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It's not a recession, it's the late cycle

Key takeaways

  • The US economy is in the late phase of the business cycle, not the mid-cycle, and not a recession.
  • History suggests that volatile markets, slower economic growth, and increasing signs of an eventual recession are typical of the late cycle, but some indicators suggest a recession is becoming further away, rather than closer.
  • Energy, materials, health care, and consumer staples stocks have historically done well in the late cycle.
  • Developing and sticking to a financial plan can help you remain invested and on course toward your goals throughout the phases of the business cycle.

For more than a year, economists and consumers alike have been watching for signs that the US economy is entering a recession. Instead, economic indicators suggest that we are still in the late phase of the business cycle.

Fidelity's Asset Allocation Research Team says that the economy continues to show late-cycle characteristics including a tight labor market, relatively high interest rates, and strong business and consumer spending. In fact, they believe that over the past several months, the economy may have moved further away from a recession, rather than closer to one.

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What is the late cycle?

The late cycle is a phase of the business cycle, which is the name that economists give to the pattern of changes in economic activity that take place over time. In the late cycle, economic activity often reaches its peak. Growth slows but remains positive. Rising inflation and a tight labor market may lead the Federal Reserve to raise interest rates, and corporate earnings may decline. The late cycle ends when economic activity contracts and the economy enters recession.

A long twilight?

While late cycles have historically preceded recessions, the economy has also taken an average of a year and a half to move from the start of the late cycle into those recessions. The current late cycle began in the summer of 2022.

That may make the late cycle a good time to review your portfolio and make sure you're prepared for an eventual downturn and the early-cycle recovery that will follow it, which is often the most fruitful time for investors.

If you already have a well-diversified portfolio that accurately reflects your goals, time horizon, and tolerance for market volatility, you may find you have little to be concerned about. If you need to rebalance your portfolio, it may help to look for guidance to the history of late cycles and recessions. You should be cautious, though, about making changes to your portfolio in pursuit of opportunities during the late cycle because of the historically volatile nature of markets in this part of the cycle and the possibility of a downturn ending the cycle. "There's typically a lot of uncertainty at this stage and it's not uncommon for stocks to make sizable moves up and down," says Lars Schuster, institutional portfolio manager with Fidelity's Strategic Advisers LLC. "It may make sense to keep your stock, bond, and short-term investment exposures close to neutral for your situation."

Investments in the late cycle

While no 2 cycles have been identical, US stocks have risen during the late cycle, averaging an annualized 6% return. However, market leadership has changed. When inflation and interest rates have risen in the past, investors have shifted away from economically sensitive assets like stocks of companies that make nonessential consumer goods and big-ticket items like cars and houses.

Meanwhile, energy and materials have done well, as have stocks of companies that earn money by selling products that meet basic needs—such as consumer staples, utilities, and health care.

Information technology and consumer discretionary stocks have lagged during the late cycle, as inflationary pressures hurt profits and capital spending by corporations, while investors move away from the most economically sensitive areas.

The higher inflation and interest rates that are typical of the late cycle have weighed on the price performance of longer­-duration bonds in the past, but those higher rates may also create opportunities for income-seeking bond investors. Cash has historically tended to outperform bonds during the late cycle, and money markets and CDs have benefited from higher rates as well.

Consider commodities

Historically, commodities such as oil, wheat, iron ore, and copper have been popular with investors during the late cycle. Their prices have typically risen with inflation and ongoing demand and they've offered diversification from increasingly volatile stocks during the late cycle. But over the past several years, global trade wars, the COVID pandemic, and the war in Ukraine have all distorted the historical relationships between commodity prices and the waxing and waning of the business cycle.

While commodities may still be useful late-cycle diversifiers, investors should also know that they may perform poorly as late cycle gives way to recession. Professionally managed commodity ETFs, mutual funds, or a multi-asset strategy may help you add the benefits of commodity exposure while also managing the risks.

Investments after the late cycle

Because late cycles typically end in recessions, it's useful to understand what may lurk beyond the horizon as well. Recession has historically been the shortest phase of the cycle, lasting slightly less than a year on average and stocks have lost 15% annually on average.

As growth contracts, stocks that are sensitive to the health of the economy lose favor, and defensive ones perform better as they also did during the late cycle. These include stocks of companies that sell items such as toothpaste, electricity, and prescription drugs, which consumers are less likely to cut back on despite a recession. In a contracting economy, these companies' profits are likely to be more stable than those of others. In fact, the consumer staples sector has a perfect track record of outperforming the broader stock market during recessions. Utility and health care companies have also been helped during recessions by the high dividends they pay.

