Business Cycle
The business cycle is the recurring pattern of expansion and contraction in economic activity: growth builds to a peak, slows into a recession, bottoms at a trough and recovers. Different assets and sectors tend to do well at different stages.
Economies don't grow in a straight line. Periods of rising jobs, profits and spending give way to slowdowns, then recover again. Understanding where the economy sits in this cycle helps investors decide which sectors to favour and how much risk to take. This entry explains the stages, how cycles are dated and how markets react.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- Economic cycle, Trade cycle, Boom and bust cycle
- Updated
The business cycle in plain words
The business cycle describes the expansion and contraction an economy goes through over time; one cycle is a boom followed by a contraction.1
After an expansion the economy reaches a peak, and the recession that follows is a period of weaker growth.1
In the US, NBER dates cycles: expansions run from a trough to a peak, recessions from a peak to a trough.2
The stages of the cycle, step by step
Expansion
Output, jobs and profits rise. See Gross Domestic Product.
Peak
Growth tops out, inflation often high. See Inflation.
Contraction
Activity slows; profits fall.
Recession
A significant, broad decline. See Recession.
Trough
The low point before recovery.
Recovery
Growth resumes and a new cycle begins.
Worked examples
Example 1 — Measuring a recession
Short recessionA peak is dated in February and the trough in April of the same year.
| Recession length | 2 months (peak to trough) |
NBER classifies the peak month as the last month of the expansion and the trough as the last month of the recession.2
Example 2 — Sector rotation
Cyclicals leadIn early recovery, a cyclical stock rises 35% while a utility rises 8%.
| Cyclical | +35% |
| Defensive | +8% |
Cyclical sectors tend to lead in recoveries and lag in downturns. See Cyclical and Defensive Stocks.
Example 3 — Earnings through the cycle
−60% EPSA manufacturer earns $5 a share at the peak and $2 in the recession.
| Earnings drop | ($5 − $2) ÷ $5 = −60% |
Profits of economically sensitive firms swing widely with the cycle. See Operating Leverage.
What tends to do well in each phase
| Aspect | Economy | Often favoured |
|---|---|---|
| Early recovery | Growth picks up | Cyclicals, small caps |
| Mid expansion | Steady growth | Broad equities |
| Late cycle | Inflation, tight policy | Commodities, defensives |
| Recession | Falling output | Bonds, defensives. See Bond |
How investors use the business cycle
Sector rotation
Shifting between sectors. See Stock Market Sectors.
Asset allocation
Stocks vs bonds through the cycle. See Tactical Asset Allocation.
Reading indicators
Leading data signal turns. See Leading Economic Index.
Central bank outlook
Policy reacts to the cycle. See Federal Reserve.
Advantages and disadvantages
Advantages
- Framework for thinking about markets.
- Helps with sector and asset choices.
- Explains swings in profits.
Disadvantages
- Turning points are only clear in hindsight.
- Cycles vary in length and depth.
- Markets often move before the economy.
Going deeper
Read as far as you need. Each level builds on the one before it.
Boom and recession
Beginner
A boom is rapid economic growth, while a recession is a period of relatively stagnant or falling activity.1
Official dating
Intermediate
NBER's chronology identifies the months of peaks and troughs, often months after they happen.2
Markets lead
Advanced
Stock prices usually anticipate turns, bottoming before the economic trough and topping before the peak. See Leading Economic Index.
Common mistakes
Waiting for official dates
They arrive too late to trade.
Assuming fixed lengths
Cycles are irregular.
Ignoring policy
Rates and stimulus reshape cycles.
Over-rotating
Timing sectors precisely is hard.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- The business cycle alternates expansion and contraction.
- Phases: expansion, peak, recession, trough.
- NBER officially dates US cycles.
- Sectors perform differently in each phase.
- Markets usually move ahead of the economy.
Frequently asked questions
How long is a business cycle?
Who decides when a US recession starts?
Can cycles be prevented?
Further learning
- Recession
The contraction phase.
- Gross Domestic Product
The main measure of output.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Business Cycle (opens in a new tab) Checked .
- NBER. Business Cycle Dating (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.