The Cyclical Economy & Your Business

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(This is not intended to be a thorough examination of the cyclical patterns of our economy; I only wish to shed some light on this topic through some general observations.) Many of us would probably agree with the characteriza- tion of the past decade as the “roaring 90s” as some have called it. Job growth and overall growth of the national economy were perhaps the best they ever had been, at least in modern memory. By late 2000, however, many saw the writing on the wall. These “contrarians” as they are often called, began pulling their money out of the stock market as well as actually shorting particular stocks and the market indexes in general. These folks were surely the first to recognize that good times could not last forever.

Volatility up, volatility down. Do you remember the meteoric rise of stocks such as Yahoo, Cisco and Juniper Networks? These flagships of the “new economy” made history for their rapid rise in share price but also for their swift decline. The lesson here is: a volatile stock, quick to rise in good times is often the stock quickest to decline in tougher times. The opposite is true as well. According to Peter Lynch in his best-selling book, Beating the Street, “Just when it seems that things can’t get any worse with these companies, things begin to get better. The comeback of a depressed cyclical with a strong balance sheet is inevitable.” We have seen these prophetic words come to pass this last financial quarter with world equity markets setting the best results in 17 years. Just when we thought terrorism and economic recession would finish off the financial markets forever, the smart money was already showing strong gains.

Classic cyclicals Some of the best-known cyclicals include: copper, aluminum, steel, autos and paper. I would also like to mention wine in this group. Like waves on a shore, these goods tend to fluctuate in an ebb and flow of over and under supply. To develop this idea a little further, let’s take wine as an example. As soon as we witness a period of prolonged prosperity, people take notice and decide that we could all have increased sales and profit if only we increased production.

The wine market as an example I have seen this first hand, through my experience in the wine business and through my wine import company, the Southern Wine Group. Just when it seems that no one needs more wine, vineyard planting increases. As soon as these plantings come “on line” there seems to be a perfect correlation between this new supply and the market’s lack of ability to absorb this new production without a decline in prices. Remember, however, that the wineglass is half full, not half empty. An ocean of cheap wine will not last forever. As people begin snapping up this inexpensive, but excellent wine, the overall supply of the good decreases. The bright side of this equation is that we would expect to see more consumption of wine by people of our nation. If this consumption holds up and people continue to drink wine, the oversupply situation will subside and demand will exceed supply once again, leading to a recovery in the wine market and an increase in prices and the supply of wine demanded. So far we are on track for that very event. Consumption has increased and grape prices in California’s central valley are beginning to recover, as such, wines such as Trader Joe’s runaway success, “Two-Buck Chuck” may become “Three-“ or “Four-buck Chuck.” If this happens, we will see a recovery in the wine market and a new cyclical upturn will begin again. The fact that this possible recovery in the wine market will happen within the context of an overall economic recovery in our nation makes perfect sense. Good times tend to bode well for cyclicals as they are consumed in greater and greater quantities as the economy recovers.

Relating it to your business Your business will likely be no exception. When the above is taken into account, one should realize that when times look bleakest, a possible recovery may not be far off in the making. Likewise, when things look the best and everyone is singing praises of the current economy, realize that continued good times may be coming to an end. A business that realizes this important fact about business cycles in general and keeps a healthy contrarian attitude, will be the best prepared to face our economy’s environment of periodic cyclical change.

Kirk Ermisch is a new business professor at COCC. He founded the first American winery in Argentina and brings a wealth of experience in international trade. He can be reached for comment at kermisch@cocc.edu.

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