Business Cycle Analytics Services - Business cycle analysis

The evolution of economic activity does not follow a straight line in a market economy, it fluctuates. Periods of prosperity and rapid economic growth are followed by periods of economic contraction or slower growth in preparation again for faster growth. This cyclical movement of general economic activity is not periodic. It embodies what is described as the business cycle, or more closely defined as the fluctuation of economic activity around a growth trend.

Private companies’ production and sales are subject to these macro business cycle forces. The broader business cycle is invisible. While the number of cranes piercing the skyline, or the number of ships lining up to enter the harbour, provide some hint of the state of the business cycle, this is hardly workable information when it comes to executive decision-making and strategising. Every firm – small, medium or large – have to navigate the business cycle. Getting the business cycle wrong will cost your firm dearly, either through financial losses, unsatisfactory growth and/or unnecessary retrenchment, etc. At the macro-economic level, mistimed economic policy decision-making can cause dramatic socio-economic welfare losses.

The identification of turning points in the business cycle is critical, as well as methods in providing real-time (and forward-looking) information on business cycles. Furthermore, the practice of business cycle analysis is very involved with identifying how much of the fluctuation of economic activity (e.g. GDP) is explained by trend changes (typically on the supply-side of the economy) and/or the business cycle (typically driven by changes in expenditure – on the demand-side of the economy).

The same techniques can be applied to private company production and sales data. Some firms, such as those in retail, wholesale, manufacturing, construction and mining operate in highly cyclical sectors. Changes in sales and output levels are strongly driven (or influenced) by the business cycle. BCA business cycle analysis separates the noise from fundamental tendencies in the economy and identifies turning points in company sales cycles by linking it to the broader business cycle. This information is carefully disseminated to executives and economic policymakers, assisting with decision-making. For a more detailed overview of sectoral (or industry) cycles, click on the relevant block…

Sectors

Considered from a Keynesian perspective, it is usually demand that drives production in a free enterprise economy. It follows that one is likely to find the drivers of the business cycle evolution on the demand side of the economy, e.g. export demand and domestic fixed investment expenditure. This does not mean that the various economic sectors do not influence the cyclical dynamics of an economy. In fact, sectoral business cycle dynamics often determine the shape of the general business cycle.

From a sectoral perspective, the manufacturing cycle is central to the broader business cycle development given the sector’s wide forward and backward linkages in the economy. The general (mining) commodity cycle is of critical importance to emerging economies, which often rely on the mining of commodities to export. In a small open economy such as South Africa, trade linkages play a key role in the country’s business cycle dynamics. Construction (including residential and non-residential building activity, as well as civil construction works), often lagging the general business cycle, has its unique cyclical dynamics. While there are linkages between construction and property (house prices, shopping & industrial rentals, etc.), the property cycle typically has its own dynamics with a strong medium-term frequency (of 18 years and longer). Whereas fixed investment and exports typically drive the SA business cycle, consumer demand acts as an important stimulus as it contributes more than 60% of expenditure on GDP. The retailing cycle is therefore an important part of the overall business cycle dynamics.

Retail Cycle

The business cycle is invisible but real. In essence, the business cycle involves successive periods of economic acceleration/ expansion followed by slowdown or contraction in ‘unceasing rounds’. The interaction of macro-economic magnitudes at the turning points teaches us much about the nature and characteristics of business cycles.
From a Keynesian perspective it is demand that drives output. Firms typically wait until stocks are depleted and production capacity close to fully utilised before considering expansion, i.e. invest in capital equipment. Retail spending – particularly on durable and semi-durable goods – is therefore an important business cycle indicator. Spending on essentials (non-durable goods) and services tend to be less cyclical.

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Manufacturing Cycle

Despite the shrinking share of manufacturing value-added in national GDP, at 11.8% in 2021, the sector remains critical in the propagation of cyclical forces through the broader economy. Given an output/GDP ratio of 3.96 (measured in 2017), the implication is that for every one rand of manufacturing profits or wages (read: GDP) generated, four rand’s worth of economic activity results. This translates to the sector accounting for more than a fifth of all economic activity, i.e. when the sector’s direct and indirect linkages with other sectors are considered. Given its size, the sector has a contemporaneous relationship with the national business cycle. Closer analysis of sub-sectoral activity reveals some leading elements as well (e.g. the automotive sector).

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Construction Cycle

The construction cycle is a broad term, encompassing a range of building and construction activities. This sector consists of residential and non-residential building and civil construction works. The building & construction pipeline would also include architects and quantity surveyors, both activities being leading indicators for the sector. Key economic indictors in the building & construction pipeline, include building plans, building completions and fixed investment expenditure as classified by Statistics SA (residential & non-residential buildings and construction works). While the sector is small (accounting for only 4% of national GDP), it is pivotal from a business cycle perspective. Fixed investment spending is an important driver of the business cycle and within the national expenditure category, building and construction is a critical function, being a catalyst of economic activities. Building and construction activity lags the national business cycle – up to a full year on average at peaks of the cycle and by 6-9 months after the economy emerges from recession. Also linked to the building & construction sector, is the property sector; however, property (housing prices & rentals, shopping, office & industrial rentals) has its own peculiar cycles.

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Commodity Cycle

Research has shown that particularly metal commodity prices’ turning points tend to cluster. This allows for the identification of a commodity price cycle. It has been found that particularly global capital flows, in turn, driven by real US short-term interest rates play an important part in the commodity cycle. Whereas global demand also acts as a driver, the relationship has been less apparent. It is also necessary to distinguish between the short- and long-term movements of commodity prices. From a long-term perspective, the phases of the commodity (super) cycle have been identified: a long upturn peaking in 1980 (in line with the 1981 peak in global capital flows), followed by a long downturn between 1980-81 and 1999/2000 followed by a protracted upturn peaking in 2011 (again in line with the global capital flow cycle). The COVID-19 induced peak in commodity prices in 2021 was driven by exceptional factors and the commodity upturn is expected to continue petering out, also as the US Fed commences with the normalization of monetary policy. To the extent that US real interest rates remain relatively low, it will remain a supportive factor for metal commodity prices.

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The Property Cycle

The real estate cycle forms part of the general business cycle, with a prominent lag relationship. In the general economy, business cycles typically have two sources, either endogenously due to macroeconomic imbalances, or exogenously, due to external and discrete shocks. In the property sector, endogenous cycles typically occur due to frictions arising from various lags (related to the price-mechanism; the investment decision and actual construction), apart from the exogenous influences at the macroeconomic level. It is important to be aware of the property cycle in order to conduct efficient business planning and financial management. The reality is that even with detailed information and analysis of past cycles, it remains a challenge to accurately anticipate and plan for future cycles. Nonetheless, proper analysis of real estate cycles improves market transparency, underpins rational decision-making, which, in all, improve a property firm’s ability to navigate the cycle.

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