Navarro found that the movement of stock prices and the stock exchange show changing expectations stock holders in future movement of corporate profits. The business cycle is a critical element in forming decisions over corporate profits, since the profits in the time of the extension of the economy, are much higher than in times of recession. When stock holders expect strong growing economy, will make sure that the stock prices start to rise and improve profits on stocks. If the investors notice the arrival of recession, the trading process shows its pattern in expecting low profits on stocks.
Burns and Mitchel were researching the business cycle at the beginning of the 20. century with observing different economic indicators and fount that the fluctuations of business cycle reflect repeated events with similar properties in different countries. In general it holds that the business cycle shows some periodical and nonregulary movement in economic activity that is the dace of fluctuations or changes in the gross domestic product, or other microeconomic indicators like: unemployment rate, inflation or stock indices.
the business cycle is split in four phases:
1. economic expansion from growth to normal growth rate,
2. economic growth on non inflation phase,
3. the cyclical peak in growth till the holding of normal trend,
4. growth that falls below the trend and completes the cycle.
Each phase of the business cycle has its own relevant implications over the profits of different stock classes and sectors. Stock prices are really sensitive to each phase of the cycle. In the first phase offers ideal conditions to hold financial instruments, mainly stocks. In this phase begins the new growth of stock prices from the accumulation of holdings and business investments. In the early stage of economic growth expansion, the inflation rate is still dropping. Tough the economic activity has raised and it shows in the capital market. In the second phase of the cycle a warning sign is shown because on the raise in interest rates and additional interest in other investments. Supply is limited with capacity and demand accelerates at the rate of economic activity. In the third phase of the cycle the moderators start to control the excessive growth in making some wrong decisions and pushes the economy back in recession. Strong monetary policy and slow growth of the economy show on stocks like a phase of higher returns and high volatility on capital markets. The fourth phase is the most prominate phase for the stocks due to high liquidity and expectations of the new change in the economic growth.
