When the economy heads toward a recession, it's natural for investors to worry about falling stock prices and the impact on their portfolios. At the same time, you may hear reports of 澳洲幸运5官方开奖结果体彩网:dropping housing starts, increased jobless claims, and shrinking economic output. But what do ✤house building and shrinking output have to do with your portfolio? And, aside from all of these risks, how does a recession affect you as an investor?

As you'll see in this article, these symptoms are part of a larger picture, which determines the strength of the economy and indicates whether we are in a period of recession or expansion. To understand the state of the economy at a given time and how this affects the stock market, we need to start with the 澳洲幸运5官方开奖结果体彩网:business cycle. Generally, the bu♍siness cycꦚle is made up of four different periods of activity, each of which can last for months or years.

Stage 1: Peak

At its peak, the economy is running at full steam. Employment is at or near maximum levels, 澳洲幸运5官方开奖结果体彩网:real gross domestic product (GDP) is growing at a healthy rate, and incomes are rising. All this positive economic activity is reflected in stock prices, with share prices for many companies and industries rising to all-time highs. To show their gratitude to shareholders for their continued support and investment, companies may increase 澳洲幸运5官方开奖结果体彩网:dividend payouts.

Less encouragingly, prices tend to be rising due to 澳洲幸运5官方开奖结果体彩网:inflation. Even so, most businesses,🥀 workers, and investors are enjoying the boom tim🅰es.

Stage 2: Recession

The adage "what goes up must come down" applies perfectly here. After experiencing a great deal of growth and success, income and employment begin to decline due to any number of causes. It could be an external event that triggers the downturn, such as an invasion or a 澳洲幸运5官方开奖结果体彩网:supply shock, a sudden correction in overheated asset prices, or a drop in consumer spending due to inflation, which in turn can lead fiಌrms to lay off employees.

During a recession, stock prices typically plummet. The 澳洲幸运5官方开奖结果体彩网:markets can be volatile with share prices experiencing wild swings. Investors react quickly to any hint of news—either good or bad—and 澳洲幸运5官方开奖结果体彩网:the flight to safety can cause some investors to pull🅠 their money out of the stock market entirely.

Because the wages companies pay workers and the prices they charge consumers are "澳洲幸运5官方开奖结果体彩网:inelastic," or initially resistant to change, cutting payrolls is a common response. Rising unemployment pushes consumer spending down even further, setting off a vicious cycle of economic contraction. A recession is generally defined as two or more consecutive quarters of a decline in real GDP. However, the National Bureau of Economic Research (NBER) defines a recession as any period of "significant decline in economic activity that is spread across the economy and lasts more than a few months" and uses a variety of factors including GDP, employment, retail sales, and industrial production to make that determination.

Stage 3: Trough

The trough is the part of the business cycle when outpꦐut and employment bottom out before they begin to rise again. At this point, ♚spending and investment have cooled down significantly, pushing down prices and wages.

Troughs can be challenging to pinpoint while they are happening, but they are recognizable in hindsight. Troughs are the point where business activity moves from 澳洲幸运5官方开奖结果体彩网:contraction to recovery. A sign that the trough has occurred—or is about to occur—is when 澳洲幸运5官方开奖结果体彩网:stock prices begin to rally after a significant decline. Thi🍌s rebalancing of the economy makes new purchases attractive to consumers and new investments—in labor and assets—attractive to firms. 

Stage 4: Recovery and Expansion

During a recovery or "expansion," the economy begins to grow again. As consumers spend more, firms increase their production, leading them to hire more workers. Competition for labor emerges, pushing up wages and putting more money in the pockets of workers and consumers💦. That allows firms to charge more for products, sparking inflation that starts low and slow but may eventually bring growth to a halt and start ꩲthe cycle over again if it rises too high. Over the long-term, however, most economies tend to grow, with each peak reaching a higher high than the last.

How Does the Business Cycle Impact Investors?

Understanding the business cycle doesn't matter much unless it improves 澳洲幸运5官方开奖结果体彩网:portfolio returns. What's an investor to do during a recession? The a🦋nswer depends on your situation and wha♔t type of investor you are.

First, remember that a bear market does not mean there's no way to make money. Some investors 澳洲幸运5官方开奖结果体彩网:take advantage of falling markets by 澳洲幸运5官方开奖结果体彩网:short selling stocks, meaning they make money when share prices fall and lose money when they rise. Only sophisticated investors should use this technique, however, du🌠e to its unique pitfalls. The most important of these is that losses from short selling are theoretically unlimited since there is no obvious limitཧ to how far a stock's value can rise.

Another breed of investor treats a recession like a sale at the local department store. This technique, known as 澳洲幸运5官方开奖结果体彩网:value investing, looks at a declining share price as a bargain waiting to be scooped up. Betting that better times will eventually return to the economy, value investors take advantage of bear markets to 澳洲幸运5官方开奖结果体彩网:pick up high-qu♐ality companies on the cheap.

There is yet another type of investor who barely flinches during a🍒 recession. A follower of the long-term, buy-and-hold strategy knows that short-term problems will barely be a blip on the ch𝓀art over a 20- to 30-year horizon.

Another Approach for Investors

Of course, few of us have the luxury of looking decades down the line, or the iron stomach required to do nothing in the face of huge 澳洲幸运5官方开奖结果体彩网:paper losses. ♏Value investing is not for everyone either, as it requires extensive research, while short-selling requires even tougher discipline than buying and holdingꦦ. The key is to understand your situation and pick a style that works for you.

For example, if you are close to retirement, the long-term approach definitely is not for you. Instead of living at the whim of the stock market, consider diversifying into other assets such as 澳洲幸运5官方开奖结果体彩网:treasury securities, money market funds, and certifiꩲcates of deposit (CDs).

The Bottom Line: The Business Cycle Isn't Perfect

The business cycle model is, of course, oversimplified. Economies sometimes experience 澳洲幸运5官方开奖结果体彩网:double-dip recessions, for example, in which another recession follows a short recovery. Nor do all economies enjoy a positive long-term growth path. The relationships among spending, prices, wages, and production described above are also too simple. Governments often have a large influence at all stages of the cycle. Excessive taxation, regulation, or money-printing can spark a recession, while fiscal and 澳洲幸运5官方开奖结果体彩网:monetary stimulus can turn a shrinking economy around when the supposedly natural tendency to rebalance&🅷nbsp;fails to materialize.

Reading the headlines during a recession can convince you the sky is falling. But understanding the business cycle can help you realize that 澳洲幸运5官方开奖结果体彩网:downturns are a normal part of a fu🍷nctioning economy. When the economy begins to show signs of a recession, it's important to deve🎃lop a strategy for dealing with risks based on your financial situation.