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Because shares
of stock represent equity in companies, and the activity of companies defines
the business cycle, it should not surprise us that changes in the business cycle
have a profound impact on the stock market. When demand and sales are up,
businesses prosper and grow, and both the value and dividends of their common
stocks increase as well, leading to bull market conditions of active
trading and rising prices. Aggressive growth stocks—i.e., stocks in
companies with histories or prospects of above-average growth in value—tend to
do particularly well during expansionary periods in the business cycle.
Holders of convertible preferred stock and convertible bonds often choose this
time to exercise their option to convert their securities into shares of common
stock, in order to share more fully in the increased profitability of the
company.
Conversely, during periods of contraction when demand and
production begin to fall, companies begin to struggle. Their profitability
declines, growth slows, and they may even be forced to reduce the size of their
operations. As a result, the value of their common stock declines as well,
leading to the infamous bear market when investors limit new stock
purchases, focus their holdings on stable companies that resist declines, and
may even move capital out of stocks and into safer vehicles such as bonds.
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