End of business cycle investing

Typically, when the long-term interest rate approaches the short-term interest rate, it tends to suggest that market participants investors are signaling declining growth in the future and lower inflation. It may also suggest that the demand for long-term business borrowing and investment is declining.

The market cycle — our investments While the business cycle is driven largely by fluctuations in macroeconomic fundamentals — such as unemployment, inflation or interest rates — the market cycle represents the fluctuation of stock prices over time.

Market fluctuations tend to be more pronounced as they are further influenced by changes in investor psychology and behavior. Similar to business cycles, market cycles have distinct phases that vary in length and are composed of an expansion, a peak, a contraction, and a trough or bottom. The beginning of the expansion tends to coincide with increasing investor optimism that the economy is growing, which is followed by excitement as stock prices rise, leading up to the peak.

As the market crests and prices start to decline, we tend to see disappointment and increasing pessimism, followed by a sell-off capitulation , marking the trough. They show a couple takeaways. First, we can tell that the decline in stock prices typically precedes a recession. Secondly, while the duration of recessions can sometimes be ephemeral and the percentage change in GDP appear to be immaterial, the magnitude of decline in stock prices can be relatively severe.

Take the technology, media, and telecommunications TMT bubble that burst in , for example. An investor would have seen half their wealth evaporate during this time period. Understanding the basics of how cycles work can help you avoid making emotionally based investment decisions that can permanently impair your portfolio.

Energy, materials, health care, and consumer staples stocks have historically done well in the late cycle. Stocks, bonds, and cash have delivered similar returns during the late cycle. Developing and sticking to a financial plan can help you remain invested and on course toward your goals throughout the phases of the business cycle.

The saying goes that a recession is when your neighbor loses their job and a depression is when you do. But what is it called when both you and your neighbor are working but worrying about possible layoffs, rising prices, and volatile stock markets?

The answer is the late phase of the business cycle. That's where Fidelity's Asset Allocation Research Team says the US economy is currently, rather than in a recession as headlines might suggest. Dirk Hofschire, senior vice president of asset allocation research, explains that the economy is showing late-cycle characteristics including a tight labor market, declining profit margins, rising inventories, tighter monetary policy, and a flatter yield curve.

But he cautions that, although near-term recession risks remain moderate, the economy may move through this late-cycle phase faster than it has in the past. During this phase of the business cycle, expect stocks to continue to rise with heightened volatility. When a recession eventually hits is anyone's guess. But with the exception of the Great Recession, recessions have tended to be short and followed by robust recoveries.

So focus on your long-term goals rather than on short-term market gyrations. If you have a plan you believe in, stick with it. If you're unsure, a financial professional can help you build one or make adjustments as needed. What is the late cycle? The late cycle is a phase of the business cycle, which is the name that economists give to the pattern of changes in economic activity that take place over time.

In the late cycle, economic activity often reaches its peak. Growth slows but remains positive. Rising inflation and a tight labor market may lead the Federal Reserve to raise interest rates and corporate earnings may decline. The late cycle ends when economic activity contracts and the economy enters recession. A short twilight? While late cycles have historically preceded recessions, the economy has also taken an average of a year and a half to move from the start of the late cycle into those recessions.

This one could be shorter because of the outsized role that Federal Reserve policies and government stimulus spending have played in the current business cycle compared to earlier ones. That may make the late cycle a good time to review your portfolio and make sure you're prepared for an eventual downturn and the early cycle recovery that will follow it, which is often the most fruitful time for investors.

If you already have a well-diversified portfolio that accurately reflects your goals, time horizon, and tolerance for market volatility, you may find you have little to be concerned about. If you need to rebalance your portfolio, it may help to look for guidance to the history of late cycles and recessions. You should be cautious, though, about making changes to your portfolio in pursuit of opportunities during the late cycle because of the historically volatile nature of markets in this part of the cycle and the possibility of a downturn ending the cycle.

However, market leadership has changed. When inflation and interest rates have risen in the past, investors have shifted away from economically sensitive assets like stocks of companies that make nonessential consumer goods and big-ticket items like cars and houses. Meanwhile, energy, materials, and utility stocks have done well as have stocks of companies that earn money by selling products that meet basic needs—such as consumer staples, utilities, and health care.

Past performance is no guarantee of future results. Asset class total returns are represented by indexes from the following sources: Fidelity Investments, Ibbotson Associates, Barclays, as of July 31, Source: Fidelity Investments proprietary analysis of historical asset class performance, which is not indicative of future performance.

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