Equities and the business cycle

Profits cycle
Corporate profits tend to grow in line with nominal GDP. However, the relationship between the growth rates of profits and nominal GDP is not the same across all period. During some periods, such as the late 1990s and early 2000s, the stock market experiences a bubble which causes profits increase more than GDP. During some periods, such as 1972–1981 when the US economy experiences a persistent inflation, nominal GDP growth was higher than profits growth.
Profits tended to grow more in lower positive inflationary environments. Conversely, deflationary and highly inflationary periods were detrimental to profits growth.
Despite this structural trend, profits exhibit more volatility than GDP. In the early recovery phase, when the economy come out of the recession, profits tend to increase faster than GDP. During the late phase of expansion this uptrend slows down. Finally, during a recession profits fall more than GDP.
These cyclical swings in profits growth affects equity prices cycle too. Since profits fall below their long-term growth potential during recessions, they become depressed and undervalued. Which means the best time to invest in equities is when the recession is close to end. When there is a “light at the end of the tunnel”, when the first signs of recovery are seen in the economy, it makes sense to be invested in stock market. The recession is followed by the recovery phase when (especially during the first two years of the phase) equities show highest cyclical increase in price. In fact, the stock market is one of variables in the index of leading indicators because equity prices bottom several months before the recession ends.
Performance of sectors over the business cycle
Like the stock market itself, sectors also respond differently to different phases of the business cycle. There are many factors than can affect the performance of sectors. For example, housing cycle affects the performance of housing-related sectors, such as housing finance. Performance of industries dependent on borrowing are in line with the credit spread cycle. Some sectors, such as utilities, are more sensitive to changes in interest rates than others. That’s why it is difficult to separate the impact of the business cycles from other economic factors. However, some relationships have been observed between the business cycle and the performance of various sectors.
Performance of some parts of the economy, the so-called “defensive sectors”, show less cyclicality than others. These sectors are health care, consumer staples, and utilities. These sectors tend to be stable even during recessions, thus overperforming other equities during hard times. Since they are less sensitive to the overall market performance, they have below-than-average beta.
On the contrary, equities of cyclical sectors have higher-than-average beta which means their share prices change more relative to the overall market performance. Consumer discretionary, financials, energy, materials and industrial companies are cyclical sectors. Companies in these sectors perform well when the economy is recovers or expands. Thus, they have more volatile revenues than defensive sectors.