Whenever someone discusses the “housing market,” the first reaction is to think about home prices. But just like the broader economy, the housing market has a sequence that involves many parts, which all move in a particular order.

There are certain early warning signs that always turn first, years before home prices move. Think of it like a row of dominoes. One falling piece knocks over another, and it’s a chain reaction.

If your process for understanding the housing market starts with what home prices are doing in your local area, you are watching the last domino in the sequence and using that to predict when the next one will fall. This plan will never help forecast what the months and quarters ahead will look like.

In this post, we will walk through the exact sequence of the housing market from building permits to construction activity to supply to employment, all the way to home prices. The exact sequence that occurred in the 2008 housing crash and is repeated throughout history. Then we’ll review what the data says about the housing market today.

To help you understand this housing sequence, we created a free step-by-step housing guide with graphs and timelines like the one above, so you can always have the resource and the sequence handy. This will massively help you interpret incoming housing data and place it in the correct order. You can download the free guide below.

Download The Free Housing Sequence Guide

The Housing Sequence

The residential housing sequence is the single most important part of the entire economy. The housing market is extremely interest rate sensitive, so it reacts strongly to changes in monetary policy, and it has an extremely high multiplier effect, meaning booms or busts in the housing market can be felt in many industries like trucking, plumbing, the manufacturing of building materials and appliances, and the list goes on and on.

The housing sequence sets off a chain reaction that is quite literally the cause of many booms and busts in the economy throughout history. Let’s walk through this sequence using the 2008 housing cycle as our reference. At the end, we’ll see what the housing sequence says about the economy today.

When the Fed tightens monetary policy and interest rates rise, the housing market feels it almost immediately. But not through prices. The first response shows up in the volume of new home sales.

New home sales measure the volume of transactions, not the price. When mortgage rates rise, fewer buyers qualify or choose to transact, and the volume of sales declines. This response happens within weeks of a rate move. It is mechanical. Higher rates reduce affordability, fewer buyers show up, and the pace of sales drops. New home sales peaked in the summer of 2005, more than two years before the broader economy entered recession and nearly two years before home prices peaked.

Building permits follow. A permit is a forward commitment to build. When builders see sales slowing, they pull back on new projects. Building permits peaked in September 2005, confirming the signal from new home sales.

When both indicators decline together after a tightening cycle begins, it forms a cluster of leading indicators. One indicator declining can be noise. A cluster of indicators in the same bucket declining together is the sequence turning.

This is the critical concept. We are not looking at any single data point and drawing a conclusion. We are watching for a sequence of indicators all moving in the correct order, because that pattern has preceded every major housing downturn in the modern era.

From Leading Indicators To Real Economic Impact

As building permits decline, actual construction activity follows. The number of housing units under construction peaked in May 2006, several months after the volume of new home sales and building permits.

A new home sale or a building permit can change in an instant. If a home is under construction, it says under construction until it’s completed. In the terminology we use at EPB Research, this is the transition from the Leading Economy into the Cyclical Economy, from forward-looking commitments to actual production and employment.

Fewer homes under construction means fewer construction workers are needed. Residential construction employment peaked in mid-2006 and began declining. This is where the sequence becomes dangerous, because job losses in construction create downstream effects on the rest of the economy.

Workers who lose construction jobs immediately cut discretionary spending. They may default on auto loans, credit cards, and mortgages. Banks experience rising delinquencies and tighten lending standards. Credit contracts further, which means even fewer buyers can qualify for home purchases, which reinforces the decline in new home sales that started the sequence in the first place.

This feedback loop is the transmission mechanism. It is how weakness in residential construction spreads from the Cyclical Economy into the Aggregate Economy. And it is why the statement “housing is the business cycle” is true, but only when you are referring to the entire sequence, including construction activity and employment. Not building permits and not home prices in isolation.

Each metric moves at a different point in the sequence, and reading them in order is what gives you foresight. Reading any one of them in isolation is what gets you in trouble.

Transition to Home Prices

Home prices peaked in early 2007, almost two full years after new home sales peaked. Sellers resist cutting prices even as every other signal has deteriorated. Inventory builds. Days on market stretch. And only after sustained pressure do prices adjust, usually related to the labor market or job losses, which is why it is a critical piece of the puzzle.

This is not unique to 2007. It is how the sequence works in every cycle. Home prices are a lagging indicator. They confirm what the earlier parts of the sequence already showed. They do not predict what comes next.

Most people watched home prices through 2005 and 2006, saw them still rising, and concluded the housing market was healthy. Meanwhile, the leading and cyclical indicators had already turned. The sequence had been running for over a year. By the time prices confirmed the downturn, the opportunity to position ahead of it had long passed.

Where We Stand Today

So now that we have this sequence in mind, at least at a high level, we can run it through today’s data to see where we stand.

Download The Free Housing Sequence Guide

We outlined the sequence as a process that flows from monetary tightening to new home sales and building permits, then into housing units under construction and employment, and then into home prices. Home prices acting as the lagging indicator that responds to oversupply and weakening demand through labor market stress.

New home sales peaked in 2020, but this was strongly related to the initial reaction during the pandemic. New home sales had a secondary peak in late 2021.

Building permits peaked at the start of 2022, a few months later. Both new home sales and building permits have not staged significant upturns yet.

The number of housing units under construction had an official peak in October 2022, but stayed elevated until the start of 2024. This one year period where units under construction were stalling but not declining was a big reason why this cycle has taken a long time to play out.

Historically, housing construction peaks were more abrupt than gradual, sweeping ones.

Housing units under construction remain in a forceful downturn. With less construction activity comes less demand for residential housing employment.

This is the most critical step of the sequence today. We noted that housing units under construction didn’t really start to slide until the start of 2024 and this is when residential building employees peaked. However, we simply have not seen a huge decline in residential building employment.

Certainly not the level of decline that occurred in past cycles when construction activity fell, and this is the absolute most critical variable in the entire economy today. Without a decline in housing-related employment, the rest of the cycle cannot complete. The next domino won’t fall.

There’s not enough downstream stress created from early stage unemployment in cyclical areas.

