Kavan Choksi Sheds Light on the Business Cycle That Marks the State of the Economy at a Given Time

As the economy heads towards a recession, most investors would be worried about falling prices of stocks, as well as its impact on their portfolios. As per Kavan Choksi, at the same time, one may also hear reports of shrinking economic output, increased jobless claims and more. Such symptoms are part of a much bigger picture, which determines the strength of the economy, as well as indicates whether it is in a period of recession or expansion.

Kavan Choksi provides a brief understanding of the business cycle that underlines the state of the economy at a given time

To understand the state of the economy at a given point in time and how this impacts the stock market, one should have a clear idea of the business cycle.  This business cycle typically comprises of four different periods of activity, each of which may last for several months or years.

• Stage 1: Peak- This is the stage when the economy is running at full steam at its peak, and employment is at or near maximum levels. GDP would be growing at a healthy rate, and incomes shall be rising. All of such positive economic activity tends to be reflected in stock prices, as share prices of several companies rise to all-time highs. Companies may increase dividend payouts in order to show their gratitude to shareholders for their continued support and investment. On the less encouraging side, prices may go up due to inflation. However, even with that, most investors, workers and businesses do enjoy the boom times.

• Stage 2: Recession- The saying “what goes up must come down” fits this situation perfectly. Subsequent to a period of significant growth and success, income and employment begin to decline for various reasons. This downturn can be triggered by external events like an invasion or supply shock, a sudden correction in overheated asset prices, or even a decrease in consumer spending due to inflation, thereby leading companies to lay off employees. During a recession, stock prices generally fall sharply. The markets can become highly volatile, with share prices experiencing dramatic swings.

• Stage 3: Trough- This is the phase of the business cycle when employment and output bottom out prior to rising again. Spending and investment would have cooled down significantly at this point, ultimately down prices and wages. Troughs might be challenging to identify while they are taking place, but tend to be pretty recognizable in hindsight. They are basically the point where business activity moves from contraction to recovery.

• Stage 4: recovery and expansion- During a recovery or “expansion,” phase the economy starts to grow once more. Increased consumer spending leads firms to boost production and hire more workers. This results in competition for labour, ultimately driving up wages and increasing disposable income for workers and consumers. Moreover, companies start to raise their prices, which initiates inflation that starts gradually but can eventually slow down growth and potentially restart the cycle if it becomes too high.

Kavan Choksi mentions that the stock market generally has negative returns during the early part of a recession. This generally happens due to the negative sentiment around poor or lacklustre corporate earnings. However, the stock market does generally recover before the recession is over.