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Apr20
Business Cycles - Late Stage Expansion
At some point in an expansion the Federal Reserve Bank will get a whiff of pending inflation.  They will start to raise interest rates again.  This will lead to a flattening of the yield curve.  The yield curve is the graph of interest rates from cash to 30 years.  This graph has a slope with cash usually being lower and long-term being higher.  A flattening yield curve means that the difference between the short-term rates and the long-term rates decreases.

Companies start to reach high utilization rates for their plants and equipment.  The unemployment rate reaches its lowest levels.  Labor has more clout and the benefits of increased productivity shift to employees.  Remember that labor represents more than 60% of expenses, so when wages and salaries go up, margins usually go down. 

The growth in corporate earnings begins to slow.  Gains in the stock market become more modest.  Large, well diversified companies do the best in this environment.
Bond prices start to fall.  You should be thinking about floating rate bonds, Treasury Inflation Protected Bonds (TIPS), and shorter duration bonds.  You want to shorten duration in your bond portfolio significantly during this part of the expansion.  You might lower your allocation to bonds at the same time.

In the stock market, you should bring your portfolio beta back to 1.  This would be a time when large cap and macro cap stocks would do the best.  You might wish to increase your allocation to international stocks if their economies are at an earlier stage of the business cycle.

This is a period when you should begin to increase your allocation to cash.  In cash instruments, you can reinvest at increasingly higher yields as the Fed increases interest rates. 

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