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THE SOUTH AFRICAN INDEX INVESTOR |
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“Greater rewards, lower costs” |
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TOOL BOX |
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Investment Philosophies, Theories and Practices (continued…)
Business Cycles
The recurring cycle of expansions and contractions of the economy is known as the business cycle. The one cycle inevitably leads to the other and as such has a profound effect on how stock markets perform.
During an expansion stock prices rise because the business environment is favourable. Interest rates are low and the disposable income of consumers is at a high, thus encouraging consumer spending, which normally accounts for 60% of economic growth. The sales and profits of businesses increase, which lead to rising stock market prices (bull market). While the economy continues to expand, full production capacities are reached, shortages occur, and inflation pressures start to mount.
In order to curb rising inflation pressures, the Reserve Bank will hike the discount rate to force interest rates higher. The additional cost of doing business and the lower disposable income of the consumer in turn, slow down the economy. Businesses experience lower sales, and more importantly lower profits, which adversely impact stock prices and expectations. Investors move out of stock to alternative asset classes and a bear market is born. |
