A Strong Economy And Risks For The Markets

Summary

  • The latest business cycle started in early 2020.
  • Commodities and interest rates responded as suggested by historical patterns.
  • The latest data point to a strong cycle ahead and increased risks for the markets.

The economy is strong, no doubt about it. The trend of the business cycle and financial markets reflects the current positive economic conditions. The markets are reacting as they have typically done during this phase of the business cycle.

The business cycle moves in waves because it reflects justifiable miscalculations by business managers about the desired level of inventory needed to meet expected demand. It is a complex decision biased by the continuous vociferous comments from analysts and commentators.

The bottom line for decision-makers is how much to produce to meet demand through the supply chain.

Source: www.peterdag.com

Why does the economy slow down? Why does the business cycle move from Phase 2 to Phase 3? Where is the current position of the business cycle now?

These are crucial questions. Their answer drives tactical and strategic investment decisions, and it shows the risks facing the markets.

The major causes for the economy to slow down and the business cycle to transition from Phase 2 to Phase 3 are: rising commodities, rising interest rates, and rising inflation.

During Phase 2 of the business cycle managers are focused on building inventories to meet rising demand for their products. Demand is strong and production must be increased aggressively. To do so business has to purchase raw materials, hire production workers, and increase borrowing to finance the production process.

Toward the end of Phase 2 the intensity of building up inventories causes inflation and interest rates to rise to levels hindering consumers’ purchasing power and consumers’ confidence. The outcome is demand starts slowing down.

Business remains optimistic about the future and does not recognize this change in demand. They keep ramping up production to keep plants operating at full capacity. Eventually, however, inventories are rising at a much faster pace than demand, causing profitability to suffer. The inventory/sales ratio shows a visible rise.

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