Dec
23
2022
Using Fundamental Analysis to Choose Stocks
A popular method that analysts use to evaluate stocks is fundamental analysis. Learn what it is and how it’s used for stock purchases.
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SoFi
Student Loan Consolidation and Refinancing
Dec
22
2022
What Is an Equal-Weighted Index? How to Calculate It
An equal-weight index gives each constituent the same weight in the index, versus a market-cap-weighted or price-weighted index, where bigger companies (or those trading at higher prices) hold a larger share of the index.
Equal weighting strives to equalize the impact of each company’s performance on the overall index. Traditional market-cap weighting tends to give bigger companies more influence over outcomes.
Equal-weight investing is a smart beta strategy that may appeal to certain types of investors more than others. This article will delve deep into equal-weight investing, including:
• What Is an Equal Weighted Index?
• How to Calculate an Equal Weighted Index.
• Advantages of Using an Equally Weighted Index.
• Disadvantages of Using an Equally Weighted Index.
What Is an Equal-Weighted Index?
A stock market index tracks the performance of a specific group of stocks or a particular sector of the market. For example, the S&P 500 Composite Stock Price Index tracks the movements of 500 companies that are recognized as leaders within their respective industries.
Stock market indices are often price-weighted or capitalization-weighted.
• In a price-weighted index, the stocks that have the highest share price carry the most weight. In a capitalization-weighted index, the stocks with the highest market capitalization carry the most weight.
• Market capitalization represents the value of a company as measured by multiplying the current share price by the total number of outstanding shares.
While some investors may wish to invest in stocks, others may be interested in mutual funds or index funds, which are like a container holding many stocks.
How Equal Weighting Works
An equal-weighted index is a stock market index that gives equal value to all the stocks that are included in it. In other words, each stock in the index has the same importance when determining the index’s value, regardless of whether the company is large or small, or how much shares are trading for.
An equally weighted index essentially puts all of the stocks included in the index on a level playing field when determining the value of the index. With a price-weighted or capitalization-weighted index, on the other hand, higher-priced stocks and larger companies tend to dominate the index’s makeup — and thereby dictate or influence the overall performance of that index.
This in turn influences the performance of corresponding index funds, which track that particular index. Because index funds mirror a benchmark index, they are considered a form of passive investing.
Most exchange traded funds (ETFs) are passive funds that also track an index. Now there are a growing number of actively managed ETFs. While equal-weight ETFs are considered a smart beta strategy, they aren’t fully passive or active in the traditional sense. These funds do track an index, but some active management is required to rebalance the fund and keep the constituents equally weighted.
Examples of Equal-Weight Funds
Equal-weight exchange-traded funds (ETFs) have grown more common as an increasing number of investors show interest in equal-weight funds. Equal weight falls under the umbrella of smart-beta strategies, which refers to any non-market-capitalization strategy.
The term “smart beta” doesn’t mean a particular strategy is better or more effective than others.
Equal-weight funds, for example, are designed to shift the weight of an index and its corresponding funds away from big cap players, which can unduly influence the performance of the index/fund. And while an equal-weight strategy may have improved fund performance in some instances, the results are inconsistent.
Here is a list of the top five equal-weight ETFs by assets under management (AUM), according to ETF.com.
1. Invesco S&P 500 Equal Weight ETF (RSP )
2. SPDR S&P Biotech (XBI )
3. SPDR S&P Oil and Gas Exploration and Production (XOP )
4. SPDR S&P Global Natural Resources ETF (GNR )
5. First Trust Cloud Computing ETF (SKYY )
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How to Calculate Equal-Weighted Index
To calculate equal weighted index, you need to know two things:
• The share price of each stock that’s included in the index
• Total number of stocks included in the index
If you’re calculating an equally weighted index value for an index that has five stocks in it, each one would be weighted 20%, regardless of its stock price or market capitalization. To find an equal-weighted index value, you would simply add the share price of each stock together, then multiply it by the weight.
So for example, say an index has five stocks priced at $100, $50, $75, $90 and $85. Each one would be weighted at 20%.
Following the formula, you would add each stock’s price together for a total of $400. You’d then multiply that by the 20% weighting to arrive at an equal-weighted value of 80.
As fund turnover occurs and new assets are exchanged for old ones, or as share prices fluctuate, the equally weighted index value must be recalculated.
