Lesson 1
The Four Phases
Identify the current phase and position accordingly. Early cycle: own cyclicals. Mid cycle: ride the market. Late cycle: shift to defensives. Recession: preserve capital, prepare to buy.
📊 Indicators mentioned in this lesson (click for details):
The business cycle is the regular pattern of expansion and contraction in economic activity. It follows predictable phases that determine which assets outperform.
Phase 1: Early Cycle (Recovery)
- Coming out of recession
- Fed still accommodative
- Earnings recovering from depressed levels
- Credit starting to flow again
- Duration: 12-18 months
Winners: Cyclicals (Financials, Consumer Discretionary, Industrials, Small Caps)
Phase 2: Mid Cycle (Expansion)
- Longest phase
- Steady growth, moderate inflation
- Fed gradually normalizing
- Duration: 3-5 years
Winners: Broad market, Quality Growth
Phase 3: Late Cycle (Peak)
- Growth slowing but still positive
- Inflation rising, Fed hawkish
- Credit tightening begins
- Duration: 12-18 months
Winners: Energy, Healthcare, Staples
Phase 4: Recession (Contraction)
- Negative GDP, unemployment rising
- Fed cutting aggressively
- Duration: 6-18 months
Winners: Cash, Treasuries, Utilities, Staples
How to Track the Business Cycle
Use this indicator checklist to identify the current phase:
Leading Indicators (look 6-12 months ahead):
- Yield curve (2s10s (T10Y2Y)): Inverted → Late cycle/recession coming. Steepening after inversion → Recession imminent.
- Initial jobless claims (ICSA): Rising above 250k → Slowdown starting.
- ISM New Orders: Below 50 → Contraction ahead.
- SLOOS: Net tightening >40% → Recession historically follows.
- Conference Board LEI: 6+ months of decline → High recession probability.
Coincident Indicators (confirm current phase):
- Nonfarm Payrolls (PAYEMS): Negative prints = recession confirmed.
- Unemployment Rate (UNRATE): Rising 0.5%+ from low (UNRATE) = Sahm Rule triggered (recession).
- Industrial Production: Declining = contraction in progress.
Phase Identification Cheat Sheet:
| Indicator | Early | Mid | Late | Recession |
|---|---|---|---|---|
| GDP Growth | Accelerating | Steady 2-3% | Slowing | Negative |
| Unemployment | Falling fast | Low, stable | Rising slowly | Rising fast |
| Inflation | Low/rising | Moderate | High/peaking | Falling |
| Fed Policy | Accommodative | Normalizing | Restrictive | Cutting |
| Yield Curve (T10Y2Y) | Steepening | Flat | Inverted | Re-steepening |
| Credit | Loosening | Neutral | Tightening | Frozen |
| Earnings | Recovering | Growing | Decelerating | Declining |
Practical Tracking Approach:
- Check LEI monthly (Conference Board).
- Watch initial claims (ICSA) weekly.
- Monitor yield curve (T10Y2Y) daily.
- Review SLOOS quarterly.
- Track ISM monthly.
When 3+ leading indicators flip, the phase is likely changing.
Check your understanding
Lesson Quiz
Quiz Check
It's early cycle (coming out of recession). Which sectors should you overweight?
Quiz Check
By late 2021, inflation is rising, the Fed is turning hawkish, profit margins are peaking. What cycle phase is this?