It's the dawn of the early cycle

What the end of recession means for your portfolio.

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Key takeaways

  • The US economy has moved from recession into the early phase of the business cycle.
  • History shows stocks have delivered their highest returns during the early cycle, though markets can be volatile and investors anxious.
  • Sector leaders historically have included consumer discretionary, financial, real estate, auto, consumer durable, industrial, and technology stocks.
  • Developing and sticking to a financial plan can help you remain invested and on course toward your goals through the early cycle.

After falling into recession amid record declines in growth and employment, the US economy has now begun to recover, according to Fidelity's Asset Allocation Research Team. A recession, as defined by the National Bureau of Economic Research, is a significant and widespread decline in economic activity as measured by production, employment, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough.

Dirk Hofschire, senior vice president of asset allocation research, says the economy is now in the early phase of the business cycle. "Household and corporate spending has improved as the economy has been reopening, albeit fitfully, with support from extraordinary fiscal and monetary policy," he says.

The last time investors and consumers found themselves in an early cycle was more than a decade ago as the economy struggled forward from the global financial crisis. Since so much time has passed since we were here last, it's worth stepping back to better understand what the early cycle is and how to approach it.

Into the early cycle

At a glance, the early cycle may not look much different than the recession. Many businesses that closed during the downturn remain shut. Millions of workers are without jobs while others may fear coming layoffs.

Despite the gloom, though, the economy's vital signs are improving. Corporate profits, employment, lending by banks, and manufacturing activity have started to increase rather than fall, marking the turning point between recession and recovery. Stocks have risen on expectation of an eventual recovery and massive support by the Federal Reserve. Today's record-high stock market may appear "disconnected" from a still-struggling economy, but this pattern is similar to what has happened after previous recessions.

No 2 recessions or recoveries are exactly alike and the speed at which economic growth and employment have recovered from past recessions has varied. The US is emerging from an unusual recession which government policy responses to the COVID-19 pandemic played a significant role in creating. But while government policy will also play a role in restarting the economy, the familiar factors such as corporate earnings, interest rates, and inflation that have steered the direction of the stock market during past recoveries will likely do so this time as well.

Investing in the early cycle

While both investment returns and the durations of phases of the business cycle have varied over time, since 1962, stocks have delivered their highest absolute performance during the early cycle, with an average total return of more than 20% per year during this phase, which has lasted roughly one year on average.

Sectors of the stock market that typically benefit most from low interest rates—such as consumer discretionary, financials, and real estate—historically have outperformed. Consumer discretionary stocks have beaten the broader market in every early cycle since 1962.

History suggests that industries that typically benefit from increased borrowing—including diversified financials, autos, and household durables—have also been strong performers.

Economically sensitive sectors—such as industrials and information technology—have historically rallied on average as recession turned to recovery, with industries including transportation and capital goods gaining in anticipation of economic recovery. Information technology and materials stocks typically have been aided by renewed consumer and corporate spending expectations.

Sectors which generally see consistent demand, such as communication services and utilities, have typically enjoyed smaller gains in the early cycle relative to others. But while communication services has historically underperformed on average, its evolving mix of industries raises questions about whether it will do so in the future. Energy stocks also have lagged on average during the early phase, when inflationary pressures and energy prices tend to be lower.

Early cycle anxiety

While history shows that the early cycle has on average been a good time for investors, it's not a place for the faint of heart. Typically, in the early cycle, unemployment remains high and consumer confidence low and anxiety about the future may challenge even the most disciplined investors to believe the lessons of history that things will likely get better.

Indeed, even while history shows that the long-term trend for stocks is upward, short-term reversals—or "double-dip recessions"—are not unknown, and fears about which way the economy and the market may move next are not unreasonable. Says Hofschire, "While the US economy has emerged from a classical recession, it remains in a vulnerable state, with continuing dependency on additional government spending to support it."

Stay the course

When recovery doesn't look much different than recession, investors who have exited the market in response to negative economic news and heightened volatility may be tempted to wait until the economy looks more robust, even with markets rising. Markets are often volatile in the early cycle and bad economic news often persists and things may even appear to get worse. "The progression from recession to early cycle is an important turning point for riskier investments," says Lars Schuster, institutional portfolio manager with Fidelity's Strategic Advisors, Incorporated. "However, it's also a time when getting invested is fraught with emotion."

To help manage the anxiety and conflicting emotions that may arise from watching the market and economy as they move fitfully from the recession and through 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.

Over time, saving and investing regularly and establishing and maintaining an appropriate asset mix helps successful investors buy low, sell high, and build wealth. 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 advisor.

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