{"id":19105,"date":"2021-08-04T14:42:45","date_gmt":"2021-08-04T14:42:45","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=19105"},"modified":"2026-06-29T18:50:02","modified_gmt":"2026-06-29T18:50:02","slug":"explain-how-the-phase-of-the-business-cycle-affects-short-term-and-long-term-earnings-growth-expectations","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/explain-how-the-phase-of-the-business-cycle-affects-short-term-and-long-term-earnings-growth-expectations\/","title":{"rendered":"Business Cycle and Earnings Growth Expectations"},"content":{"rendered":"\r\n<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"ImageObject\",\r\n  \"url\": \"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle.jpg\",\r\n  \"caption\": \"The-Business-Cycle\",\r\n  \"width\": 1590,\r\n  \"height\": 1560,\r\n  \"copyrightNotice\": \"\u00a9 2024 AnalystPrep\",\r\n  \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\r\n  \"creditText\": \"AnalystPrep Design Team\",\r\n  \"creator\": {\r\n    \"@type\": \"Organization\",\r\n    \"name\": \"AnalystPrep\"\r\n  }\r\n}\r\n<\/script>\r\n<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"Which of the following statements about the business cycle and earnings growth expectations is least likely accurate?\",\r\n    \"answerCount\": 3,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is C. Cyclical industries tend to have earnings that are stable and immune to variations in the business cycle. This statement is incorrect because cyclical industries are highly sensitive to economic conditions. Their earnings typically rise during periods of economic expansion and decline during economic slowdowns or recessions. In contrast, defensive industries generally have earnings that remain relatively stable throughout the business cycle.\"\r\n    },\r\n    \"suggestedAnswer\": [\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Defensive industries have earnings that are relatively stable to changes in the business cycle.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"The sensitivity of earnings of a corporate bond to variations in the business cycle is positively correlated with the level of cyclicality.\"\r\n      },\r\n      {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Cyclical industries tend to have earnings that are stable and immune to variations in the business cycle.\"\r\n      }\r\n    ]\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/NFyA0qXHhww\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<p>Earnings and business cycles have a very close relationship. Investors should, therefore, have a good understanding of the business cycle to make projections of earnings. Even then, it is worth noting that the effect of the business cycle on the profitability of the business cycle differs across companies. This is because of the varying characteristics of different companies.<\/p>\r\n<p><img loading=\"lazy\" decoding=\"async\" class=\"aligncenter size-full wp-image-26651\" src=\"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle.jpg\" alt=\"The Business Cycle\" width=\"1590\" height=\"1560\" srcset=\"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle.jpg 1590w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle-300x294.jpg 300w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle-1024x1005.jpg 1024w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle-768x754.jpg 768w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle-1536x1507.jpg 1536w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/08\/The-Business-Cycle-400x392.jpg 400w\" sizes=\"auto, (max-width: 1590px) 100vw, 1590px\" \/>The goods that a company produces and the services it offers play an important role. It is worth clarifying that some goods and services are insensitive to economic conditions. Some of such goods include toiletries. People will neither use the bathroom less because of a recession nor use it more because the economy is booming. Companies providing such products are called <strong>defensive<\/strong> or <strong>non-cyclical<\/strong> companies. Defensive companies have earnings that are stable during business cycles.<\/p>\r\n<div style=\"margin: 18px 0;\"><a style=\"display: block; text-align: center; padding: 14px 18px; border: 2px solid #2F5BFF; border-radius: 18px; color: #ffffff ; font-weight: 600; font-size: 16px; text-decoration: none; background-color: #1a73e8 ;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\">Practice business cycle and earnings growth concepts with our CFA Free Trial.<\/a><\/div>\r\n\r\n<p>A rise in the profitability of <strong>cyclical companies<\/strong> indicates the likelihood of a future improvement in the broader economy. Cyclical companies produce consumer and durable products and are, therefore, more sensitive to the business cycle phase. Their revenues fluctuate depending on the rate of economic growth.<\/p>\r\n<p>Earnings growth is also determined by other factors, including the experience of the management, the financial structure of a firm, among others. However, these factors may not show a good relationship with the business cycle. For example, in a booming economy, all managers will seem to be generating profits for their companies, even those that lack experience.<\/p>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Which of the following statements about the business cycle and earnings growth expectations is <em>least likely<\/em> accurate?<\/p>\r\n<ol type=\"A\">\r\n\t<li>Defensive industries have earnings that are relatively stable to changes in the business cycle.<\/li>\r\n\t<li>The sensitivity of earnings of a corporate bond to variations in the business cycle is positively correlated with the level of cyclicality.<\/li>\r\n\t<li>Cyclical industries tend to have earnings that are stable and immune to variations in the business cycle.<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is C.<\/strong><\/p>\r\n<p>Cyclical industries produce consumer and durable products and are therefore more sensitive to the business cycle phase. Their revenues fluctuate depending on the rate of economic growth. In other words, revenues are higher in periods of economic expansion and lower in periods of economic downturn.<\/p>\r\n<p><strong>A is incorrect.<\/strong>\u00a0Defensive industries comprise any business whose immunity to business cycles relatively stable. The earnings of such an industry are unaffected by economic fluctuations. The industry usually deals with the production of utilities, healthcare products, among others.<\/p>\r\n<p><strong>B is incorrect.<\/strong>\u00a0The sensitivity of the earnings of a corporate bond to variations in the business cycle is positively correlated with the level of cyclicality. Earnings are higher in periods of economic expansion and are lower in periods of economic downturn.<\/p>\r\n<\/blockquote>\r\n<p>Reading 43: Economics and Investment Markets<\/p>\r\n<p><em>LOS 43 (h) Explain how the phase of the business cycle affects short-term and long-term earnings growth expectations.<\/em><\/p>\r\n\r\n<div style=\"text-align: center; margin: 30px 0;\"><a style=\"display: inline-flex; align-items: center; justify-content: center; padding: 12px 26px; border-radius: 9999px; background: #1e5bd8; color: #ffffff; font-weight: bold; text-decoration: none;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a> <p style=\"margin-top: 12px; font-size: 16px; line-height: 1.5;\">Review how the phase of the business cycle affects short-term and long-term earnings growth expectations with CFA Level 2 study notes, practice questions, mock exams, and video lessons designed to strengthen your exam preparation.<\/p>\r\n <\/div>","protected":false},"excerpt":{"rendered":"<p>Earnings and business cycles have a very close relationship. Investors should, therefore, have a good understanding of the business cycle to make projections of earnings. Even then, it is worth noting that the effect of the business cycle on the&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,473],"tags":[216,564],"class_list":["post-19105","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-portfolio-management","tag-cfa-level-2","tag-portfolio-management","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Business Cycle &amp; Earnings Growth | CFA Level II<\/title>\n<meta name=\"description\" content=\"Learn how business cycle phases affect short- and long-term earnings growth, including stability in defensive industries and sensitivity in cyclical sectors.\" \/>\n<meta name=\"robots\" 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