Business Cycles Ends With Recessions

The current economic environment indicates a late business cycle, suggesting an inevitable recession within the next few years, which markets typically price in ahead of time.

• The current economic environment indicates a late business cycle, making an eventual recession highly probable.

• Markets, especially risk assets, typically price in recessions well before they are officially declared, requiring proactive portfolio adjustments.

• A negative feedback loop involving layoffs, reduced hiring, and decreased spending is a key characteristic of an approaching recession, which has not fully materialized yet but shows warning signs.

The economy is in a late business cycle environment, characterized by metrics indicating excess has dried up, making a recession likely within the next two to three years. This projection is based on a modified indicator that normalizes the S&P 500 against the unemployment rate, inflation, and interest rates by the M2 money supply. Markets, particularly risk assets like cryptocurrency and eventually stocks, tend to price in these downturns well before a recession is officially declared, making it crucial for investors to adjust portfolios proactively rather than reactively.

Late Business Cycle Evidence

• 00:01:06 Economic indicators suggest the current environment is in a late business cycle phase, supported by a metric derived from the S&P 500 divided by the unemployment rate squared, multiplied by inflation and interest rates. Historically, when this metric cools off from elevated levels, a recession eventually follows, bringing it back down to historical lows. While a topping of this metric doesn't perfectly align with a stock market peak, it signals an eventual collapse.

Money Supply and Normalization

• 00:04:17 Incorporating the M2 money supply into the business cycle visualization provides a clearer perspective, especially given the significant increase in money supply since 2020. Normalizing the S&P 500-based metric by the M2 money supply reveals that the current peak is similar to the 2000 peak, suggesting a similar market dynamic. This normalized chart reinforces the assessment of being in a late business cycle, not the start of a new one, with a recession anticipated to reset the cycle.

The Negative Feedback Loop

• 00:07:44 A recession typically starts with a 'negative feedback loop' where companies lay off workers to save costs, but these laid-off individuals struggle to find new jobs due to low job openings, quits, and hiring rates. This leads to reduced consumer spending, decreased company revenues, and further layoffs, perpetuating the cycle. Currently, key indicators like real GDP and initial claims are not yet in this feedback loop, but declining job openings and hiring suggest it could accelerate if the stock market experiences a significant drop.

Market Timing and Strategy

• 00:13:07 Historically, the S&P 500 bottoms an average of 15 days before a recession is officially declared, meaning waiting for an announcement is a reactive and often suboptimal strategy. High-risk assets like altcoins and Bitcoin tend to bleed first, followed by the broader stock market, and finally sectors like energy and precious metals. Investors are advised to be selective and hedged in a late business cycle, as markets price in future weakness, and acting on recession headlines may be too late to position advantageously for the subsequent market recovery.