Why Most Investors Misread Business Cycles
The Behavioral Traps That Keep Investors From Timing Market Tops
Business cycles are one of the most challenging subjects for new traders and investors to grasp. While the concept is relatively straightforward, in practice, learning to consistently apply what we actually know about business cycles takes, on average, at least two decades. Later on, we will explain why.
The Sentiment Factor: Another Look at Market Cycles
To begin, here is a 50-year chart of the S&P 500 and U.S. long-term unemployment rate, sourced from Trading Economics.
Pictured in blue, with scale on the right side, is the S&P 500. Pictured in green, with scale on the left side, is the US long-term unemployment rate.
In theory, the dynamics of the business cycle operate as follows. On average, the economy expands approximately 75%-80% of the time, indicating an increase. The expansion is driven by the availability of credit, rising optimism, and a reduction in unemployment, which is correlated with optimism.
Eventually, the economy reaches a level of full employment and maximum optimism. Everybody is expecting the best, but not paying attention to the fact that asset prices and labor costs have risen quite substantially. Such points of “goldilocks” are 2000, 2007, and 2020, to mention a few.
We did not want to overwhelm the reader, but we will give you another chart – a 50-year chart of S&P500 and University of Michigan Consumer Sentiment, courtesy of Trading Economics:
Pictured in blue, with a scale on the right side, is the S&P 500. Pictured in green, with scale on the left side, is the University of Michigan Consumer Sentiment.
As you can see the areas of extreme pessimism – 1991, 2008, 2010, 2023, and 2025. Additionally, there were areas of extreme optimism, notably 2000, to a lesser degree in 2007, and certainly 2019-2020.
As of mid-2025, we have somewhat conflicting data: the long-term unemployment rate is relatively low, the S&P 500 is close to its all-time highs, while Consumer Sentiment is at a record low. What is the conclusion at present with this conflicting data? Data is indeed contradictory, but the most essential ingredient to declare a top in the business cycle is optimism. We don’t understand the dynamics of the low unemployment rate. Still, as we mentioned, in our opinion, the most essential ingredient to declare the top of the business cycle is higher consumer sentiment. With that sentiment at all-time lows, the S&P 500 should be a buy, not a sell.
Knowing vs. Applying: Why Most Investors Still Get It Wrong
The material we present here is not something we have discovered independently. We put our words into context, allowing our readers to verify the information for themselves on Wikipedia or Investopedia, if they wish. Anyway, we’re here to tell you that, despite most people being able to understand the concept, they will not be able to apply it consistently. The reason is the Dunning-Kruger Effect:
Unfortunately, human beings do not learn linearly, but rather in a zig-zag format, as seen in the Dunning-Kruger Effect. A good example is a first date. There is a wealth of wisdom and tips that can be offered to the boy. We are looking at a man’s perspective, as most traders and investors are men.
However, those tips are unlikely to have a significant impact. One needs experience! It is on the fifth or even sixth date, if the relationship even goes that far, that the boy can loosen up and use some of the tips. Could this have happened earlier? Yes, it can, perhaps on the third or even to some degree on the second date, but it is useless to expect a boy to follow any advice successfully on the first date. Of course, it can happen; we presume it is scarce.
The Harsh Truth: You Learn in Cycles Too
Statistics say that even though you will understand the dynamics of the business cycle in theory, in practice, you will find reasons to doubt them. As they say, in theory, there is no difference between theory and practice. In practice, however, there is.
Yes, in your first business cycle, 5-10 years of your career, you are unlikely to apply all of the wisdom you know consistently. Hopefully, if luck is on your side, you will get a chance on your second or even third business cycle. Keep in mind that it is not a certainty at all – most people, even professionals, rarely apply consistently what they theoretically know.