The equally weighted index formula can be used to determine the value of a particular index. You may want to do this when determining which index ETF to invest in or whether it makes sense to keep a particular index mutual fund in your portfolio.
Advantages of Using an Equally Weighted Index
An index investing strategy might be preferable if you lean toward more conservative investments or you simply want exposure to a broad market index without concentrating on a handful of stocks. That’s something you’re less likely to get with mutual funds or ETFs that follow a price-weighted or capitalization-weighted index.
Here are some of the reasons to consider an equal-weighted index approach:
• An equal-weight strategy can increase diversification in your portfolio while potentially minimizing exposure to risk.
• It’s relatively easy to construct an equally weighted portfolio using index mutual funds and ETFs.
• It may appeal to value investors, since there’s less room for overpriced stocks to be overweighted and undervalued stocks to be underweighted.
• Equal-weighted indices may potentially generate better or more incremental returns over time compared to price-weighted or capitalization-weighted indices, but there are no guarantees.
Disadvantages of Using Equally Weighted Index
While there are some pros to using an equal weighted approach, it may not always be the best choice depending on your investment goals. In terms of potential drawbacks, there are two big considerations to keep in mind:
• Equal-weighted index funds or ETFs that have a higher turnover rate may carry higher expenses for investors.
There is typically a constant buying and selling of assets that goes on behind the scenes to keep an equal-weighted mutual fund or ETF in balance.
Higher turnover ratios, i.e. how often assets in the fund are swapped in and out, can lead to higher expense ratios if a fund requires more active management. The expense ratio is the price you pay to own a mutual fund or ETF annually, expressed as a percentage of the fund’s assets. The higher the expense ratio, the more of your returns you hand back each year to cover the cost of owning a particular fund.
• Equal-weighted indices can also be problematic in bear market environments, which are characterized by an overall 20% decline in stock prices. During a recession, cap-weighted funds may outperform equal-weighted funds if the fund is being carried by a few stable, larger companies.
◦ Conversely, an equal-weighted index or fund may miss out on some of the gains when markets are strong and bigger companies outperform.
| Advantages | Disadvantages |
|---|---|
| Can increase diversification | Will typically have higher costs |
| Constructing an equal-weight portfolio is straightforward | May see outsize declines in bear markets |
| Equal-weight strategies may appeal to value investors | May not realize full market gains |
| Equal-weight strategies may perform better than traditional strategies, but there are no guarantees |
The Takeaway
In an equal-weight index, each stock counts equally toward the index’s value, regardless of whether the company is large or small, or what shares are currently trading for. The same is true of any corresponding fund.
There are advantages to investing in an equal-weight index fund over a capitalization-weighted index or price-weighted index. For example, equal-weighted indices may generate better or more consistent returns. Investing in an equal-weight index may be appealing to investors who prefer a value investing strategy or who want to diversify their portfolio to minimize risk.
With a SoFi Invest online trading account, you can begin building your portfolio using SoFi’s streamlined, secure investing app. You can follow a DIY path by choosing which stocks or ETFs to invest in, in addition to many other options including fractional shares, IPO shares, and more. SoFi doesn’t charge any commission, and members have access to complimentary financial advice from professionals.
FAQ
How do equal-weight ETFs work?
Like an equal-weight index, an equal-weight ETF holds the same proportion of each of its constituents, which in theory may equalize the impact of different companies’ performance.
When should you buy equal-weighted ETFs?
If you’d like to invest in a certain sector, but you don’t want to be riding the coattails of the biggest companies in that sector because you see the value in other players, you may want to consider an equal-weight ETF.
What is the equally weighted index return?
The return of an equally weighted index would be captured by the performance of an investment in a corresponding index fund or ETF. So if you invest $100 in Equal Weight Fund A, which tracks an equal weight index, and the fund goes up or down by 5%, you would see a 5% gain or loss.
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by email customer service at [email protected]. Please read the prospectus carefully prior to investing.
Shares of ETFs must be bought and sold at market price, which can vary significantly from the Fund’s net asset value (NAV). Investment returns are subject to market volatility and shares may be worth more or less their original value when redeemed. The diversification of an ETF will not protect against loss. An ETF may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
SOIN1022012
Dec
20
2022
What Are Labor Market Indicators?
The labor market is a key component of the economy, as it represents the supply and demand for workers and their respective wages. Labor market indicators are statistics that reflect the state of the labor market, providing information about employment levels, wage growth, and other factors that can impact the overall economy.