The average sales price of a new home hasn’t declined much from peak. It’s a volatile series, and if we smooth the data, average new home prices haven’t turned down, which makes perfect sense with the sequence.

Prices have stalled, and housing is absolutely regional.

There have been some strong declines in new home prices in parts of Texas, Florida and areas with an oversupply of building.

The regional discussion is important and a topic for an entire article, but the national data is what we’re focusing on in this breakdown - and how it relates to the broader economy.

The Case-Shiller National Home Price Index, which tracks existing home prices rather than new home prices, is also at a cycle high, consistent with the sequence outlined and the fact that the home price domino cannot completely fall without the employment domino falling.

We will dive into the reasons why employment hasn’t moved as much as you would have expected, given the magnitude of the construction decline, in future posts.

The main takeaway from this analysis is the sequence or the order of events in which the housing cycle moves and how that plays into the broader business cycle.

Monetary policy has impacted the pace of new home sales and the level of new building permits. This led to a sharp decline in housing units under construction and, so far, just a small decline in the associated residential construction employment. This is where we are today.

Home prices on a national level will remain elevated until that employment domino fully declines.

There will continue to be huge regional differences in home prices, and that’s an important conversation, but for now, you know exactly where we stand in the national housing cycle.

We track this entire sequence and provide updates every month in the EPB Business Cycle Trends Report and our specific Residential Construction Report.

If you want the condensed version of this housing sequence in a quick reference guide, so you can track it yourself, download the free housing sequence guide using the button below.

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This statement is repeated nearly every day across financial media as proof that “the consumer” drives the economy.

The logic seems correct.

If consumer spending is almost 3/4 of the entire economy, and consumer spending slows, the economy will decline…

So the best practice must be to watch the consumer, track sentiment, and focus on anecdotal data points like “is the airplane full?” or “is the restaurant packed?”, all things we hear discussed frequently.

The problem is that these comments about the consumer and the focus on economic data like personal consumption treat the consumer as a single, uniform bucket.

The consumer is either still spending or not.

But when you dig beneath the headline and look across all categories of consumer spending, it becomes clear that the 70% figure is dangerously misleading. In reality, less than 20% of all consumer spending really matters for the economy.

In this post, we will highlight which categories of consumer spending actually impact the business cycle and why focusing on “the consumer” and waiting for a slowdown in total consumption is a horrible idea.

Breaking Down Consumption

Personal consumption can be split into three primary categories: durable goods, non-durable goods, and services.

Durable goods include items such as motor vehicles, furniture, and household appliances.

Non-durable goods are items such as food, clothing, and gasoline.

Service consumption is by far the largest category, including housing, healthcare, insurance, restaurants, and utilities.

These three primary categories of consumer spending can be split into 15 more specific buckets, which offer a lot of detail on how certain categories behave in recessions and expansions.

Going back over 50 years, we looked at the average growth rate for each of these 15 categories during recessionary periods and during expansionary periods.

The difference in growth rates during recessions and expansions is extremely informative and tells you exactly how “cyclical” a given bucket of consumer spending really is.

In other words, is this a category of consumer spending that really changes during recessions or not?

We can call this change in growth the expansion-recession spread.

Housing and utilities are 16% of consumer spending.

The average growth rate for this category of consumer spending during expansions is 2.9%. In recessions, the average growth rate is 2.0%. The spread is less than one percentage point. Rents get paid. Utilities get used. This category is essentially unaffected by the business cycle.

Health care is 18% of consumer spending, the single largest category in the entire basket. In expansions, average growth is 3.8%. In recession, 3.5%. The spread is 0.3 percentage points. Health care spending is as close to recession-proof as any category in the economy.

Financial services and insurance account for 7% of spending. In recessions, this category actually shows higher growth - part of this is because insurance is a very lagging indicator in terms of when prices increase. In expansions, average growth is 3.6%. In recession, 5.2%.

Food and beverages consumed at home, or groceries, are about 7% of spending. The expansion-recession spread is effectively zero.

We just listed more than 40% of the consumer spending basket that does not change at all, whether the economy is in expansion or recession. In recessions, these categories don’t even show negative growth. They are essential items that always grow.

This is why, when you look at total consumer spending, you are capturing huge buckets of the economy that don’t ever contract, giving a false sense of stability and completely overshadowing the parts of the economy that are more cyclical and offer insights into the financial health of the consumer.

Another 30% of consumer spending is what we’d call “mildly” cyclical, which leaves less than 20% of the entire consumer spending basket that really swings in recessions compared to expansions - this is the only area of consumer spending worth watching.

The 16% That Matters - Focus Here

Almost all the items in the less important 80% are either services or non-durable goods. That leaves the durable goods as the important swing factor.

The highly cyclical consumer spending categories are durable goods, which are big-ticket and generally purchased with financing, so they are sensitive to interest rates.

Motor vehicles and parts is 3.5% of consumer spending. Its cycle behavior is completely different from the stable categories. Average growth in expansions is 8.4%. In recessions, -4.8%. The expansion-recession spread is over 13 percentage points. This is the single most important factor in the consumer spending basket as it relates to the business cycle, even though it accounts for only 3.5% of the total.

Compare that to health care, the largest consumer category. The expansion-recession spread is 0.4 percentage points.

We also see very large swings in growth between expansions and recessions in recreational goods, furniture, household appliances, and transportation services.

When the labor market starts to cool and consumers start to feel the pinch, these are the categories where it shows up first. They are small, and they don’t move the total right away, so if you are watching the consumer as one big bucket, you’ll never see the early signs.

Putting It All Together

The consumer is 70% of GDP. This is true. But more than half of consumer spending belongs to categories that have essentially the same growth rate in expansions and recessions. They do not signal where the cycle is heading, and they can even mask the trends that are really developing beneath the surface.

A very narrow slice of consumer spending is actually volatile and provides a true signal of the underlying economy's momentum. Broadly speaking, these are durable goods.

The business cycle is not driven by the 70% of GDP. It is driven by a narrow slice within that 70% that most commentary never isolates.

At EPB Research, we focus on the three primary pressure points of the economy that drive all the booms and busts, and durable goods consumption is the only slice of consumer spending worth watching, along with residential housing investment and business equipment investment.

