Where are we now?

It seems that the economy of most developed countries moves in a regular pattern, known as the boom and bust cycle. I know that I'd like to know what time it is now so that I could prepare for what's likely to occur in the near future. While the clock is not foolproof, it does demonstrate indicators to watch out for.

Application

This article will be of interest to:
Business Owners who want to under stand more about how the economy works and how they might be affected at different stages of the cycle.
Private Investors who want some independent guidance on when is the right time to own stocks, property and fixed interest deposits.
Real Estate Investors who need to understand why property prices move in cycles and how the comment that real estate prices only ever increase is not true.

What Is The Economic Clock?

The economic clock, pictured above, demonstrates that as an economy moves through its economic cycle there is a time to buy certain types of investments and possible a time not to buy. Notice that I don't say 'sell', because one of the most important investment habits to develop is a long-term investment horizon.
The economic clock is not a signal about what to buy to quickly become wealthy. Rather, it identifies that the return a particular investment will generate depends on what time it is in the economic cycle.
For example, if it was two o'clock then neither share or property is likely to be the best investment option.
To understand the process of the economic clock, let's go through one full cycle.

The Six O'Clock Recession

Recessions mark the peak of a downward swing in an economic cycle.

A recession is defined as a period of two or more successive quarters of decreasing production. Production is usually measured in terms of Gross Domestic Product (GDP), so in layman's terms, any two consecutive periods of negative GDP will constitute a recession.
Recessions are characterised by high unemployment, caused by employers shedding staff as production levels fall, cutting profitability and the need for labour.
With less employment comes a drop in the average weekly earnings and with fewer dollars to spend, consumers demand less, resulting in even lower consumption.
Historically Australia has entered a period of recession every seven to nine years with our last recession in 1990.

Recovery 'Till Midnight

A recovery from recession begins with increased government spending (known as fiscal policy) and control of interest rates (known as monetary policy).
More spending on government projects increases the demand on private sector businesses, which in turn look to employ more staff to cope with increased production needs. Lower interest rates prompt businesses to borrow and invest in capital projects.
Market analysts believe the beginning of the recovery phase is an excellent time to invest in the stockmarket. Companies which survived the recession will be efficient and well placed to obtain higher earnings from growth in target markets resulting in higher share prices and bigger profit distributions.
Share prices move through a period of gradual increases as the hour hands pass between six o'clock until about eleven o'clock when those who have missed out on the stockmarket gain start buying leading to more aggressive market highs. A frenzy begins which marks the beginning of the end of the recovery cycle, which peaks when the economy is booming.
Just before midnight a phenomenon known as 'the greater fool theory' begins. The greater fool theory suggests that no matter what price an investor pays for a share, someone (the greater fool), with less education and less understanding of the market, will buy it at a higher price. Eventually the price rises to a figure when the greatest fool buys because s/he cannot find anyone to buy it at a higher price. When the greatest fool buys the market has reached its peak and is set for a correction.
You know you are in the 'great fool' period when you hear that investors with little or no knowledge of the fundamentals of investing believe they can't lose.

Midnight Boom Before The Impending Correction

Just as the greatest fool has purchased articles appear in the media about how wonderful the stockmarket is and how the good times are never going to end. In recent times stockbrokers coined the term 'new economy' stocks only to see traditional economic theory pierce the hype and bring stock values down.
Well before the clock strikes midnight the wise investors have exited stocks and are looking for the next opportunity. They have left because they understand that there is likely to be a correction in the market, since share prices cannot be justified by traditional stock valuation methods, such as asset backing per share or earnings multiples.
As investors leave the market, supply (sales) become higher than demand (purchasers) triggering a sell off and a slump in share prices. Investors who were too slow (or greedy) are burned, particularly those that have leveraged (via margin lending facilities) and the panic begins as people scream 'sell'.

Property 'Till Three O'Clock

The smart investors that 'got out' at the top move into property with reliable 'bricks and mortar'.
Extra demand in property pushes demand above supply and results in higher prices.
This itself isn't a problem, except that the government sees the economy is overheating and looks to introduce measures to enable a 'soft landing' through increasing interest rates to flatten demand by consumers.
With higher interest rates comes less profit in real estate since most investors have leveraged their property purchases. Rises in interest rates continue until it is no longer viable for purchasers to continue investing in property and soon there are more sellers than buyers. Property prices, like share prices, correct.
There is trouble on the way.

Decline Back To Six O'Clock

Decline begins as business confidence begins to fall. Investors find little value in either stocks or property and with impending trouble on the horizon fixed interest securities become very popular again.
Lower business confidence means that new capital ventures are postponed.
Less spending and higher interest rates result in lower demand, which results in less production. With fewer sales there is a squeeze on earnings, resulting in profit downgrades; economic rationalisation becomes a hot topic in the boardrooms.
The economy slows to the point where productivity stalls and then declines. When this happens for two periods in a row, the economy is said to be in a recession.