Predicting The Business Cycle
A Stock Market Matters Perspective
Global economies ebb and flow. In effect, economies trend, and if they trend, it makes them forecastable. Predicting the business cycle is easier if we can forecast the trend in economies.
Asset prices are affected by business cycle trends. By predicting the business cycle, asset prices become forecastable.
Four camps offer different frameworks and explanations with the aim of predicting the business cycle.
Classical economists focus on supply-side factors, while Keynesian economists emphasise demand-side influences.
The monetarist perspective highlights the role of money supply, and real business cycle theorists attribute fluctuations to external shocks like technological changes.
At Stock Market Matters, we broadly subscribe to the monetarist perspective.
That perspective emphasises the role of monetary policy and the quantity of money in the economy. According to monetarists, particularly those following Milton Friedman’s theories, fluctuations in economic activity are primarily driven by changes in the money supply.
Key Factors In Predicting The Business Cycle
Global economies are driven by the secular cycle.
In addition, the role of human psychology and behaviour and the role of policymakers in economic cycles presents a significant challenge in predicting the business cycle.
Consumers, businesses, and investors’ emotional responses to economic conditions can lead to self-reinforcing cycles, such as bubbles or crashes.
Policymakers’ interventions, such as fiscal stimulus or monetary tightening, aim to moderate fluctuations in the economy and the business cycle.
However, the effectiveness of their interventions is often debated. Misjudgements can exacerbate cycles or lead to unintended consequences like inflation or stagnation.
That said, liquidity and the debasement of currency linked to debt are the dominant and most significant factors in macroeconomics.
It explains most of the price movements in all assets.
Secular Cycle
A key formula to understanding the secular cycle is:
GDP Growth = Population Growth x Productivity Growth + Debt Growth
If the population grows, there are more people doing economic activity, which will grow the economy.
Productivity is a multiplier. Economic output can be increased with increased productivity.
Debt growth is used to offset population and/or productivity growth limitations. The economy grows; however, the increase in debt is robbing the future.
Demographics And Productivity
In many Western countries, the demographics have ageing populations.
Consumer spending declines over time in ageing populations. This tends to lead to slower economic growth and a secular decline in inflation rates, trending toward deflation.
People are living longer, but the birth rate has been collapsing, and despite populist sentiment suggesting otherwise, immigration levels are not enough to offset that trend.
Consequently, the labour force participation rate has been falling over time. The economy needs people in the labour force to be productive.
In short, Western countries are faced with a structural slowing of productivity and population growth.
To offset the impact of demographics, governments have taken on more debt.
Debt Growth
Globally, the debt to GDP is around 350%.
Countries in the West have huge debt problems, and the U.S. is the most indebted country, as a percentage of world GDP, of any country in history.
As the population slows and economic growth slows, governments’ and central banks’ ability to service debt becomes more challenging.
To service the existing debt requires more debt.
More debt is required to create GDP growth.
The combined effect of the demographics and debt trends is slow and declining economic growth with a bias toward periodic busts.
That is the big picture today. Robotics and AI may provide the answer to population and productivity growth in the future.
Debt Refinancing and The Business Cycle
The Great Financial Crisis of 2008 marked a significant turning point in the business cycle and its cyclical nature.
The world just reached unsustainable debt levels.
More specifically, the financial sector was broken, and its combined debts were such that it seemed inevitable that a global depression more significant than that of the 1930s would be unavoidable.
To avoid a depression, governments and central banks decided to put the financial sector’s debts on the central bank’s balance sheets.
In 2008, the U.S. national debt was approximately $10 trillion. Fast-forward to today, and the debt has surged to nearly $35 trillion.
So, how can governments and central banks keep adding to the debt?
The answer is liquidity.
In the U.S., between 2009 and 2014, they used the Federal Reserve balance sheet.
Then they started using additional levers to debase the currency and inject money into the economy.
That started with the Treasury General Account and now includes the M2 money supply (the banking system).
Governments have debased their currency (by money printing) to offset and service the debt.
Money printing drives asset and scarce asset prices (gold, property, art, etc.) only. It does not drive wages, corporate earnings, or commodity prices.
94% of the price movement of stocks in the S&P 500 is driven by liquidity.
That explains why, over time, assets look optically more expensive.
Optically, because if you rebase the equity market in the U.S. by the Fed balance sheet, then the equity market has not increased in value; purchasing power has not increased by owning the S&P 500.
Earnings or wages grow broadly in line with GDP growth, and asset prices grow in line with the liquidity driven by money printing. So, asset prices grow faster than wages, which is why those who own assets get richer (optically) and the poor get poorer.
Your Future Self Is Worth Less
When governments turn on the money printer (and add liquidity) to address the debt and other financial crises, everyone pays the cost of that money printing via reduced purchasing power.
In the U.S., currency debasement (money printing) has reduced the purchasing power of the dollar by 8% annually since 2008.
If you add to that inflation at 3%, then your wealth needs to increase by 11% annually just to stay the same.
If we use the formula for future value under inflation:
FV=PV×(1+r)nFV = PV \times (1 + r)^n
Where:
- PV (Present Value) = $100
- r (Annual Inflation Rate) = 11% or 0.11
- n (Years) = 16 (from 2008 to 2024)
Then $100 in 2008 would need approximately $507.34 in 2024 to have the same purchasing power
In effect, money printing or currency debasement is a stealth tax.
The ability to print money and debase the currency to service debt explains why governments are able to run high levels of debt. They use liquidity and debasement as financial repression to service the debt.