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An accelerating economy can absorb nearly any geopolitical shock without falling into recession. An economy that is already deteriorating is vulnerable to even modest disruptions, because those disruptions only need to add pressure to a cycle that has already turned.

That distinction is critical for evaluating what the US-Iran conflict means for the economy today.

What History Shows

Geopolitical events are most frequently cited as recession triggers in public commentary, but often, they are misread.

The September 11 attacks did not cause the 2001 recession. Manufacturing employment had already peaked in 1998, more than two years before the attacks occurred.

The devastating attacks caused a legitimate pullback in corporate investment and financial market chaos, but it's clear that a major business cycle deterioration was already well underway.

The 2008 oil price spike did not cause the financial crisis. This is often described as the final piece that really broke the consumer.

But again, the cyclical economy had been contracting since 2006, two full years before oil reached its peak. Residential construction had already collapsed. Credit markets were already tightening. The energy shock added pressure to an economy already in serious trouble, but the recession itself had been set in motion years earlier by the housing cycle and the credit conditions that followed.

The pattern across both events is the same. The cyclical sectors of the economy turned first. The geopolitical shock arrived in an economy that was already weakening substantially. The shock accelerated the deterioration rather than causing it.

Now, there are also cases where shocks arrived before the cyclical economy had peaked. During the Iranian Revolution in January 1979 and the oil embargo in October 1973, construction and manufacturing employment had not yet reached its cyclical peak at the moment the shocks occurred.

In both cases, the shocks did not immediately produce recessions in the way that later oil shocks did. Let’s explore further.

The Data

The table below maps two critically important variables at the moment each major geopolitical or oil-related shock occurred: the number of construction and manufacturing jobs already lost from the cyclical employment peak, and the direction/level of corporate profit margins at the time of the shock.

The 2008 oil spike, the September 11 attacks, and the Gulf War, all shared two characteristics. The cyclical economy was already in decline, with hundreds of thousands of jobs already lost, and corporate profit margins were falling at the time of the shock. The two shocks from the 1970s were slightly different.

The economy had not lost jobs, but profit margins averaged about 9%.

Today’s reading sits in a middle position. The cyclical economy is 20 months into decline with 132,000 jobs lost, which is a real deterioration but nowhere near the scale of 2001 or 2008. At the same time, corporate profit margins are near 15.8%, which is substantially higher than they were heading into any of the recessionary shocks in this dataset.

Is There a Shock Buffer?

Profit margins deserve particular attention because they directly shape how businesses respond to deteriorating conditions. When margins are high, companies have room to absorb revenue pressure by accepting lower profitability rather than cutting payroll, which is a costly and difficult decision to quickly reverse.

When margins are thin, any revenue softness or cost increases force major headcount adjustments for survival.

Heading into the Gulf War, corporate margins were at 7% and falling. Heading into the September 11 attacks, they were at 7.5% and falling. Heading into the 2008 oil spike, they had dropped to 9% and were falling sharply as the housing collapse was already destroying profitability across the financial sector.

Today, margins are at 15.8% and so far, stable. That gap is meaningful. It represents the difference between an economy where businesses are already under pressure and will respond quickly to new shocks, and an economy where businesses have the financial cushion to absorb a period of disruption without immediately eliminating jobs.

Now, it is worth mentioning that profit margins are not evenly distributed across the economy, and the household buffer is extremely thin compared to the corporate buffer.

The Oil Transmission Mechanism

A sustained increase in energy prices can act as a tax on consumer spending or as a profit-margin compressor. When households spend more on gasoline and utilities, they have less to spend on discretionary goods. The first place that reduction shows up in the economic data is durable goods consumption, which are primarily big-ticket and more discretionary-type items.

Durable goods consumption is part of the 20% of the economy that drives all the major fluctuations in economic activity.

If energy prices stay elevated for multiple quarters rather than spiking briefly and reversing, the cyclical economy faces pressure from two directions simultaneously: the existing weakness that has been building since 2023, and a new demand-side headwind from higher energy costs. That combination would be more concerning than either factor in isolation.

The key distinction is between a brief spike and a sustained elevation. Oil markets have moved in response to the conflict, but as of now, the move does not yet represent the kind of prolonged elevation that would register as a meaningful cyclical drag, particularly considering the buffer that is present - at least on the corporate side.

Bottom Line

The US-Iran conflict deserves serious attention. It is a real event with potential economic consequences, particularly through its effect on oil prices and energy costs. But serious analysis requires separating what is knowable from what is speculative, and what is signal from what is noise.

The historical record is clear: geopolitical shocks do not write their own recessions. They accelerate deterioration that is already in motion, or they pass through economies that have the underlying strength to absorb them.

It goes without saying that a shock can be large enough to overcome any set of initial conditions, like economic lockdowns. Shocks definitely come with varying magnitudes, and that matters.

Today, the important cyclical engine of the economy has been weakening for 20 months, which is a real vulnerability. The weakening has been long in duration but mild in magnitude.

On the other side, corporate profit margins are at historically elevated levels.

The economy does not enter this shock from a position of strength in the cyclical sectors, but it also does not enter it with completely depleted buffers that were present in 2001 or 2008.

EPB Research subscribers receive regular updates on the full Business Cycle Sequence, including granular breakdowns of each cyclical component and what the latest data means for monetary policy, corporate profits, and the labor market.

As real income gains continued to fall short of society’s expectations, calls for government solutions grew louder, but ultimately, these efforts worsened the problem.

I produced a full animated breakdown on YouTube, walking through exactly why the rate of private investment has been declining, how this has impacted our population's standard of living, how we can fix it, and where the economy is heading if we don’t.

Watch it here:

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On the surface, this looks like a healthy economy.

A 6% pace of nominal growth is slightly above the pre-pandemic average, and there are no obvious signs of distress in the headline number.

If you stopped your analysis here, you would conclude that the economy is fine and that monetary policy is working.

In fact, the case for rate hikes could even come to the table. But lately, interest rates have been falling, exactly the opposite of what you’d expect from these stronger headline figures.

Stopping your analysis at the headline is exactly how you end up being wrong at the major turning points.