A wide range of analysts, from economists to investors to business owners to policymakers, pay close attention to various labor market indicators to help gauge the state of the economy. These data can play a critical role in determining how investors and businesses make investment decisions and how policymakers shape laws and regulations that affect society.
What Is the Labor Market?
The labor market, also known as the job market, is where workers and employers come together to find jobs and workers, respectively. It is critical to the economy because the supply and demand for labor determines wages and other employment-related issues.
The labor market is influenced by various factors, including the overall health of the economy, the level of education and training of the workforce, and government policies that impact employment and wages. The labor market can also be affected by broader economic trends, such as globalization and technological change.
Strong employment levels, low unemployment, and rising wages characterize a healthy labor market. These developments may indicate a robust economy and can lead to improved living standards for workers and their families. On the other hand, a weak labor market can signal economic difficulties, like a recession, and result in lower wages and higher levels of unemployment.
The labor market plays a crucial role in the functioning of the economy. By paying attention to the labor market and labor market indicators, investors can better evaluate the health and well-being of the economy, which may help inform investment strategies.
💡 Recommended: Cyclical vs Non-Cyclical Stocks: Investing Around Economic Cycles
Common Labor Market Indicators
Investors, economists, and policymakers use several common economic indicators to evaluate the state of the labor market. These indicators, most of which are released by the Bureau of Labor Statistics (BLS) , can provide valuable information about employment levels, wage growth, and other factors that can impact the economy.
Some of the most common labor market indicators include:
Unemployment Rate
One of the most closely watched labor market indicators is the unemployment rate, which is the percentage of the labor force that is not currently employed but is actively seeking work. This number can give insight into the overall health of the economy, as a high unemployment rate can indicate a sluggish economy. A low unemployment rate may signal a strong economy where most workers can find jobs.
The unemployment rate is calculated by dividing the number of unemployed workers actively seeking work by the total number of individuals in the labor force (which includes both employed and unemployed workers). The unemployment rate is expressed as a percentage. For example, if there are 100 unemployed workers and 500 individuals in the labor force, the unemployment rate would be 20% (100/500 = 0.20).
Nonfarm Payrolls
Nonfarm payrolls, also known as nonfarm employment or total nonfarm payrolls, measure the number of people employed in the United States. The nonfarm payrolls number is derived from the monthly Employment Situation report (also known as the Jobs Report), which is based on a survey of nonfarm establishments. This survey excludes farm workers, private household workers, employees of nonprofit organizations, and other types of businesses.
The nonfarm payroll number is considered an essential indicator of the state of the labor market, as it provides information about employment levels across a wide range of industries. A rising nonfarm payroll number can indicate a strong labor market and a growing economy, while a falling number can signal economic difficulties.
Average Hourly Earnings
Average hourly earnings is a measure of the average wage earned by workers. Along with the nonfarm payrolls report, it is released monthly by the BLS and is considered an important indicator of wage growth and the well-being of workers.
Average hourly earnings are calculated by dividing the total wages paid to workers by the number of hours worked. This number is then expressed in terms of an average hourly wage. For example, if the total wages paid to workers are $100,000 and the total number of hours worked is 2,000, the average hourly earnings would be $50 per hour (100,000/2,000 = 50).
Average hourly earnings can provide valuable information about the state of the labor market and the well-being of workers. Rising average hourly earnings may indicate that workers are seeing their wages increase, which may signify a strong labor market and a growing economy. However, rising wages may be a cause of inflation. On the other hand, falling average hourly earnings may signal economic difficulties and stagnant wages.
Employment-to-Population Ratio
Another critical labor market indicator is the employment-to-population ratio, which is the percentage of the population that is currently employed. This indicator is calculated by dividing the number of employed individuals by the total population.
The employment-to-population ratio can give a sense of the extent to which the labor force is being utilized. A high employment-to-population ratio can indicate a strong labor market, while a low ratio can signal economic difficulties. Additionally, this ratio can also be used to compare the employment levels of different groups within the population. For example, analysts may use the ratio to compare the employment levels of men and women or to evaluate the employment levels of different age groups.
Labor Force Participation Rate
The labor force participation rate (LFPR) is the percentage of the population that is either employed or actively seeking work. It is calculated by dividing the number of individuals in the labor force (which includes both employed and unemployed workers) by the total population and is expressed as a percentage. The LFPR can provide information about the availability of workers in the labor market and can be used to evaluate trends in the workforce.
