Financial cycles and their relevance in predicting economic activity

Cycles play an important role in influencing natural, social and economic events. This paper is concerned with the degree to which underlying cycles in financial markets are capable of predicting major turning points in an economy. The Dow Jones Industrial Average and Standard & Poor’s 500 indices are used and analyzed to study cyclical fluctuations in the United States economy. This is done through a series of tests, the first of which focuses on the precision to which turning points predicted by cycle analysis mirror actual market turning points. The second part of this research evaluates the profitability of an investment strategy based on cycle analysis against the returns generated by two control strategies, a random and risk-free strategy. Finally, we looked at the phenomenon of interference as a mechanism to extend the accuracy of cycle analysis in anticipating important market movements in economic activity. The findings of this paper demonstrate to what extent cycle analysis can effectively predict pivot points across indices and the American economy and thus the relevance of cycles in further understanding economic activity.