They should invest at the end of a depression when the economy begins to recover. Investors should disinvest either just before or during the boom, or, at the worst, just after the boom. Investment and disinvestments made at these times will earn the investor greater benefits. It must however be noted that there is no rule or law that states that a recession would last a certain number of years, or that a boom would be for a definite period of time. Hence the length of previous cycles should not be used as a measure to forecast the length of an existing cycle. An investor should also be aware that government policy or other events can reverse a stage and it is therefore imperative that investors analyze the impact of government and political decisions on the economy before making the final investment decision.