Stripping Away the Noise

At EPB Research, we don’t like to analyze total or headline GDP.

We break economic growth into layers, removing the components that carry no cyclical signal, until we’re left with the parts of the economy that actually drive the business cycle.

The first cut starts with total GDP and removes inventories, government expenditures, and net exports, which we call “Irregular GDP.”

These components are volatile, policy-driven, and provide almost no useful information about where the private economy is headed. What remains is Core GDP, or simply: consumption + fixed investment.

Core GDP is running at a 5.4% annualzied pace in nominal terms. This is still a reasonably strong pace of growth with no glaring signs of stress. But we’re not done.

Core GDP breaks into two distinct components: Cyclical GDP and Non-Cyclical GDP.

The non-cyclical portion, which is mostly services consumption and investment in nonresidential structures, is highly stable and not materially impacted by changes in monetary policy.

Non-Cyclical GDP is stable and currently growing at 5.9% in nominal terms. Watching the non-cyclical portion of GDP tells you almost nothing about where the economy is going next because the impacts of monetary policy are not felt in these areas.

The impact of monetary policy is felt in the Cyclical portion of the economy.

The cyclical economy, comprised of durable goods consumption, residential investment, and business equipment investment, is where all the meaningful fluctuation occurs.

This is the 20% of the economy that drives 100% of recessions.

Cyclical GDP is rising at a 3.5% annualized pace, which is actually not alarming on its own. The Cyclical portion of GDP always contracts into recessionary periods - even in nominal dollars - so a 3.5% growth rate is actually reassuring.

But it’s what’s inside that 3.5% that matters.

The AI Distortion

While it’s very difficult to isolate the specific parts of the GDP accounts directly affected by AI spending, we can roughly approximate the impact by examining the growth rates of data center investment, computer equipment investment, and software investment.

These three buckets of GDP, what we call “AI GDP,” are growing at a whopping 24% annualized pace, exploding since late 2023.

This is clearly an extraordinary growth rate, reflecting a massive wave of capital expenditure on AI infrastructure from the world's largest technology companies.

Isolating this category of growth is not to say it doesn’t matter. Quite the opposite. This is real investment and real economic activity.

The Impact on Cyclical GDP

Cyclical GDP measures durable goods consumption, business equipment investment, and residential investment.

Computer equipment investment is a very narrow slice of business equipment investment and a driver of our “AI GDP” bucket.

When we strip out computer equipment investment from Cyclical GDP, the growth rate falls from 3.5% to 0.6%. Computer equipment investment represents just 6% of Cyclical Core GDP, yet it accounts for nearly the entire difference between a cyclical economy that looks relatively stable and one that is essentially stagnant and flashing recession.

In the chart above, for most of the period from 2015 through 2019, Cyclical GDP and Cyclical GDP less computer equipment tracked each other closely. The gap between them was minimal, and that made sense since computer equipment was just 6% of the total.

Today, that gap is as wide as it has ever been, and it's masking real weakness within the traditional interest rate-sensitive sectors that are in need of policy support.

What the Rest of the Cyclical Economy Is Saying

Without the major contribution from computer equipment investment and Cyclical GDP is on the verge of contraction.

Historically, nominal contractions in Cyclical GDP are recessionary. There was a brief and minor contraction in 2022, but the labor market was strong, and this was largely driven by the exhaustion of pent-up demand during the COVID-spending spree that was quickly reversed.

The interest rate sensitive, big-ticket parts of the economy that respond most directly to monetary policy have been under sustained pressure.

Why This Matters for Monetary Policy

It is clear that the cyclical economy, stripped of AI investment, is not overheating. It is barely moving. These sectors are in need of monetary policy support as they are the traditional engine of economic growth.

The counterargument is that AI investment is still economic activity, still generating income, still supporting employment in technology and construction, and that is true.

The question is not whether AI investment is real today. The question is whether it can sustain its current pace indefinitely and whether it can continue to offset weakness in every other part of the cyclical economy.

The Bottom Line

Now, it’s not accurate to say that AI investment is keeping the economy out of recession, despite all the charts and data we have just reviewed. Cyclical GDP excluding computer equipment investment is still not contracting, but it’s decelerating and stagnating, and the risk is that it will continue to slide.

This would be a different conversation if Cyclical GDP was contracting at -5%, but the economy was still avoiding recession. That is likely what you’d think if you only listened to mainstream analysis, but that is not supported by the data.

The facts are that total GDP is running at a 6% nominal pace. The ever-important Cyclical portion of GDP is growing at a 3.5% pace, but if we remove a narrow 6% slice of computer equipment investment, we drop to a stagnant 0.6% (negative in real terms).

That is not a sign of broad economic strength. It is a sign of an economy that remains more dependent on monetary policy support than the aggregate data suggests.

Hopefully, the head-scratching decline in interest rates amongst seemingly strong headline figures should be less confusing after this growth breakdown.

EPB Research subscribers receive regular updates on the full Business Cycle Sequence, including granular breakdowns of each cyclical component and what the latest data means for monetary policy, corporate profits, and the labor market.

This wasn’t a random fluke. There were a couple of forces at work that distorted the traditional signals, and understanding what happened is one of the most important lessons of this business cycle.

I put together a full animated breakdown on YouTube, walking through exactly what drove the divergence between leading and coincident data, and what it means for how we use these tools going forward.

Watch it here:

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All economic fluctuations come from a few narrow sectors, and if you want to anticipate major changes or downturns, you need to focus on these smaller sectors that actually drive them.

The question is: which sectors lead the most and which are the most reliable?

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In this post, we’ll rank the major components of GDP by two critical dimensions: how far in advance each indicator declines before recessions and how deeply each indicator contracts.

A good leading indicator, or a sector with predictive value, is one that contracts early and deeply.

The results of this study serve as the foundation for the EPB Research framework and our approach to analyzing business cycles.

What Makes A Good Leading Indicator

A good leading indicator needs to do two primary things:

1. Decline early

2. Decline deeply

An indicator that declines early but only has a very shallow contraction will never provide enough confidence or a clear enough signal for action. An indicator that declines deeply but late is not useful for any predictive analysis. An indicator like this may be useful as a confirmation tool, but not as a leading signal.

