In the economic sweet spot: Why the economic downturn may take a few years

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Many people want to know where we are in the business cycle. After the stock market rose strongly in 2017, “gambler fallacy” is causing investors to worry that losing streak will weaken their earnings. However, given its unique nature, this cycle can only be in the seventh inning if the economy is a baseball game and there may be additional situations.

Normal cycle

In the early stages of the normal cycle, the economy started to recover and the commercial sales growth accelerated, even though the overall activity level remained sluggish. Although sales have started to improve, companies are worried that improvements will not last long. Fortunately, lack of confidence is almost impossible to prevent a new round of growth, as companies often have excess capacity.

As sales continue to improve, confidence in economic recovery increases and companies are hiring more people to expand their businesses and lower their jobless rates. Improvements in the labor market have rebuilt public confidence in the economy and helped to sustain economic growth. At this stage, the economic news is usually positive, and even more confidence will make the neutral report look even more optimistic. Increased confidence also encourages consumers and businesses to consume more freely. Public confidence contributes to the self-sufficiency bias of economic growth.

 

When inflation is upgraded, the end of most cycles begins. As wages are scarce, wages rise and other prices go up. To counter inflation, the Federal Reserve lowered its economic needs by raising interest rates. The problem is that raising interest rates generally does not affect the economy about a year after its implementation, making it very difficult for the Federal Reserve to reduce its economic growth without exceeding its standards. Therefore, a rate hike usually leads to a recession, often accompanied by a sharp drop in share prices.

What makes this cycle different?

A competitive business environment helps to curb inflation more than ever before. Slow sales growth and low capacity utilization have deprived pricing power businesses.

Therefore, the price of consumer goods (ie, durable goods), which has a longer useful life, is actually lower than last year despite the rising demand for consumer goods.

Weak sales growth and intensifying pricing competition have made business expansion more cautious. As the economy approaches full employment, the pace of wage growth will not accelerate and will therefore not be expected to widen, at the same time as labor productivity growth will be weak.
Where are we from?

At this point, we have entered a “sweet spot” of the business cycle: the public is already confident about economic growth but before inflation plunges enough to start the downturn.

The U.S. economy grew 2.5% in the third quarter of 2017, just a little faster than the entire cycle. Despite headwinds in consumer spending this year, some key inflation figures are still well below the long-term Fed goal. At this rate of economic growth, this cycle should have an expanded horizons. Even a 2.5% increase will ultimately result in higher rates of inflation through labor shortages or other key inputs, but not as fast as growth.

As a result, the fact that many economic forecasters call for accelerated growth by 2018 can be significant. The 3% estimate is not uncommon, especially if the new tax stimulates faster growth. This may shorten the period of rising inflation and the end of the cycle.

 

However, faster growth requires closer attention to the data. The rise in wages may precede more widespread inflation, which should lead to higher interest rates before the economy actually starts to slow. With the implementation of the order, more cautiousness is necessary. But before that, we need to realize that the current sweet spot may last longer than usual. Keep in mind that even if faster growth leads to higher inflation, this cycle should not be ended immediately. In view of the normal lag time for the rise of interest rates, economic growth should be maintained at a positive value of about 12 months.

Psychologists tell us that we feel uncomfortable when we continue for a long period of time, so the “fallacy of gamblers” often prompts us to forgo too much investment in economic sweet spots. If growth is slow enough to weather the rise in inflation, we could have another two years or so before the next economic downturn, which may be good news for investors and continue investing.

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