Interest-rate-sensitive stocks, including those of financial, industrial, information technology, and real estate­ companies, typically have underperformed the broader market during this phase.

Investment-grade corporate and government bonds have outperformed stocks and cash in most recessions, aided by interest rates that typically fall during recessions.

Late-cycle anxiety

While history shows that the late cycle has usually still delivered positive returns for stock and bond investors, it's not a place for the faint of heart. As economic indicators and headlines grow increasingly gloomy and the word "recession" gets thrown about recklessly, anxiety about the future may challenge even the most disciplined investors to believe the lessons of history that recessions are typically short-lived and that things will likely get better afterward.

Stay the course

The longer the late cycle persists, the more investors may be tempted to exit the stock market in an attempt to avoid the market downturn that they expect will accompany an eventual recession. However, those investors who do so may not reenter the market in time for the eventual start of the early cycle when historically markets have tended to recover even as the overall economic picture remains gloomy.

To help manage the anxiety and conflicting emotions that may arise from watching the market and economy as they move fitfully toward recession and the eventual start of the early cycle, it's helpful to have a long-term asset allocation plan as part of a broader financial plan. An appropriate asset allocation includes a mix of stocks, bonds, and cash that aligns with your goals, time horizon, and your ability to manage risk. Your plan can help you avoid emotional overreactions to volatility so you can stay on track toward your long-term financial goals.

What that plan looks like may depend on who you are. If you're a decade or more from needing the money in your portfolio to help pay for living expenses in retirement, late-cycle and recession volatility may represent a chance to buy high-quality stocks at discount prices in hopes that they will rise as times improve. However, if you're near or in retirement and concerned you cannot afford to wait for an eventual stock market recovery, you may want to revisit your plan and make adjustments if necessary.

Moves to make, maybe

While individual investors should be cautious about making big changes to their asset allocations during the late and recession phases of the cycle, professional managers such as the investment team at Strategic Advisers LLC do adjust the portfolios they manage to reflect their views about where the economy is in the cycle. These so-called cyclical asset allocation tilts involve carefully adding or reducing exposure to various categories of stocks, bonds, and short-term assets. Adjustments of these sorts typically only represent a small part of each portfolio and are only made within the context of a long-term strategic investment strategy.

Over time, saving and investing regularly and establishing and maintaining an appropriate asset mix help investors succeed. Getting started or refining your plan? Start with your goals. Try our online tools in the Planning & Guidance Center. Or for professional help, consider a Fidelity consultant.

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The Asset Allocation Research Team (AART) conducts economic, fundamental, and quantitative research to develop asset allocation recommendations for Fidelity's portfolio managers and investment teams. AART is responsible for analyzing and synthesizing investment perspectives across Fidelity's asset management unit to generate insights on macroeconomic and financial market trends and their implications for asset allocation.

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

References to specific investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk.

Past performance is no guarantee of future results.

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance. The Russell 1000® Index is a stock market index that represents the highest-ranking 1,000 stocks in the Russell 3000® Index, which represents about 90% of the total market capitalization of that index.

Indexes are unmanaged. It is not possible to invest directly in an index.

Keep in mind that investing involves risk. The value of your investment will fluctuate over time, and you may gain or lose money.

Diversification and asset allocation do not ensure a profit or guarantee against loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.

The commodities industry can be significantly affected by commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.

In general, the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk, and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so holding them until maturity to avoid losses caused by price volatility is not possible. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

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Fidelity® Wealth Services provides non-discretionary financial planning and discretionary investment management through one or more Portfolio Advisory Services accounts for a fee. Advisory services offered by Fidelity Personal and Workplace Advisors LLC (FPWA), a registered investment adviser, and Fidelity Personal Trust Company, FSB (FPTC), a federal savings bank. Nondeposit investment products and trust services offered through FPTC and its affiliates are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency, are not obligations of any bank, and are subject to risk, including possible loss of principal. Discretionary portfolio management servicesprovided by Strategic Advisers LLC (Strategic Advisers), a registered investment adviser. Brokerage services provided by Fidelity Brokerage Services LLC (FBS), and custodial and related services provided by National Financial Services LLC (NFS), each a member NYSE and SIPC FPWA, Strategic Advisers, FPTC, FBS, and NFS are Fidelity Investments companies.

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