The chart below plots 15 major components of GDP across these two dimensions, using data from all recessions between 1955 and 2019.

The y-axis shows the duration of decline in quarters or how far in advance each component begins contracting before a recession.

The x-axis shows the depth of decline or how severe the contraction is relative to the component’s historical volatility. Negative Z-scores indicate contractions that are deeper than normal; positive Z-scores indicate components that barely contract or even grow into recessions.

The upper-left quadrant contains the best leading indicators: components that decline both early and deeply.

The lower-right quadrant contains the worst leading indicators: components that decline late, barely at all, or not until well into a recession.

The Best Leading Indicators

In the chart above, a few components of GDP stand out as the best leading indicators.

Residential investment: leads by roughly 7 quarters on average and also holds the deepest average contraction heading into recessionary periods. Housing investment is the clear standout as the best leading segment of the economy. It’s often said, “housing is the business cycle,” for this reason.

Transportation equipment: leads by roughly 5 quarters on average. The contraction ahead of recessionary periods is not as deep as residential, but the combination of depth and duration still ranks business investment in transportation equipment as the second-best component of the economy for recession forecasting.

Other equipment: this is another component of business investment, declining about 4.5 quarters on average ahead of recessions, with a similar depth of decline as transportation equipment.

Durable goods consumption: leads by about 3.5 quarters with a deep average contraction. Cars, appliances, and furniture are all durable goods items, and these big-ticket consumer purchases are financed with credit and are highly sensitive to interest rates and consumer confidence. Durable goods consumption doesn’t always contract early, but sharp declines are common at the onset of a recession.

These components, residential investment, business equipment investment, and durable goods consumption, are all interest rate sensitive, generally lean more discretionary, and are big-ticket items that are financed.

These three components of GDP are interconnected and empirically the best segments of the economy to watch for early cyclical movements. They are the earliest and deepest movers ahead of recessions. In a previous post, “The 20% of the Economy That Drives 100% of Recessions,” we highlight why this is where investors and economy-watchers should focus. This data provides even more supportive evidence.

The Worst Leading Indicators

Everything in the bottom right corner of the first chart is a poor leading indicator, and these are often the largest segments of the economy.

Non-residential investment in structures is an example of a poor indicator.

Investment in non-residential structures like hospitals, education buildings, and office buildings is a bad indicator because it generally peaks after a recession has already started, unlike residential investment, which offers a 7-quarter lead-time on average.

Non-residential investment is a volatile component of GDP and can ultimately make a recession mild or severe, but it is not an early warning sign.

Today’s boom in data center investment falls into this category.

Why This Matters for Economic Analysis

The implications of this ranking are extremely important for those watching the economy and looking to forecast changes in corporate profits or monetary policy.

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When economic pundits say “the consumer is fine” or “we are a services economy,” they’re pointing to the exact components of GDP that never lead recessions.

These are very large segments of the economy, but when these sectors weaken, the recession is already well underway, and other categories like residential investment or business equipment investment have been contracting for over a year.

This is why conventional economic analysis is always reactive rather than anticipatory.

The important business cycle signal is concentrated in a narrow slice of the economy, the roughly 20% of GDP, that can decline up to 7 quarters in advance. Everything else is noise.

It’s Not All Gravy (Dealing With False Signals)

If residential investment is the best leading indicator with the longest lead time and deepest contraction, why not just watch housing and call it a day?

Because even the best leading indicator comes with false signals.

Residential investment has declined meaningfully outside of recession periods multiple times since 1955.

Take 1967 as an example. There was a big decline in residential investment, but a full recession never transpired. When these false signals occur, it is almost always because profit margins started from an elevated level, and the contraction did not spill over into employment.

In fact, this dynamic is exactly what has transpired over the last 2 years and something we documented in our latest article: Why Leading Indicators Failed This Cycle.

This is why it's never a good idea to use only one indicator. A basket approach helps eliminate these false signals, or taking the combined signal from residential investment, business equipment investment, and durable goods consumption.

This cycle also highlighted an important lesson about watching profit margins in cyclical industries like residential construction and in the broader economy.

High margins create resilience. Low margins create fragility. The same demand shock can have wildly different employment effects depending on where margins started.

The Bottom Line

Not all economic indicators are equal.

Residential investment, transportation equipment, and durable goods consumption lead recessions by quarters and contract sharply, offering strong, easier-to-spot signals.

Services consumption, investment in non-residential structures, and government consumption barely move until a recession is already underway, and sometimes, not at all.

Far and away the best sector of the economy to track is housing, but false signals are a genuine concern. Tracking a basket or a combination of the top leading components can help with this problem.

Also, having a good understanding of profit margin dynamics can inform you of the fragility in the economy and whether a recession can develop quickly or require longer bouts of monetary and credit contractions.

If your analysis is dominated by the 80% of the economy that doesn’t lead, you’ll always be late. Focus on The 20% of the Economy That Drives 100% of Recessions.

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Understanding why requires revisiting what leading indicators actually are, and why they work.

In this post, we’ll use one of the most popular leading indicators, building permits, as a prime example to understand what happened this time and what it means for the validity and usefulness of traditional leading indicators going forward.

What Leading Indicators Are & Why They Work

The economy moves in a sequence. There is a mechanical chain of events that always occurs, and that sequence cannot change. Leading indicators work because they sit at the front of that sequence, measuring the early changes or the early dominoes that fall before the economic changes occur in the later part of the sequence, in data like employment.

Recessions are synonymous with declines in employment. A recession cannot occur without a decline in employment. When leading indicators decline, they are essentially forecasting a decline in employment, although that is several steps away in the normal order of events.

Consider the logic or the normal chain reaction. Businesses don’t hire and fire randomly. They respond to changes in demand or changes in profit margins. But these demand or profit changes don’t appear instantly; they build through a series of steps.

For example, a customer places a new order before a good is produced. Production generally occurs before revenue, and changes in revenue affect corporate staffing decisions. So a decline in new orders forecasts a future decline in employment, but several steps happen along the way that can take an unknown amount of time.