JOLTs
JOLTS, or the Job Openings and Labor Turnover Survey, is a monthly survey conducted by the BLS. It provides data on job openings, hiring, separations (including layoffs, discharges, and quits), and other labor market dynamics in the United States.
The JOLTS data can provide insight into employment and job growth trends and can also be used to identify potential labor shortages or surpluses. For example, a high number of job openings and quits can indicate a strong labor market, while a low number can signal a weak labor market.
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Initial Jobless Claims
Initial jobless claims, also known as new unemployment claims or jobless claims, measure the number of individuals who have filed for unemployment benefits for the first time. This number is released weekly by the United States Department of Labor (DOL).
The number of initial jobless claims is a measure of the pace of layoffs in the economy. A rising number of initial jobless claims can lead to a weak labor market and a slowing economy. In contrast, a falling number can signal a strong labor market and a growing economy.
Continuing Jobless Claims
Continuing jobless claims, also known as continuing unemployment claims or continuing claims, is a measure of the number of individuals who have filed for unemployment benefits and have yet to find a job. Like initial jobless claims, this indicator is released weekly by the DOL.
The number of continuing jobless claims provides information about the number of individuals who have been unable to find work after filing for unemployment benefits. A high number of continuing jobless claims can indicate a weak labor market, suggesting that many workers are struggling to find employment. On the other hand, a low number of continuing jobless claims can signal a strong labor market, as it suggests that most workers can find jobs.
The Takeaway
Labor market indicators are an important tool for understanding the state of the economy and the health of the labor market. By tracking these indicators, you can better understand the factors that drive employment, wage growth, and the economy and make more informed decisions about your investments. Depending on the data, labor market indicators may show a strong economy, which may be a positive sign for your portfolio, or vice versa.
Ready to build your own portfolio to meet your financial goals? SoFi can help. With a SoFi Invest® online investment account, you can trade stocks, exchange-traded funds (ETFs), fractional shares, IPOs, and more with no commissions.
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SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SOIN0922038
Dec
20
2022
Annual Report: The Key Info Companies Provide in Theirs
An annual report is a document that provides insight into a company’s operations and financial performance over the previous year. While annual reports are primarily associated with large, publicly traded companies, small businesses and non-profit organizations may also release yearly reports.
Companies issue annual reports to provide shareholders, potential investors, employees, and other interested parties with a comprehensive overview of the company’s financial position. Companies also use annual reports to inform investors about the company’s performance and prospects for the future. Annual reports can be an essential tool for investors to make informed decisions about their investments.
What Is an Annual Report?
As noted above, an annual report is a document that publicly traded companies are usually required to issue each year to share information about their financial performance and activities with their shareholders. These reports typically include quantitative and qualitative details about the company’s revenue, expenses, profits, losses, and plans for the future.
Companies send annual reports to their shareholders before they hold annual meetings, often to assist in the shareholder voting process. Additionally, reporting companies will post their annual reports on their websites.
A company’s annual report is typically prepared by the company’s management team, with input from other members of the organization, such as the finance department and the board of directors.
The individuals and teams preparing the annual report can vary depending on the company and the information it wishes to include. It is typically a collaborative effort involving many different people within the organization. In some cases, a company may also enlist the help of external parties, such as auditors or consultants, to assist with preparing the annual report.
Often a company’s creative and communications teams will be involved in preparing the report, as they contribute to the narrative text, graphics, and photos that may be in an annual report. By making it visually appealing, companies can make it easier for readers to digest the information.
A publicly traded company’s annual report is related to, but different from, the Form 10-K annual report that they must file with the Securities and Exchange Commission (SEC). The Form 10-K annual report may contain more detailed information about the company’s earnings and financial condition than the annual report. Companies may send Form 10-K to their shareholders instead of – or in addition to – providing them with a separate annual report.
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What Information Is Contained In an Annual Report?
The main components of an annual report typically include an overview of the company’s operations and financial performance, financial statements, and information about the company’s management and board of directors.
The specific components of an annual report can vary depending on the company and the information it wishes to share with its shareholders. In addition to the main features outlined below, the contents of an annual report may also include other information, such as details about the company’s corporate governance practices, its environmental and social impact, and any additional information that the company feels is important for shareholders to know.
