Stocks Market and Business Cycle

The major movements in bond, stocks, and commodity prices are caused by long-term trends in the emotions of the investing public. These emotions reflect the anticipated level and growth rate of future economic activity, and the attitude of investors toward that activity.

The Financial Markets and the Business Cycle

The major movements in bond, stocks, and commodity prices are caused by long-term trends in the emotions of the investing public. These emotions reflect the anticipated level and growth rate of future economic activity, and the attitude of investors toward that activity.

For example, there is a definite link between primary movements in the stocks market and cyclical movements in the economy because trends in corporate profitability are an integral part of the business cycle. If basic economic forces alone influence the stocks market, the task of determining the changes in primary movements would be relatively simple. In practice, it is not, and this is due to several factors.

First, changes in the direction of the economy can take some time to materialize. As the cycle unfolds, other psychological considerations, such as political developments or purely internal factors like a speculative buying wave or selling pressure from margin calls, can affect the equity market and result in misleading rallies and reactions of 5 to 10 percent or more.

Second, changes in the market usually precede changes in the economy by 6 to 9 months, but the lead time can sometimes be far shorter or longer.

Third, even when an economic recovery is in the middle of its cycle, doubts about its durability often arise. When these doubts coincide with political or other adverse developments, sharp and confusing counter cyclical price movements usually develop.

Fourth, profits may increase, but investors' attitudes toward those profits may change. Changes in bond and commodity prices are linked much more directly to economic activity than are stocks market prices, but even here, psychological influences on price are very important. Currencies do not fit well into business cycle analysis. Although data reported several months after the fact are very good at explaining currency movements, technical analysis has been most useful for timely forecasts and the identification of emerging trends.