This is why leading indicators have historically worked so well for recession forecasting. They capture the early weakness before it becomes visible in headline employment numbers. By the time unemployment rises, the leading indicators have been declining for months or even years.

But here’s the critical insight that most people miss: leading indicators don’t cause recessions. They measure the front of a sequence that, if completed, produces a recession. The indicator can work perfectly, measuring exactly what it’s supposed to measure, while the sequence itself fails to complete.

That’s precisely what happened this cycle, and we will use the sequence in residential construction to demonstrate this point.

The Incomplete Residential Construction Sequence

Building permits offer the clearest example of what happened during this economic cycle because the sequence or transmission mechanism is well documented, and the failure of the sequence to complete is unambiguous.

Building permits are issued before construction begins. Building permits signal what residential builders intend to do over the coming months. When building permits decline, fewer homes get started, which means fewer homes are under construction 6-12 months later.

When fewer homes are under construction, there is less demand for employment associated with home construction.

So building permits don’t forecast a recession directly; they forecast changes in residential construction employment, which, given its volatility, drives the vast majority of typical recessionary job losses.

Residential construction and the associated employment are so critical because the sector is highly interest rate-sensitive, meaning changes here occur before other sectors.

A laid-off construction worker cuts back on restaurants, retail purchases, and services. This multiplier effect connects the housing sector to broader consumer spending and, ultimately, to recessionary dynamics.

The sequence, when it completes, looks like this:

Permits fall → housing units under construction decline → residential employment falls → broader labor market weakens → consumer spending slows → recession risk rises.

This cycle, the front of the sequence worked exactly as expected. Building permits fell, and then housing units under construction declined. But residential construction employment barely budged. The indicator did its job. The sequence didn’t complete.

Understanding why is essential for forecasting the economy going forward. We need to know if the old relationships or sequence of events have permanently changed or if they have only been temporarily delayed.

The Two Changes That Broke The Sequence

There are two main factors that explain why (so far) the permit-to-employment sequence has failed to complete and thus, failed to produce a traditional recession despite three years of steady declines.

1. Profit Margins

2. Residential Remodeling

Profit margins in the residential construction sector exploded higher during the pandemic-era boom. Homebuilders, which typically operated with an average 10% operating margin in 2018 and 2019, saw margins explode to 20% as demand vastly exceeded supply.

In early 2022, building permits began to decline as the Federal Reserve raised interest rates. Typically, when permits decline, construction slows, and profit margins compress.

In fact, that’s exactly what happened!

However, profit margins started from such an extreme level, above 20%, that three years of margin compression left builders with an average margin of 12%, still above where they operated for the entire decade pre-2020.

Normally, when construction spending slows, profit margins compress, and that compression triggers layoffs. A builder with thin margins cannot absorb a revenue decline. Costs must be cut, and labor is typically the largest controllable cost.

In this cycle, the margin buffer absorbed the demand slowdown without forcing the employment adjustments that leading indicators had predicted.

Permits declined, construction activity cooled, but profit margins cushioned the blow and have prevented the sequence from fully playing out.

Could the full sequence still occur? Yes.

Margins have been compressing, and if they continue to fall, builders will eventually face the same cost-cutting pressures they always face during downturns.

The question is whether demand stabilizes before margins reach critical levels. If permits and construction spending bottom out while margins remain comfortable, the employment decline never occurs. If permits continue to fall or margins erode further, the classic transmission mechanism could still come into play.

The second factor, remodeling, is more structural in nature.

Building permits track new residential construction. They don't tell us much about remodeling and renovation activity.

Over the past several decades, remodeling has captured a larger share of overall residential construction spending.

This matters because residential remodelers are part of the overall residential building employment sector, which is a big swing factor in the labor market.

In the early 2000s, residential remodelers were only 30% of total residential building employment. Today, remodelers are nearly 50% of total employment.

If we revisit the function of leading indicators, they primarily predict changes in employment, which ultimately drive the recessionary process.

Historically, employment in the residential construction sector was dominated by new construction activity, which building permits accurately forecast. As employment shifted toward remodeling, building permits have less influence on forecasting these employment changes.

The Future of Leading Indicators

This business cycle contained several important lessons regarding leading indicators.

First, the leading indicators don’t predict the recession. The leading indicators are the first mover in a sequence of events that ultimately lead to changes in employment. Following every step of the sequence is extremely important, and jumping from the first to the last step without considering what happens in the middle can lead to mistakes.

Second, leading indicators often measure a subset of economic activity. When that subset's share of the total changes, the indicator's usefulness changes too.

Third, profit margins are an underappreciated variable in the sequence or the transmission mechanism from demand to employment. High margins create resilience. Low margins create fragility. The same demand shock can have wildly different employment effects depending on where margins started.

Where We Stand Now

As of today, the transmission mechanism from building permits to residential employment remains incomplete. The front end worked as expected. Permits fell, and construction activity followed. But the back end, the employment and labor market consequences, never materialized at scale.

The most likely explanations are the combination of remodeling strength and profit margin buffers. Both factors are still operative but potentially eroding. The question going forward is whether economic conditions stabilize before these buffers are exhausted or whether continued pressure eventually completes the sequence that leading indicators predicted three years ago.

This analysis was intended to provide a high-level breakdown of how to track the Business Cycle and its full sequence of events.

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As real income gains continued to fall short of society’s expectations, calls for government solutions grew louder, but ultimately, these efforts worsened the problem.

The main issue is that real income growth is tied to productivity gains, and sustained increases in productivity growth require what’s called “capital deepening,” or more (and better) machinery, equipment, and physical infrastructure for workers, allowing each person to produce more in the same amount of time.

This capital deepening process requires continued investment in physical goods and infrastructure, and over the last several decades, the US economy has invested less and less in these critical areas.

In this post, we’ll explore why the rate of private investment has been declining, how this has impacted our population's standard of living, how we can fix it, and where the economy is heading if we don’t.

How The Standard of Living Improves

The standard of living or the perception of prosperity improves when real income grows at a sufficient pace for the average person. Real income, or income after accounting for inflation, is tied to productivity growth.

An economy can only consume what it produces (not counting the trade deficit…we will get there).

If you want to consume more, you have to produce more. Producing more per hour is productivity, and that’s the only way real incomes rise.