Governments and central banks did something similar with the debt accrued at the end of World War II. The result was that the economy became cyclical, productivity eventually grew, and debt was optically reduced.
Debt Jubilee
In 2008, governments and central banks collectively agreed to a debt jubilee to finance the debts. They set all interest rates to zero and restructured all the debts into the one-year to five-year sector.
They then debased the currency and increased the value of the collateral in the system so that it could support the debts.
The interest on the debt is rolled over every three to four years. However, when it gets rolled over, there is insufficient GDP growth to pay down the debt, and so it’s added to the next cycle. They then inject liquidity and debase the currency to pay for it.
In short, they borrow on a credit card, and every three to four years, they pay it back by taking another credit card.
They effectively created a four-year cycle of debt refinancing by debasing the currency and servicing the short-term debt.
The result is that the business cycle now follows the debt refinancing cycle and is played out over a four-year cycle beginning in 2008.
The debt refinancing cycle is also linked to the U.S. presidential election cycle, as 2008 was the year of the elections.
Predicting The Business Cycle
Understanding the secular cycle and the factors driving it provides a bigger-picture perspective that provides context when analysing and predicting the business cycle.
Understanding the business cycle framework provides a heads-up for asset price performance.
Liquidity plays a crucial role in the business cycle by influencing economic activity, investment, and financial stability.
During economic growth periods, liquidity (and easy access to cash or credit) allows businesses to invest in new projects, hire workers, and expand operations. Consumers also benefit from access to credit, leading to increased spending.
When liquidity dries up—often due to tighter monetary policy, financial crises, or investor uncertainty—businesses and consumers find it harder to access funding. This can slow investment, reduce hiring, and lead to economic contraction.
Central banks adjust liquidity through interest rates and quantitative easing. Lower interest rates encourage borrowing, while tightening monetary policy (raising rates or reducing asset purchases) limits liquidity and slows economic overheating.
Liquidity ensures smooth transactions and price stability in financial markets. When liquidity is low, markets can become volatile, leading to sharp price swings and potential economic disruptions.
In essence, liquidity acts like oil in the economy’s engine—it keeps transactions, investments, and financial activities running smoothly. The business cycle reacts accordingly when there is too much or too little.
Tracking The Business Cycle
Since 2008, the business cycle has followed the four-year debt refinancing cycle.
Broadly, that could be represented as:
2022 Trough
2023 Expansion
2024 Peak
2025 Contraction
2026 Trough
The Institute for Management Supply and the Global M2 Money Supply are two resources that can be used when analysing the business cycle to confirm where the business cycle is relative to the debt refinancing cycle:
The Institute for Supply Management (ISM) survey tracks the monthly rate of trend in the economy.
Economic growth and liquidity are correlated. Liquidity is a function of growth and the business cycle and can be tracked via the Global M2 Money Supply.
Institute for Supply Management (ISM)
The Institute for Supply Management (ISM) is a monthly survey that provides insight into economic activity. It’s an oscillator that signals the economy’s monthly rate of trend and leads the economy by around a month.
If you compare the ISM to the U.S. GDP, they are highly correlated. If you compare ISM to global GDP, they are highly correlated.
The U.S. is the largest consumer of goods in the world and drives global manufacturing cycles, which are key components of the business cycle.
In addition, the U.S. also drive the debt super cycle, and with that debt, they purchase more goods.
The relationship between the ISM and the S&P 500 year-on-year is correlated. If the ISM is falling, then the rate of return in the S&P 500 is falling, and vice versa.
Corporate earnings are linked to the business cycle, and the ISM tracks the monthly rate of trend of the economy and the business cycle.
ISM Levels
If the ISM is above 50, then the economy is expanding. Below 50, the economy is contracting.
If the ISM is above 50, it means that supply chain confidence is starting to improve, which in turn likely means that consumer and corporate confidence is starting to improve.
If that is the case, then bank lending, which is an injection of liquidity, will likely improve. This means more consumption and investment, which leads to more earnings and an increase in GDP.
In that environment, cyclical stocks (energy, industrials, and consumer discretionary) outperform defensive stocks (consumer staples, utilities and healthcare)
At a later stage in the business cycle, when the ISM is around 60, inflation will challenge the economy. That will lead to central banks raising interest rates.
Higher interest rates increase the cost of borrowing, while wages are generally rising. That compresses margins, eventually leading to layoffs, which in turn leads to less consumption, less investment, less earnings, and lower GDP.
Global M2 Money Supply
As noted above, economic growth and liquidity are correlated. Liquidity is a function of growth and the business cycle.
Liquidity is used to debase the currency to effectively pay down debt and, as important, service the outstanding debt.
More importantly, liquidity drives asset prices. So, if liquidity can be forecasted, then asset prices are forecastable.
2022 Trough
2023 Expansion (liquidity starts to rise)
2024 Peak (liquidity continues to rise)
2025 Contraction (liquidity peaks)
2026 Trough (liquidity withdrawn to try to cool inflation and the economy)
A good proxy for liquidity is the Global M2 Money Supply. Asset prices lag the M2 money supply by around 12 weeks.
Additional Resources
Investing is a journey, and knowledge of the business cycle is a key tool for helping investors navigate the stock markets confidently.
However, it’s not the only tool.
We have provided additional material, in audio, video and PDF formats, under the resources heading.
They include a video (
In addition, the Stock Market News Update page keeps you updated on stock market matters and helps to filter out the noise from reliable insights.
Resources
Access a comprehensive range of resources below, including audio articles, educational videos, and tools designed to help you grasp the complexities of stock market matters.