Business Cycle Analysis

There is a lot of pessimism in the business and financial news cycle these days due to the uncertainty related to the administration's moves on trade, immigration, foreign policy, and other matters important to our nation's future. The dreaded "R" word (#recession) is appearing more and more. What I find missing is the discussion of the momentum visible in the US #economy coming into 2025. Take the consumer for example. Although #consumerconfidence has taken a steep dive in recent months, we were out there spending money at a healthy clip through February. Compared to last February, seasonally adjusted Advanced Retail Trade and Food Services were up 3.1% last month. Quarterly growth was even higher at 3.8%. Yet all the headlines talked of a whiff in consumer spending. The B2B economy, as reflected in US #industrialproduction data released this week, was also on the rise (from a business cycle perspective - see chart below) through February. In fact, the annual growth rate entered positive territory for the first time since late 2023, while the quarter-over-quarter #data implies further cyclical rise in the months ahead. Why is no one talking about this? At the very least we must recognize that the economy was accelerating before all the trade-related shenanigans began. Alex's Analysis: Leading indicators like Capacity Utilization (6-month lead), Copper Futures (9-month lead) and ISM's PMI (12-month lead) continue to point to further rise in the US industrial economy into the second half of the year. Most consumers, who account for nearly 70% of our economy in GDP terms, remain employed (outside of DOGE cuts), and thus should be able to continue spending in the near-term future if the trend holds. My current assessment is if the policy volatility and uncertainty can be contained to the first half of the year, with decisions on reciprocal #tariffs and specific product categories made soon after the April 2nd research deadline, we should not see a recession in the US in 2025. However, if we can't get out of our own way and the chaos continues past Q2, then the headwinds may become strong enough to result in a contraction of economic activity this year. I will eagerly await the developments and keep you updated if my expectations change.

Let’s understand capital cycle 📈 , how it impacts industries and #businesses, and how to detect the #capital cycle - Looking at 🏗 cement industry of Bangladesh through the lens of capital cycle - Why is the profitability of cement companies cyclical? Think about an industry where companies sell similar kinds of physical products with no unique value proposition and where a number of players are competing. Now, let’s say companies in that industry are enjoying a high profit margin and/or a high return on invested capital (ROIC). What do the companies most likely do In this situation? They invest more to increase their capacity of production so that they can maximize their return. New companies also enter the industry to tap into the high return potential. As a result, the supply of the products sharply increases. All of a sudden, the growth of supply increases far more than demand. What happens when growth in supply exceeds growth in demand? Price #competition arises. Some players start cutting their product prices, and others follow suit. And when they cut their prices to sustain their sales level, they sacrifice profitability. Their profit margin drops, and their ROIC drops. As profitability or return continues to decline, #investment also slows. Then comes a point when no new investment comes because no one wants to invest in low-return generating businesses. Now, supply side doesn’t grow, but the demand side continues its natural growth trend. Then gradually, a demand-supply gap arises, where demand becomes higher than supply. Price competition subsides. Companies can now increase product prices. Their margin improves, and so does their ROIC, and the cycle continues. The same cycle is evident in the cement industry of Bangladesh. One big leading indicator of the capital cycle is the industry capex-to-depreciation ratio. If capex to depreciation = 1, the companies are only investing to maintain their current production capacity/supply If capex to depreciation > 1, the companies are expanding capacity/supply If capex to deperciation < 1, soon capacity/supply will decline From the aggregated data of listed cement companies in Bangladesh, we see that the industry's capex to depreciation ratio was less than 1 to just above 1 during 2013–16, rose to above 5 in 2018–19, and then gradually fell to below 1 in recent years. The industry’s profitability had an inverse relationship to the ratio of capex to depreciation, with a bit of lag. Yes, there are many big players in the cement industry that are not listed. But if you followed the business news, you would see there is less news of cement capacity expansion now than there was during 2018–19, suggesting the start of a new phase of the cycle.

This map should make real estate investors uncomfortable. Not because it shows red states. But because of where the red and yellow are spreading and what usually comes next. This is a state-level business cycle map (Philadelphia Fed data). Green means expansion. Yellow means stalled. Red means contraction risk. Here’s the signal most people miss: When red clusters in the Midwest and Northeast at the same time, and yellow dominates everywhere else, the economy isn’t growing, it’s losing balance. That’s where real estate risk quietly builds. Leasing slows before vacancies rise. Renewals weaken before rents fall. Expenses keep climbing while income stalls. That gap compresses NOI long before prices adjust. And that’s why this phase is so costly. Most investors are still underwriting growth. But growth is now narrow, regional, and fragile. Markets labeled “treading water” have no margin left. One shock, refinancing, employment, credit and yellow turns red. The mistake isn’t buying bad assets. It’s buying good assets at the wrong point in the cycle. There is a smarter way to operate when the map looks like this. It starts by shifting from upside thinking to downside discipline before the market forces that shift for you. Late cycles don’t reward optimism. They reward patience, durability, and margin of safety. If this map made you pause, that’s the point. Source: Federal Reserve Bank of Philadelphia – State Coincident Indexes #RealEstate #MarketCycles #RiskManagement #MultifamilyInvesting #CommercialRealEstate #CapitalPreservation #MacroTrends

Many economists use the Conference Board’s Coincident Economic Index® (CEI) to date business cycle peaks and troughs. The CEI is comprised of four coincidental indicators -- payroll employment, real personal income less transfer payments, real manufacturing and trade sales, and industrial production -- that are included among the data used to determine the onset (and end) of US recessions. The latest reports indicate that at end of August, three of four are advancing. The outlier was industrial production, which was affected by Hurricane Beryl and likely to bounced back. No recession yet.