Letter from the CEO
Annual reports usually start with a letter from the chief executive officer (CEO) or chairman of the board that provides an overview of the company’s performance and highlights any significant events or developments that have occurred over the past year.
Performance Overview
Companies often provide a review of the company’s operations, including information about its products or services, market position, and any important milestones or achievements that have occurred over the past year, in an annual report.
Financial Statements
Financial statements, such as the balance sheet, income statement, and statement of cash flows, providing detailed information about the company’s financial performance and position, are a critical part of an annual report.
Corporate Leadership Overview
Annual reports include information about the company’s management and board of directors, including biographies and details about their backgrounds and experience. The reports may also have detailed information about executive compensation.
Future Outlook
A discussion of any risks or uncertainties that the company faces and how it plans to address them in the future is often included in the annual report. This can be helpful for shareholders and potential investors to gain an understanding of the company’s possible performance in the future.
Example of an Annual Report
Annual reports can vary depending on the company, its industry, and whether it is a publicly traded or privately held firm.
For example, an annual report for a company in the retail industry might include information about the company’s same-store sales over the past year. Additionally, the report may provide details about the products it sells, a breakdown of its inventory, an overview of its financial position, and information about the company’s management team and any potential risks or challenges it faces in the coming year.
To find out more about a specific company’s annual reports, you can usually find them under the investor relations portion of the company’s website or through the SEC’s EDGAR database .
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Who Can Benefit From Reading an Annual Report?
Several groups of people may benefit from reading an annual report. For example, the company’s shareholders are usually interested in an annual report to use the information to understand the company’s financial performance and make more informed decisions about their investments.
Other groups who may find annual reports useful include potential investors, who can use the information in the annual report to assess the company’s financial health and determine if it is a good investment opportunity. In addition, analysts, customers, journalists, and other stakeholders may find annual reports to be a valuable source of information about a company and its operations.
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The Takeaway
An annual report is a crucial document that provides a comprehensive overview of a company’s performance and financial position. These documents can be a critical resource for investors to make informed investment decisions. It is important to understand the information contained in the report and to analyze the information critically. By doing so, investors can make informed decisions about their investments as they build a wealth-building portfolio.
If you’re interested in building a portfolio to build wealth, SoFi Invest® can help. With a SoFi online brokerage account, you can trade stocks, exchange-traded funds, fractional shares, and more with no commissions, all in the SoFi app.
Photo credit: iStock/Charday Penn
SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below:
Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.
External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
SOIN1122027
Dec
20
2022
Business Cycle Investing
Investors often pay attention to the ups and downs of economic activity – fluctuations known as the business cycle – and readjust their investments accordingly. With this business cycle investing strategy, investors typically adjust their exposure to various sectors with stocks or bonds in their portfolios. Some industries outperform during economic expansions, while others do better during contractions.
Business cycle investing is not an exact science, and past performance isn’t indicative of future returns. But historically, specific industries have prospered during each stage of the business cycle. Here’s a rundown of the different business cycle stages and which industries have been more favorable to invest in during each phase.
What Is a Business Cycle?
A business cycle refers to the periodic expansion and contraction of a nation’s economy. Also known as an economic cycle, it tracks the different stages of growth and decline in a country’s gross domestic product (GDP), or economic activity.
Worker productivity, population growth, and technological innovations are all factors that can contribute to whether an economy is going through a period of boom or bust. Such elements play a role in how many goods and services a nation’s businesses produce and how much its consumers purchase.
Other factors, such as wars, pandemics, natural disasters, and political instability, can also influence the economy. These can cause a recession to happen sooner or otherwise shift the economic environment of a nation or the world.
In the U.S., the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) announces whether the economy is in a recession or a new iteration of the business cycle. Policymakers attempt to manage the business cycle by adjusting fiscal and monetary policies, such as taxes, stimulus packages, or interest rates.
Some people refer to business cycles and market cycles interchangeably. However, the business cycle measures the entire economy, while market cycles refer to the ups and downs of the stock market. Although the two can be correlated, they aren’t the same.
How Does the Business Cycle Work?
The business cycle works by alternating between periods of economic growth and decline. During the expansion phase, economic activity grows, and the economy is relatively healthy. A period of economic expansion is typically characterized by low unemployment, rising wages, and increasing consumer and business confidence.
