In the United States, the yield curve has been flattening for the better part of the last decade, albeit from a level of significant steepness following the global financial crisis. The most recent march downward started in early 2017 and has taken the yield-curve slope to a point below its long-term average to a level not seen in a flattening cycle since early 2005.

Moreover, the slope is not the only market-based indicator that has been raising concerns. Indeed, the recent jitters across international equity markets have heightened investors’ fears that bad economic times might be just around the corner.

Decoding The Business Cycle

In order to understand where we are in the economic cycle, we suggest a simple framework for classifying the various states of the economy over a full business cycle.

In the United States, an NBER-classified recession is a relatively narrow set of events in which a contraction is observed across a wide array of indicators. Since 1953, according to the NBER, the United States has been in recession only 14 percent of the time; since 1990, this has fallen to 10 percent. Arguably, a more granular framework than a binary “in” or “out of” recession could be a more valuable tool for investors.

In order to define a set of business-cycle states, we intersect two output-based metrics. The first metric is the well-known output gap, which measures whether the level of production is above or below its estimated potential level, based on data from the OECD (Organisation for Economic Co-operation and Development). We then combine this output-gap data with country-specific slowdowns and expansionary phases as measured by the Federal Reserve Bank of St. Louis (available in the FRED database). These phases indicate the momentum, or speed, at which the economy is running. The intersection of these two measures allows us to classify four stages of the business cycle.

Four Business-Cycle States

We name these four interaction states as follows: bull economy, correction, bear economy and rebound. In a bear economy, for instance, the output level is below its potential and its growth rate is decelerating, which produces a double whammy! Arguably, the global economy may now be shifting from a bull economy to a correction phase, as suggested by current volatile market conditions.

In the United States, since 1966 each of these economic states has lasted an average of about 12 months, with recoveries lasting slightly longer at 15 months. Said another way, on average, a full business cycle lasts between four and five years. Looking at the other major developed markets of Germany, Japan, and the United Kingdom, we see the same picture, although data availability means our lookback period is more limited.