Investment and Business Cycles - How to Stay Ahead of the Crowd

Investment and Business Cycles - How to Stay Ahead of the Crowd

Investment and Business Cycles - How to Stay Ahead of the Crowd

A Chinese proverb aptly says: "He who could foresee affairs three days in advance would be rich for thousands of years." Investors would modify that proverb to a day, a few hours or even minutes. Knowing what is going to happen is worth a lot money in business and is the difference between success and failure.

Information is the most expensive and valuable asset for an investor. If you know that something is going to happen before everybody else does you can buy cheap what later could be sold at a profit. That is why investors use professional brokers, researchers, sophisticated analysis software and every useful tool they can lay their hands on in order to be ahead of the game even if only by a few minutes.

Investors and business analysts have for a long time realized the existence of cycles in business, investment and the economy as a whole. These cycles are defined as a periodic fluctuation in the rate of economic activity, as measured by the levels of e mployment, prices and production. Although these fluctuations have been seen and studied for nearly two hundred years it is not strictly true that these fluctuations are always wave-like or circular which has caused many economists to prefer the term business fluctuation.

Obviously if you can identify a cycle (or fluctuation) and know the shape of it you can in theory predict what will happen next. You should be able to know if things are going to get better, worse, more expensive or cheaper by where you are currently positioned in the cycle. As you probably guessed this is not as easy as all that. There are many types of economic fluctuations. In fact because of the complexity of economic phenomena some argue there are as many types of fluctuations or cycles as there are economic variables.

The truth remains that cycles or periodic fluctuations are a fact of life. We have cycles in traffic (e.g. those caused by rush hours); consumption of electricity, agricultur e, purchases of clothing, saving, construction and the list goes on and on. Depending on the variable that causes the cycle these are short or long, for instance agriculttral cycles tend to be short while construction and general economic activity cycles can extend for many years.

One of the most useful uses of business fluctuations is the prediction and management of depressions or crises. At one time these depressions were seen as catastrophes in economic life rather than a normal stage in a cycle, studying things from this angel provides a completely different view to the issue.

The first researcher to explore economic cycles as a periodic occurrence was probably Clement Juglar, a French physician. According to his research and that of those that have followed his methods there exists an 8, 9 or 10 year cycle (depending who you ask) that is divided in three stages or phases: prosperity, crisis and liquidation. This cycle was rather visible in the years going f rom 1825 to 1929. However due to Government antycyclical policies Juglar cycles have been offset.

However many regard the Juglar cycle as the true or major economic cycle. Other smaller cycles have also been distinguished and studied.

What is interesting to investors is that business cycles are closely bound with economic growth. A typical example is that of 19th century Germany, a generalized upswing in the economy has been associated with the growth of the railroad, metallurgy, textile and building businesses.

Even though business fluctuations and their analysis are a useful tool for economists, investors and business managers they are rather limited. It is very often easier to identify and understand a cycle after the fact when its practical use is no longer that valuable. As mentioned above there are so many factors and variables that it is very difficult to provide specific accurate predictions.

However a very useful result of the study of busine ss fluctuations has been the identification of lead and lag indicators. Through the statistical study of business cycles and series of cycles turning points have been identified that provide a marker or turning point after which the economic activity tends to rise or drop. These indicators are used widely in economic forecasting. An example of these indicators could be data from business orders, residential building contracts, the stock market indexes, business failures or even the length of the average workweek.

Understanding and identifying these markers can mean the difference between business investment success and failure.

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