***Synchronization of endogenous business cycles***   A debate that is almost as old as economics itself is what recessions and booms originate from. Are they driven by events external to the economy, like natural disasters, or by forces internal to the economy, such as debt accumulation? In my recent paper published in the Journal of Economic Behavior and Organization, I tackle this question indirectly by examining the synchronization of economic activity across countries. The findings suggest that both external and internal forces are needed to explain empirical data.   Some terminology first. Business cycles. Sequences of booms and busts in economic activity. Exogenous business cycles. Driven by external “shocks”. Mathematically, the economy is described by a stable steady state buffeted by shocks. Endogenous business cycles. Driven by forces internal to the economy. Mathematically, the economy follows non-linear dynamics, such as limit cycles or chaos. Comovement. Positive correlation of economic activity. Synchronization. Alignment of non-linear dynamics.   It’s very hard to distinguish between exogenous and endogenous business cycles directly looking at time series of economic activity, partly because we have data for only ~10 cycles. It helps to look at properties of the economy for which exogenous and endogenous theories make different predictions. Here, I consider comovement of economic activity across countries. If business cycles are exogenous, comovement comes from shock propagation. If business cycles are endogenous, countries would follow non-linear dynamics in isolation, while linkages lead to *synchronization*. In the paper I quantify these effects through a very simple 2-equation model that describes business cycles in countries connected through international trade. When business cycles are exogenous, comovement is too low compared to the data; when they are endogenous, it is too high. The right combination of endogenous and exogenous cycles instead matches the data.   Thus, although the currently dominant view is that business cycles are exogenous, this paper provides a new type of evidence that they are at least in part endogenous. Although I’m not the first having this idea, this is the first paper that provides a complete mathematical theory and quantitative test. If the main result holds in more complex models, evidence on endogenous business cycles will have important implications in macroeconomic forecasting and policy making.   This contribution, which happens to be my only single-authored paper, comes from the last chapter of my PhD thesis, and took so long mostly because I had no coauthors nagging me to finish the paper 😊 I’m glad I could publish it in the JEBO special issue on complexity economics that I’m co-editing (all editor papers went through the editor-in-chief of the journal to avoid conflicts of interest).   Link to the paper (free access until January 18): https://lnkd.in/dwYJFSuf

A Primer on how to use the Yield Curve to become a better macro investor. The yield curve is one of the most important macro variables to watch: it contains a lot of information regarding the status of the business cycle and the degree of monetary policy tightening or easing perceived by markets. Inverted yield curves have famously predicted all recessions over the last 50 years with varying time lags. I would add that a big steepening of the yield curve is also an important signal which can explain whether monetary policy is excessively loose and/or whether the economic cycle is accelerating. But one of the key issues of ''reading'' the yield curve is that people tend to do that in isolation, while instead they should apply another angle. The trick here is to look and interpret yield curve moves within the context of the business cycle! So: here is your Yield Curve Cheat Sheet which allows you to do just that. Let's use a recent example. In the early part of 2024 the yield curve has mostly bear flattened while economists were busy revising growth prospects higher. 👉 Take a look at ''Growth Up + Bear Flattening''. What does that imply, and what asset classes benefit the most from this combination? 1️⃣ Cyclical stocks 2️⃣ Commodities In an environment where growth is moving higher and the market is busy repricing away cuts (= the curve bear flattens as rates move up mostly at the front-end), the ''Old Economy'' does well: value, cyclical, energy-related stocks deliver solid performance as the growth cycle is re-rating higher. And these sectors don't need lower rates to thrive: they just need strong economic activity. But now let's take another example: what if growth slows down, and the Fed is forced to cut rates faster? 👉 Take a look at ''Growth Down + Bull Steepening''. Well, in that case cyclical stocks and commodities actually do poorly. The yield curve bull steepens as the Fed is called to urgently cut interest rates because economic conditions are deteriorating. And finally, another example: what if the Fed decides to cut rates anyway despite growth holding up? 👉 Take a look at ''Growth Up + Bull Steepening''. In that case the yield curve bull steepens: Fed cuts push short-term interest rates lower, but traders have to incorporate term premium and uncertainty about future inflation into the long-end of the curve - hence, the bull steepening. Understanding how Yield Curve movements relate to the economic cycle and influence other asset classes is a key macro skill to acquire. In which regime do you think we are today? P.S. Enjoyed this macro analysis? Follow me (Alfonso Peccatiello) so you don't miss any post & stay updated on the launch of my Macro Hedge Fund! P.P.S. FREE TRIAL to my Institutional Macro Research? Join the biggest institutional investors in the world reading it every day - send me a DM and I'll set you up!