Reading the Cycle

What this article does

This is the final article in the Lighthouse foundation series. The previous eight articles covered specific concepts — yields, the curve, the Fed, inflation, liquidity, regimes, and the dollar. This one is about how it all fits together.

Specifically: how cycles actually unfold over years, which signals matter at each phase, and how to position yourself through transitions without trying to predict tops or bottoms.

By the end:

• You'll understand the four phases of a business cycle: recovery, expansion, late-cycle, recession
• You'll know which indicators matter most in each phase
• You'll understand how stocks, bonds, credit, and the dollar typically behave through a cycle
• You'll know the three best recession warning signals and how to read them together
• You'll have a position-sizing framework that doesn't require predicting the future
• You'll be able to read where we are in the current cycle without being a professional macro analyst

This is the synthesis. Once you finish this article, you've completed the Lighthouse foundation. The certificate is yours.

The four phases

A business cycle is the recurring pattern of expansion and contraction in the broader economy. Business cycle.

The average length of US economic expansions since WWII is approximately 64 months (5.3 years), while the average recession lasts about 11 months. The longest expansion on record was the 128-month expansion from 2009-2020.^[1] Average post-WWII US expansions last about 64 months (5+ years). Average recessions last about 11 months. The longest expansion ever was 128 months (2009-2020). Cycles aren't predictable to the day, but they share recognisable patterns.

The four phases:

1. Recovery — Economy emerging from recession. GDP growth turns positive. Unemployment peaks and starts falling. Fed is at its most accommodative (low rates, possibly QE). Credit spreads have peaked and are contracting. Risk assets perform best here because conditions improve from a low base.

2. Expansion — Mature growth phase. GDP growth steady, unemployment trending down to multi-year lows. Fed is normalising (raising rates from low levels). Credit spreads continue contracting. Inflation begins picking up. Markets generally rise but with more volatility than recovery.

3. Late-Cycle — Growth still positive but slowing. Labor market tight. Inflation pressures rising. Fed in restrictive territory. Yield curve flattening or inverting. Credit spreads at their tightest (compressed regime). This phase can last 1-3 years before recession.

4. Recession — GDP contraction. Unemployment rising. Fed cutting rates aggressively. Credit spreads widening sharply. Risk assets selling off. Most psychologically painful phase but typically shortest (about 11 months on average).

These phases blend into each other. There's no clean line between expansion and late-cycle — it's gradual transition. Recognising which phase you're in is more art than science. Late-cycle.

What the data shows in each phase

Different asset classes perform differently across cycle phases. Recovery phases historically favor cyclical equities and high yield bonds. Expansion phases favor broad equities. Late-cycle favors quality equities and Treasuries. Recessions favor cash and Treasuries.^[2] Recovery phase, expansion, late-cycle, and recession each have characteristic data fingerprints:

Recovery phase signals:

• Yield curve: steepening sharply (Fed cutting short rates aggressively)
• Credit spreads: contracting from peaks
• VIX: elevated but declining
• Fed: cutting or holding low
• Composite stress: declining
• Stocks: bouncing strongly off lows
• Asset class winners: cyclical equities, high yield credit

Expansion phase signals:

• Yield curve: positive and stable
• Credit spreads: stable in middle range
• VIX: moderate (15-25)
• Fed: normalising rates upward gradually
• Composite stress: low
• Stocks: trending higher with normal volatility
• Asset class winners: broad equities, growth stocks

Late-cycle phase signals:

• Yield curve: flattening or inverting
• Credit spreads: very compressed (15-25th percentile range)
• VIX: low (compressed regime)
• Fed: hiking aggressively, tight policy
• Composite stress: low (deceptively calm)
• Stocks: still rising but with sector divergence
• Asset class winners: quality equities, dividend stocks, possibly Treasuries

Recession phase signals:

• Yield curve: uninverting via short rates falling
• Credit spreads: blowing out (above 75th percentile)
• VIX: high (above 30, sometimes above 40)
• Fed: cutting aggressively
• Composite stress: spiking
• Stocks: declining sharply, then bottoming before economic data improves
• Asset class winners: cash, long-duration Treasuries, gold

This is the picture. The Lighthouse dashboard tracks all these signals because the COMBINATION reveals the phase, not any single one.

The three best recession indicators

When you're trying to assess if recession is approaching, three signals matter most. The yield curve, credit spreads, and the Sahm Rule together form a complementary recession warning system. When all three signal stress simultaneously, recession probability is very high. When they diverge, the picture is ambiguous.^[3] They work better in combination than alone.

1. Yield curve inversion (covered in Article 3). Every US recession since 1955 has been preceded by yield curve inversion. Lead time: 6-24 months, average 14 months. The Every US recession since 1955 has been preceded by an inversion of the 2-year/10-year Treasury yield curve. The lead time from inversion to recession start has ranged from 6 months to 24 months, averaging around 14 months.^[4] 2s10s spread is the classic measure.

