Where Are We In The Business Cycle

Igor Manukhov - Dec 16, 2022

We appear to be in early stages of economic contraction in a business cycle. Bonds tend to outperform in this stage, but stocks will be rebounding well before good news will appear. Proceed with caution, but look ahead.

Last week I read an article by Martin Pring, who is considered to be the professor of chart analysis. In his work, Mr. Pring pays a lot of attention to the business cycle and how it impacts stocks, bonds and commodities. Below is a stylized business cycle chart that shows the sequence of price peaks and bottoms for bonds, stocks and commodities (marked as B, S, C respectively).

During expansion part of the cycle, bonds reach their peak price first, then stocks, and commodities tend to peak last. That makes a lot of sense, in expansion phase, central bank has to raise interest rates to slow down overheating economy, as rates go up, prices of bonds start to fall (red B). It takes a bit of time for companies (stocks) to feel the pain of higher interest rates and higher inflation. Stock market starts to sell off in anticipation of economic slow down (Red S). Higher inflation does benefit commodities up until economic activity starts to slow down and commodities start to fall (Red C).

At this point we are in a contraction phase of a business cycle. Inflation slows down, and sooner or later central bank has to start cutting rate to stimulate the economy, bonds bottom and start rising (Green B). Stock market is a forward looking and despite all doom and gloom, stocks start to anticipate economic stimulus of lower interest rates and stocks start to rise (Green S). As economy continues to expand, demand for commodities picks up and commodities start rising (Green C).

I believe we are somewhere near Green B part of the cycle. Stocks could continue to drop, but I am pretty sure that we are closer to the bottom that we think and in a mean time, bonds are starting to work again after a disappointing 2022 performance.Of course this is just an idealized cycle, but the sequence of events is quite accurate.

 

 

 

Take a look at the second chart which shows that 10 year bonds (blue line on the top) have topped back in 2020 (pink circle), stocks (black line in the middle) have topped at the end of 2021 (blue circle) and commodities (red line on the bottom) have peaked in June of 2022 (green circle). Moreover, it appears that bonds have found the bottom back in October of this year (red circle). Maybe we are closer to the end of this mess than we think.