When Cycles Break

Expansion, peak, contraction and trough. Economics 101 outlines how these are the four key stages of an economic cycle, and for decades, investors have relied on this to make sense of markets. Economic cycles expand and contract where we observe prosperity and eventual downturns. Excesses created by an expansion can eventually clear during a downturn and after enough time, the system resets (self-corrects) and growth resumes.

This framework has helped shape how we approach many important aspects within investment management, including asset allocation and risk management. It has also taught investors to look for signals, turning points, and most importantly, to trust that imbalances created from the natural economic cycle would eventually resolve themselves.

But what if economic cycles no longer work this way?

The key principle in the theory of economic cycles is that they are mostly self-correcting. When left alone, the economy will naturally burn off excesses, weak players will exit and balance is restored. For the most part this has been the case for several decades. In recent years, however, this "reset" function has weakened, with one of the main reasons being the scale and speed of government and central bank policy intervention.

Monetary and fiscal authorities now respond to economic developments more quickly, earlier and more forcefully than they did in the past. This proactive approach can sometimes help mitigate certain characteristics from a contracting economy, like the depth of recessions. But this proactivity is not without after-effects. They can also limit the extent to which imbalances are allowed to unwind. Debt levels can remain elevated, asset prices can remain supported, and the system moves forward without fully returning, or "resetting" to its previous state.

Why does this matter? It matters because these unresolved imbalances do not disappear. They become embedded and brought forward, often with unintended consequences.

Rather than moving through a repeatable cycle, the global economy increasingly resembles a complex system shaped by feedback loops, interdependencies, and path dependency, where cause and effect become less linear. Shifts in policy, technology, or geopolitics can ripple across multiple channels at once, often reinforcing one another in unpredictable ways. Feedback loops can extend imbalances rather than clear them, while past decisions leave a lasting imprint, shaping how the system evolves rather than allowing it to revert.

A clear example of this shift can be seen from the effects of the Global Financial Crisis (GFC).  During this unprecedented time, global central banks ushered in aggressive monetary policy in an effort to prevent a deep economic contraction and help restore market functioning. While this helped in the short term, the aftermath didn’t follow a traditional economic cycle, and in turn created several imbalances: 
 

• Debt levels remained elevated instead of the deleveraging needed for a cycle to work.
• Asset price inflation became very strong and disconnected from underlying growth. This was largely due to the prolonged quantitative easing that took place.
• The economic growth that followed was supported by an extended period of low interest rates.

Because of this, economic excess couldn’t fully be flushed out through a cycle and monetary policy support became an ongoing stabilizing force for the economy.

The same pattern emerged during the COVID-19 Pandemic. In the face of lockdowns and severe economic contraction, policymakers again responded with extraordinary monetary and fiscal support to help stabilize markets and economic activity. During the Covid years, the Fed's balance sheet grew from about US$4.2 trillion in early 2020 to nearly US$9 trillion by 2022 as large-scale asset purchase programs were reintroduced¹. At the same time, the U.S. federal debt held by the public rose from roughly 79% of GDP in 2019 to approximately 97% by 2022 as a result of significant government fiscal stimulus measures².

While these actions helped prevent a deeper recession and supported a rapid recovery, they also reinforced the growing dependence on policy intervention and contributed to many of the inflationary and market distortions that followed.

The energy transition presents a third solid example of how structural policy objectives are increasingly shaping the economic environment outside of a traditional market cycle. The global push toward decarbonization and energy security has driven a significant increase in long-term capital investment, government subsidies and industrial policy support across developed economies. In the U.S., the estimated clean energy investment following the Inflation Reduction Act surpassed US$300 billion within its first two years, while global energy transition investment exceeded US$1.7 trillion in 2023³. These policies, while helping accelerate the transition toward cleaner energy sources, are also contributing to persistent inflationary pressures in certain areas of the economy⁴.

Rather than representing a short-term cyclical adjustment, the energy transition reflects a broader structural shift that is likely to influence economic and market dynamics for many years.

Having said all of this, It’s important to emphasize a balanced message: It's not that the economic system is failing to correct, it is merely correcting differently. Sharp resets are now transforming into gradual adaptation where the imbalances are being absorbed, redistributed and carried forward.