If wages go up but productivity doesn’t, prices just rise to match the increase in wages. You earn more dollars, but it buys the same amount of stuff, and nothing changed.

To produce more, it's helpful to have more and better equipment, machinery, or infrastructure to work with.

This chart shows real personal income per capita excluding government transfer payments. Essentially, we are measuring all the income the private sector can generate on its own, adjusted for inflation, per person. At the end of 2025, this amounted to roughly $48,500 per person. We’ll refer to this measure simply as real income.

Real income has increased over time, rising from $20,000 in the early 1970s to almost $49,000 today. It’s essential that real income increases over time, but the rate of increase is what’s really critical and easy to lose sight of.

From the 1960s through 2007, real income increased at a 1.8% pace. After the 2008 recession, real income dropped and never regained the 1.8% trend line as it did after all recessionary periods in the prior four decades.

Had real income growth remained on the 1.8% trendline, the US economy would be generating closer to $53,500 per capita, $5,000 more per capita, or $20,000 more for a family of four.

For many decades, people grew to expect a certain level of real income growth or a certain pace of improvement in their standard of living.

Just as with financial investments in the stock market, small changes in the rate of compounding are hard to see year to year but can grow enormously over many decades.

Shifting the growth rate in real income from 1.8% to 1.3% can’t be felt over one year. But over 18 years, the average person is almost 10% worse off than they would have been had we stayed on the same trend.

What would the average family of four be able to do with an extra $20,000 per year? Reduce debt, pay for child care, increase savings? Or, looked at in reverse, this $20,000 gap is what many families expected in 2005 or 2006 as they projected future income, and this shortfall has been plugged with debt.

It should be clear why most people feel they are not keeping up or their standard of living is not improving as fast as they expected, because for the average person, it’s not. This becomes even worse when looking at the bottom percentage of the income spectrum, since the averages are actually improved by the very wealthy. But why is it happening?

We know that real income is tied to productivity and that real income growth has shifted down. Even a decline from a 1.8% trend to a 1.3% trend has created problems that have grown very large over the last two decades.

This problem has its roots in a lack of investment.

Net private investment measures how much the private sector is investing in structures, equipment, and intellectual property after accounting for depreciation. The economy has to spend a certain amount of money just to stand still because roads, machinery, and buildings get worn out over time, and money needs to be spent simply to offset this erosion.

Net investment measures how much the economy is investing in new structures and equipment after accounting for this wear and tear.

From 1950 to 1980, we invested about 8% of GDP. From 1980 to 2007, we invested about 6% of GDP, and from 2009 to 2025, about 4% of GDP.

If we maintained just a 6% net investment rate, that would be the equivalent of $600 billion of new investment each year - investment that we are not making today.

But why?

There are several reasons for this decline in investment, but they mainly stem from an increase in government size.

Government Size & Net Private Investment

There are certain mathematical identities that describe the economy, and one critical formula is the National Savings & Investment Identity.

The National Savings & Investment Identity explains the relationships among private-sector savings, private-sector investment, government budget deficits, and the trade deficit, with the opposite of the trade deficit being foreign capital inflows.

Domestic saving plus foreign saving must equal private investment plus government borrowing.

This can be written as:

Budget Deficit = Private Savings - Private Investment + Trade Deficit

In other words, if the US budget deficit increases, private savings must increase, private investment must fall, or the trade deficit must widen (or some combination of the three).

Since the US budget deficit has increased faster than the trade deficit, it’s been necessary for private savings to increase or private investment to fall.

Private saving is the opposite of private consumption, and in the United States, we are not keen on reducing consumption, so the burden has led to a decline in private investment.

Beyond the mathematical identity that has caused a decline in net private investment due to larger government budget deficits, there are also shifting incentives arising from a larger government spending firehose.

When government spending and deficits rise as a share of GDP, private investors face increasing uncertainty about future taxes, regulations, and the rules of the game. Long-term capital projects like factories, machinery, and infrastructure require committing resources today for returns that materialize over decades, exposing investors to years of unpredictable policy risk.

Rational actors respond by shortening investment horizons, maximizing liquidity, and favoring financial engineering over real engineering.

Talent flows toward rent-seeking behavior and navigating government rather than building productive capacity.

The result is a secular decline in net investment, a slower-growing capital stock, and compounding productivity erosion.

Fixing The Problem: Is It Even Possible?

Of course, the growing government size and budget deficits are not the only reasons the rate of net investment has declined in the United States, but they are certainly the largest factors.

Fixing the problem is extremely difficult if we agree that the deficit is the largest driver, because the United States is structurally locked into higher spending through Social Security, Medicare, and Medicaid, which make up the bulk of what are called transfer payments.

Transfer payments and interest are now 58% of all government spending, which is more than $11 trillion when factoring in federal, state, and local governments.

If reducing spending is not politically feasible, increasing taxes can close the budget deficit, but that is an equally unpopular political platform.

If we assume government budget deficits will grow in the future, then the trade deficit must increase to maintain our current rates of consumption and domestic investment.

Tariff policy is designed to close the trade deficit, which is why this is a dangerous path if reducing the budget deficit is not a simultaneous plan.

Even still, it’s unlikely the trade deficit can grow at the same speed as the budget deficits are growing, even if we wanted to. So the mathematical result is lower consumption or lower investment, or some combination of the two.

A continued decline in the rate of net investment is almost assured.

Where We Are Going & What You Can Do About It

As the rate of net investment continues to stair-step lower as it has over the last several decades, productivity growth will falter.

A lower and lower rate of net investment over time means worse and less reliable roads, airports, power grids, machinery, train stations, power plants, and factories.

Decaying infrastructure leads to lower productivity outcomes, which in turn lead to lower rates of real income growth.

This chart shows the percentage of time real income growth exceeded 3% over rolling 10-year periods.

So in the early 1970s, real income growth exceeded 3% more than 60% of the time. Today, real income growth has exceeded 3% just 23% of the time in the last 10 years.

This will continue to slide, reducing the average person's sense of prosperity and leaving out the people at the bottom of the income structure.

Savings equals investment, and the core issue is that the US doesn’t save.