Eventually, the economy will reach its peak and start to contract. This is typically characterized by slowing economic growth, rising unemployment, and declining consumer and business confidence. As businesses see a decline in demand, they may lay off workers or reduce production, leading to a downward spiral of declining economic activity.
The trough phase is the lowest point in the business cycle. Economic activity is at its weakest, and unemployment is at its highest. This phase is also known as the recession bottom. From here, the economy begins to recover, and the business cycle starts over again.
How Reliable Is the Business Cycle?
The business cycle is a reliable pattern of economic activity observed over time, but it is not always predictable. Business cycles tend to follow a similar pattern, with periods of expansion followed by periods of contraction, but each phase’s timing, length, and severity can vary significantly.
Stages of the Business Life Cycle
There are four stages of the business cycle, which fall into two phases: a growth phase of expansion and a declining phase of contraction. A business cycle can last anywhere from one year to 10 or more years. Since 1945, there have been 12 business cycles.
Stage 1: Recession
The recession phase is the lowest point in the business cycle. Also known as the contraction phase, a weak economy and high unemployment define this period.
GDP, profits, sales, and economic activity decline during this stage. Credit is tight for both consumers and businesses due to the policies set during the last business cycle. It’s a vicious cycle of falling production, incomes, employment, and GDP.
The intensity of a recession is measured by looking at the three Ds:
• Depth: The measure of peak-to-trough decline in sales, income, employment, and output. The trough is the lowest point the GDP reaches during a cycle. Before World War II, recessions used to be much deeper than they are now.
• Diffusion: How far the recession spreads across industries, regions, and activities.
• Duration: The amount of time between the peak and the trough.
A more severe recession is called a depression. Depressions have deeper troughs and last longer than recessions. The only depression that has happened thus far was the Great Depression, which lasted 3.5 years, beginning in 1929.
Recessions generally lead to shifts in monetary policy and government spending that lead to a recovery phase.
Stage 2: Early Cycle
Following a recession, the economy enters an expansion phase, where there tends to be a sharp recovery as growth begins to accelerate. The stock market tends to rise the most during this stage, which generally lasts about one year. Because of loose monetary policy by the central bank, interest rates are low, so businesses and consumers can borrow more money for growth and investment. GDP begins to increase.
Just as a recession is a vicious cycle, recovery is a virtuous cycle of rising income, employment, GDP, and production. And similar to the three D’s, a recovery period, which includes Stages 2-4, is measured using three P’s: how pronounced, pervasive, and persistent the expansion is.
Stage 3: Mid-Cycle
The mid-cycle phase is generally the longest phase of the business cycle, with moderate growth throughout. On average, the mid-cycle phase lasts three years. Monetary policies shift toward a neutral state: interest rates are higher, credit is strong, and companies are profitable.
Stage 4: Late Cycle
At this stage, economic activity reaches its highest point, and while growth continues, its pace decelerates. Monetary policies become tight due to rising inflation and low unemployment, making it harder for people to borrow money. The GDP rate begins to plateau or slow.
Companies may be engaging in reckless expansions, and investors are overconfident, which increases the price of assets beyond their actual value. Late cycles last a year and a half on average.
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What Industries Do Well During Each Stage?
Historically different industries have prospered during each stage of the business cycle, depending on whether they are cyclical or non-cyclical stocks.
When money is tight and people are concerned about the economy, they cut back on certain purchases, such as vacations and fancy clothes. Also, when people anticipate a recession, they tend to sell stocks and move into safer assets, causing the market to decline.
Industries do better or worse depending on supply and demand, and the need for specific products shifts throughout the business cycle. In general, the following sectors perform well during each stage of the business cycle:
Recession
During the recession phase, the lowest point in the business cycle, economic activity is at its weakest, and unemployment is at its highest. Many industries may struggle during this phase, especially those dependent on consumer spending or business investment.
However, certain industries are able to weather the storm during a recession because they offer products and services that people need no matter how the economy is performing. These industries include healthcare, consumer staples, and utilities.
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Early Cycle
During the early cycle expansion phase, when economic activity is growing and the economy is healthy, many industries tend to do well. These can include consumer-oriented sectors, such as retail and leisure, as well as industries that benefit from increased business investment, such as construction and manufacturing. Other sectors that benefit from increased borrowing due to low interest rates include financial services, real estate, and household durables.
