The business cycle

Why this matters

The last chapter introduced the three numbers macro investors watch: growth, inflation and unemployment. They don’t move at random. They rise and fall together in a pattern that repeats, again and again, through every decade of data.

That pattern is the business cycle. Stocks, bonds, currencies and commodities each tend to do well in some phases and badly in others. So a huge part of macro investing is working out where in the cycle you are, and what comes next.

The four phases

Economies don’t grow in a straight line. They move through a repeating pattern called the business cycle:

1. Expansion. Growth is positive, unemployment falls, companies hire and invest. Inflation usually starts low and creeps up as the economy heats up.
2. Peak. The economy runs hot. Unemployment is low, inflation is often rising, and central banks may start raising rates to cool things down.
3. Contraction (recession). Growth turns negative, unemployment jumps, and inflation usually falls as demand weakens.
4. Trough. The bottom. Central banks have usually cut rates, and the stage is set for the next expansion.

The four phases of the business cycle

Output swings above and below its long-run trend. Shaded stretches are contractions (recessions).

Simplified model · real cycles vary in length and depth

No two cycles are the same length. Some expansions last more than a decade; the 2020 recession lasted two months (NBER). But the pattern is remarkably consistent.

To see real cycles, go back to the Try it chart in the last chapter. Every shaded band is a contraction, and the stretches between them are expansions.

Real-world example: the longest expansion on record

After the 2008 financial crisis, the US economy hit its trough in June 2009. What followed was slow but steady growth that just kept going. The peak didn’t come until February 2020, when COVID hit.

That expansion lasted 128 months, the longest in US records going back to 1854. The previous record was 120 months, from March 1991 to March 2001 (NBER).

The lesson: expansions don’t die of old age. A cycle usually ends because something breaks it, such as a financial crisis, an inflation fight by the central bank, or a shock like a pandemic. Watching for those triggers matters more than counting months.

Key takeaways

• The economy moves through a business cycle of expansion, peak, contraction and trough, and each phase favours different investments.
• Growth, inflation and unemployment move in a recognisable pattern through each phase.
• Cycles vary a lot in length, from a two-month recession in 2020 to a 128-month expansion from 2009 to 2020.