Economic cycles — expansion and recession

Economies do not grow in a straight line. They move through a repeating business cycle of expansion and contraction. Recognizing where you are in the cycle is one of the most useful skills an investor can build.

The four phases

1. Expansion — growth accelerates, employment rises, profits and confidence climb. Stocks generally do well.
2. Peak — the economy runs near full capacity; inflation pressure builds and the central bank often raises rates.
3. Contraction / recession — growth turns negative (a common rule of thumb is two consecutive quarters of falling GDP), unemployment rises, profits fall. Stocks usually struggle; safe assets like government bonds tend to shine.
4. Trough — the low point, after which recovery begins and the cycle restarts.

Why the cycle matters more than the headline

Different assets and sectors lead at different points:

• Early expansion tends to favour cyclical sectors — consumer goods, industrials, banks.
• Late cycle and downturns tend to favour defensives — utilities, healthcare, staples — and high-quality bonds.

Markets are forward-looking, so prices often turn before the economy does. Stocks frequently bottom in the depths of a recession, while the news is still bleak, because investors are pricing the recovery they expect.

The policy connection

The cycle and policy feed each other. Central banks cut rates in downturns to revive growth and raise them in booms to contain inflation — deliberately trying to smooth the cycle. Understanding this loop helps you interpret why a weak economic report can sometimes lift stocks (markets anticipate rate cuts) and a strong one can sink them.