Mid-Cycle
During the mid-cycle phase, when the economy is operating near full capacity, some industries may start to see slowing growth or declining profits. These can include industries sensitive to changes in consumer demand or highly competitive, such as technology and media. However, some industries perform well during the mid-cycle, like information technology and energy, because companies in these areas deploy capital that helps them grow.
Late Cycle
During the late cycle, economic activity slows down and the labor market shows signs of weakness. Additionally, the economy may face inflationary pressures due to the previous period of economic growth and low unemployment. While this inflationary pressure and economic slowdown negatively impact many industries, utilities and energy companies may do well during this period. Additionally, investors could research stocks that do well during volatility.
Who Should Invest With the Business Cycle?
Business cycle investing involves trying to anticipate changes in the business cycle and buying or selling assets based on the expected performance of those assets during different phases of the business cycle. For example, an investor following a business cycle investing strategy might buy stocks when the economy is expanding and sell them before the peak in anticipation of a downturn.
However, this active investing strategy is not suited for everyone. Investing and rebalancing a portfolio with the business cycle is difficult because timing the market is easier said than none. Business cycle investing is best for investors who have the time to stay up to date with the latest economic indicators and stock market news while also having the risk tolerance to time the market.
In contrast, some investors prefer a long-term buy and hold strategy, in which they don’t try to time the market and make few changes to their portfolio.
💡 Recommended: Is Stock Market Timing a Smart Investment Strategy?
Pros and Cons of Business Cycle Investing
Business cycle investing involves trying to anticipate and profit from changes in the business cycle. The goal is to buy assets likely to do well during certain business cycle phases and sell them before the next phase begins.
However, investors should note that the business cycle is not always predictable, and there are no guarantees that a business cycle investing strategy will be successful. Thus, it’s good to consider the pros and cons of business cycle investing.
Pros
The advantages of using a business cycle investing approach include the following:
• The ability to potentially profit from changes in the business cycle: By anticipating and acting on changes in the business cycle, investors may profit from the upswing of a recovery or the downtrend of a recession.
• A framework for decision-making: The business cycle provides a framework for analyzing economic trends and making investment decisions. This can help investors make more informed decisions about buying or selling assets.
• Diversification: Business cycle investing can help investors diversify their portfolio by adding assets likely to do well in different phases of the business cycle.
Cons
The disadvantages of using a business cycle investing approach include the following:
• Difficulty in predicting the business cycle: The business cycle is not always predictable, and it can be difficult to anticipate changes in the economic environment. This can make it challenging for investors to implement a business cycle investing strategy successfully.
• Market volatility: Business cycle investing can involve buying and selling assets at different points in the business cycle, exposing investors to stock volatility.
• Opportunity cost: By focusing on the business cycle, investors may fail to take advantage of opportunities to invest in assets that are not correlated to the business cycle but may still provide strong returns.
Investing With SoFi
No business cycle is identical, but history shows there can be a rough pattern to which industries do better as the economy expands and contracts. Investors can take cues from which stage of the business cycle the economy is in order to allocate money to different sectors.
One way to invest and keep track of the market is by using an online investing app like SoFi Invest®. With a SoFi online brokerage account, you can stay up-to-date with the latest financial market news, and trade stocks, exchange-traded funds (ETFs), and more with no commissions. Plus, you’ll have access to educational resources to support you as you continue to learn about the markets.
FAQ
What is an investment cycle exactly?
An investment cycle is a pattern of investment activity that occurs over time, usually in conjunction with the business cycle. It is typically characterized by periods of rising prices followed by periods of declining prices. The length and severity of the investment cycle can vary, and various factors, including economic conditions, market trends, and investor sentiment, can influence it.
How long are investment cycles?
The length of investment cycles can vary significantly, depending on economic activity and investor sentiment. Some investment cycles may last only a few months, while others may last several years or more.
What are the 4 stages of investment cycles?
The four stages of an investment cycle are expansion, peak, contraction, and trough. During the expansion phase, economic activity grows and investor confidence is high. Prices of investments, such as stocks and real estate, tend to rise, and demand for assets is strong. The peak phase is the highest point in the investment cycle. Prices of investments have reached their highest point, and demand for assets may start to wane. During the contraction phase, economic activity slows down and investor confidence may decline. Prices of investments tend to fall, and demand for assets may decrease. The trough phase is the lowest point in the investment cycle. Prices of investments have reached their lowest point, and demand for assets is at its weakest.
SoFi Invest®
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