2. Credit spreads (covered in Article 1). Compressed spreads followed by widening signals stress. Particularly watch CCC tier divergence. When CCC widens while BB stays calm, it's an early warning. When both widen, stress is broadening.

3. The Sahm Rule. The Sahm Rule states a recession is likely underway when the 3-month average unemployment rate rises 0.5 percentage points above its 12-month low. Created by economist Claudia Sahm, it has correctly identified every US recession since 1953.^[5] Created by economist Claudia Sahm, this rule signals recession when the 3-month average unemployment rate rises 0.5 percentage points above its 12-month low. Has correctly identified every US recession since 1953. The Sahm Rule triggered in summer 2024 and was widely cited at the time.

When all three signal stress simultaneously, recession probability is very high. When they diverge — like the 2022-2024 period when curve inverted and Sahm Rule triggered but credit spreads stayed compressed — the picture is ambiguous and timing becomes uncertain.

The 2022-2024 cycle was unusual. Curve inverted in July 2022. Sahm Rule triggered in 2024. But credit spreads remained tight, and no NBER recession occurred. Multiple signals can be right while economic timing surprises.

How market timing actually works

Stock markets typically peak 6-9 months before recessions begin and bottom 3-6 months before recessions end. This means market lows often occur during the worst economic news, not after conditions improve.^[6] This is one of the most counter-intuitive truths in markets:

Stock markets typically peak 6-9 months BEFORE recessions begin. They bottom 3-6 months BEFORE recessions end.

Read that twice. It means:

1. By the time NBER officially declares a recession started, the stock market peaked half a year ago 2. By the time NBER declares a recession ended, the stock market bottomed 4-5 months earlier 3. Market lows happen during the worst economic news, not after conditions improve

This is why retail investors who try to "wait until things look better to buy" almost always miss the rebound. By the time the news improves, the market has already rallied 20-30% off the lows.

The implication: markets are forward-looking. Economic data is backward-looking. Position sizing decisions need to be made before the picture is clear, not after.

This is also why "the market is irrational" complaints are usually misguided. Markets price expected future conditions. They've already priced in the recession when economic data finally confirms it.

Howard Marks on cycles — the most useful framework

Howard Marks of Oaktree Capital has written extensively about cycles in his books and memos. His framework emphasizes that cycles are inevitable, that excesses in one direction create the conditions for excess in the other direction, and that emotional swings amplify cyclical movements.^[7] Howard Marks of Oaktree Capital has written more usefully about cycles than almost anyone. His central insights:

1. Cycles are inevitable. Every cycle ends. Every recession ends. Every expansion ends. Anyone claiming "this time is different" is usually wrong on the long timeline, even if right on shorter timeframes.

2. Excesses in one direction create conditions for excess in the other. Late-cycle complacency creates the conditions for crisis. Crisis-era pessimism creates the conditions for the next bull market. The pendulum doesn't stop in the middle.

3. The future is unknowable, but probabilities can be assessed. You can't know exactly when a cycle turns. But you CAN assess whether conditions are bullish or bearish for forward returns. Howard Marks emphasises that the only thing better than a great forecast is a great understanding of where you are now.

4. Emotional swings amplify cycles. Markets aren't only driven by fundamentals. They're driven by collective emotion. When everyone is greedy, prices overshoot upward. When everyone is fearful, prices overshoot downward. Recognising these emotional regimes is core to being a good investor.

5. The temperature of markets matters. Marks talks about "taking the temperature" of markets — assessing whether emotional and valuation extremes are present. When markets are "hot" (everyone bullish, valuations stretched, risk being underpriced), forward returns are typically poor. When markets are "cold" (everyone bearish, valuations cheap, risk being overpriced), forward returns are typically excellent.

This framework — combined with the data signals Lighthouse tracks — gives you most of what you need to position thoughtfully through cycles.

Position sizing through the cycle

Position sizing through cycles matters more than cycle prediction. Investors who reduced exposure modestly when warning signs appeared and added exposure modestly when conditions improved have historically outperformed those who tried to time exact peaks and troughs.^[8] The single most important truth about cycle investing: position sizing matters more than cycle prediction.

Investors who try to time exact peaks and troughs almost always fail. Catalysts are unpredictable. Markets can stay irrational longer than you can stay solvent. Even Howard Marks doesn't try to call exact tops.

What works historically:

1. Modest deleveraging when late-cycle signals accumulate. Reduce exposure 10-20% when yield curve inverts AND credit spreads are compressed. You won't catch the exact peak, but you'll have ammunition for the eventual drawdown.

2. Hold cash through stress. Don't panic-sell during early recession phases. Don't try to be a hero buying every dip. Hold cash buffers that let you sleep at night.

3. Add modestly during peak fear. When VIX is above 40, credit spreads above 90th percentile, and economic news is uniformly terrible — that's typically near the bottom. Don't go all in. Add 10-20% to risk exposure progressively.

4. Stay invested through the recovery. The biggest mistake retail investors make is staying out too long after the bottom. Recovery rallies are powerful. Missing the first 6 months of a recovery typically means missing 30-50% of the cycle's gains.

5. Don't chase late-cycle exuberance. When everyone is bullish and your taxi driver is talking about his stock picks, that's late-cycle. Reduce exposure modestly even if it feels wrong.

This isn't a magic formula. It's a behavioural discipline. The hard part isn't knowing what to do — it's actually doing it when emotions are pulling the other way.

Each cycle is unique

Each business cycle is unique in its catalysts and characteristics, but cycles share common patterns. The 2008 GFC was a credit-bubble cycle. The 2020 COVID recession was an exogenous-shock cycle. The 2022-2024 cycle was an inflation-fight cycle. Different drivers, similar phases.^[9] Important caveat: while cycles share patterns, each one is unique in its catalysts and characteristics.

• The 2008 GFC was a credit-bubble cycle (housing → bank balance sheets → credit dysfunction)
• The 2020 COVID recession was an exogenous-shock cycle (pandemic → economic shutdown → recovery via stimulus)
• The 2022-2024 inflation-fight was a Fed-tightening cycle (inflation surge → aggressive hiking → eventual normalisation)
• The dot-com 2001 cycle was an equity-bubble cycle (tech valuations → corporate spending collapse → moderate recession)

Different drivers. Different durations. Different speeds. Different sector winners and losers. The general phases applied to all of them, but the specifics varied wildly.

This is why pattern-matching cycles to history is dangerous if taken too literally. "It's just like 2008" or "it's just like the 1970s" claims are usually overstated. The 2022-2024 cycle was its own unique animal — neither 1979 inflation-fight nor 2008 credit crisis nor 2020 shock.

The phases repeat. The specifics change. Watch the data, not the analogies.

How to read where we are right now

Practical guidance for assessing the current cycle phase from Lighthouse data:

Step 1: Check the yield curve. Inverted = late-cycle or recession. Sharply steepening from inversion = recession likely starting. Normal positive slope = expansion. Steepening from below = recovery.

Step 2: Check credit spreads. Compressed (below 25th percentile) = late-cycle complacency or normal expansion. Widening = transition to stress. Above 75th percentile = recession or crisis.

Step 3: Check the Fed stance. Cutting aggressively = recovery or recession. Holding accommodatively = early recovery or expansion. Hiking = expansion to late-cycle. Holding restrictively = late-cycle or restraining recovery.

Step 4: Check the Sahm Rule. Below 0.5pp threshold = expansion. Triggered (above 0.5pp) = recession likely.

Step 5: Take the temperature emotionally. Is everyone bullish? Talking heads dismissive of risk? Retail flows into equities high? Compressed regime = late-cycle. Is fear pervasive? News uniformly terrible? Retail flows into cash high? Stressed/crisis regime = recession or recovery setup.

When these signals align, you have a clear cycle reading. When they diverge, the picture is genuinely ambiguous and humility is appropriate.

Final thoughts — what this series was actually about

You've now finished the Lighthouse foundation series. Nine articles. Roughly 18,000 words of plain-English macro education. Citations from primary sources throughout.

The core message of this series, distilled:

Macro signals exist. They've existed for decades. They're free to access. Most retail investors don't bother to learn them. The ones who do gain a meaningful edge — not in predicting the future, but in understanding the present.

You don't need to predict recessions. You need to know the current regime. You don't need to time exact tops. You need to know when conditions are deteriorating. You don't need to be a professional macro analyst. You need to understand a few key indicators and how they fit together.

The Lighthouse dashboard exists because most "macro tools" are designed for traders willing to pay £24,000 a year for a Bloomberg Terminal. The same data — credit spreads from FRED, yield curves from FRED, Fed balance sheet, dollar index, regime classification — is available to anyone with an internet connection. It just needs to be presented in a way that doesn't require a finance degree to understand.

That's what Lighthouse is. That's what this series taught. The rest is up to you.

The Lighthouse takeaway

If you remember nothing else from this series, remember:

Cycles repeat. Phases recognise. Signals exist. The yield curve, credit spreads, the Sahm Rule, and the dollar index together tell you most of what you need to know about current macro conditions. Position sizing matters more than perfect timing. Each cycle is unique in catalysts but similar in phases. Markets are forward-looking; economic data is backward-looking. The best position you can be in is informed and patient — knowing where you are, watching for transitions, and avoiding the emotional extremes that destroy retail investors.

The Lighthouse dashboard is your daily check-in tool. Articles 1-9 are your reference library. The AI assistant is your tutor. Together they give you everything most retail investors lack — a clear, honest, education-first approach to macro that doesn't require you to be a professional or pay a fortune.

You've completed the foundation. Welcome to the Lighthouse.

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