Savings is essential, and one thing you can do is zig while everyone is zagging. Increasing your personal savings rate is likely the best antidote to a society with a savings deficiency.

Wealth and power will accumulate to the companies that are capital-light and monopoly-like in pricing power, which is why these well-known companies have been and likely will continue to be strong investments. But importantly, these gains have been built on an increasingly unstable foundation that will continue to erode if we remain on this same path, which many find unavoidable.

In this post, we’ll review the current state of the labor market using our sequential framework and highlight the key labor-market variables to watch in the quarters ahead.

The Headline

The December employment report showed the economy added 50,000 jobs, with the unemployment rate moving down to 4.4%.

The household survey ratios (where the unemployment rate comes from) are the gold standard labor market metrics because they come with minimal revisions.

At the end of each year, the BLS updates the seasonal adjustment factors, which results in small changes to the unemployment rate, generally 0.1% in either direction. The revisions for November shaved the unemployment rate down from 4.6% to 4.5% and then the December report showed a drop from 4.5% to 4.4%, making the month-over-month drop seem like it was from 4.6% to 4.4%.

In any case, the unemployment rate fell in December, which is a positive sign for the labor market, and it fell below the September level, so it was a sizable improvement.

(Under)Employment

The two main unemployment rates are the U3 and U6. The U6 unemployment rate is a broader measure, which includes people who are working part-time but would prefer to work full-time, so it’s a measure of unemployment and underemployment.

While the U3 rate fell below the September level, the broader U6 rate declined from the November spike but remains 0.3% higher than in August, September, and October.

So the U6 unemployment rate only partially reversed the spike that was expected to be an anomalous reading, suggesting that there was a legitimate rise in the rate of underemployment.

These charts show full-time and part-time employment ratios, and again, we reversed some of the abnormal spike we saw in November, but not the full change.

Full-time employment as a share of the labor force bounced back to 78.8% which was a positive development in December.

The part-time for economic reasons ratio, a driver of the U6 unemployment rate, hardly moved lower and remains very close to a cycle high, so there is a definitive trend in the labor market of underemployment, which is a negative, juxtaposed with a healthy improvement in the U3 unemployment rate, which is a positive.

Sequential Sector Payroll Breakdown

Our sequential business cycle process involves peeling back the layers or sectors of payrolls and narrowing in on the cyclical areas that drive all the changes in the labor market and broader economy.

Total nonfarm payrolls can be split between private and government. Government payrolls have been declining at the Federal level, which is putting downward pressure on the overall numbers.

Private payrolls can be split between construction & manufacturing (cyclical payrolls) and all private jobs excluding construction & manufacturing (non-cyclical payrolls). Cyclical payrolls appeared to rise in November, marking a transition to job gains, but those gains were revised away.

The non-cyclical payrolls, as we’d expect, continue to march higher.

Through our sequential process, we know that virtually all recessionary job losses come from cyclical payrolls.

There are job losses in some non-cyclical areas, but they are never the driver of self-reinforcing downturns.

Splitting cyclical payrolls into construction and manufacturing shows that all the declines are coming from manufacturing. Total construction payrolls edged slightly lower in December after hitting a cycle high in November.

Manufacturing payrolls are in a relentless decline with an accelerating pace starting in April 2025.

To conclude 2025, the cyclical portion of the labor market remains weak, with most of the downward pressure coming from the manufacturing sector.

The major question for the economy in 2026 is whether the monetary easing we’ve seen so far is enough to arrest the labor market declines in these cyclical sectors before they accumulate to several hundred thousand and cause downstream stress in the less cyclical and larger areas of the economy.

No Hire, No Fire Is Hurting The Youth

The increase in the unemployment rate over the last few years has fallen primarily on the youth, with more than a 3-percentage point increase from early 2023. This fits perfectly with the “no hire, no fire” labor market.

As younger age groups graduate from college, the low hiring is preventing them from finding jobs, directly pushing them into the unemployment bucket. Older age groups generally already have jobs, so the low firing rate is preventing unemployment rates from rising as rapidly in these groups.

All the reversal in the U3 unemployment rate to close out 2025 came from the 25-54 age group, which is a positive, as this is the most concerning group to see a big rise in unemployment.

Looking Into 2026

Given the low hiring nature of the labor market, there is still plenty of risk that the unemployment rate creeps back above 4.5% and heads towards 4.7% which would require the Fed to adjust their SEP and deliver on more than the one rate cut they have priced in.

The labor market has not soured in a recessionary fashion, as the layoff rate has remained muted.

While layoffs have been muted, low hiring has caused the unemployment rate to rise from roughly 3.5% in early 2023 to nearly 4.5% at the end of 2025.

The biggest risk to the labor market in 2026 is a continued slide in cyclical payrolls, as this would put continued upward pressure on the unemployment rate.

However, if cyclical payrolls stabilize, or simply decline only through attrition rather than outright layoffs, then the labor market is unlikely to create broad recessionary stress in the near term.

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Investment includes residential structures, nonresidential structures, business equipment, and intellectual property.

The answer is increasingly troubling, but it receives little attention because the negative repercussions unfold over years and decades, not months and quarters.

From the 1950s through the early 1980s, net private investment averaged around 8% of GDP. The economy was genuinely building factories, equipment, housing, and infrastructure that would compound productivity for decades. Then it dropped to around 6% through the 1990s. Today, we’re hovering around 3.7%.

A smaller share of GDP is expanding productive capacity. More of what we call “investment” is simply replacing worn-out capital rather than adding new capacity. The decline in structures and equipment is particularly concerning.

Structures constitute the physical backbone of the economy, including factories, commercial buildings, warehouses, power grid infrastructure, mining facilities, and other facilities. These assets have a long life and can serve productivity for decades.

Equipment includes industrial machinery, transportation equipment (trucks, aircraft, rail cars), information processing hardware, medical equipment, and construction machinery.

When net investment in these categories declines, we’re not expanding industrial capacity. Fewer new factories, fewer new warehouses, less physical infrastructure. Workers have less capital and less reliable technology to work with. Machinery ages and becomes less efficient.

Why is this happening? Several factors can explain the secular decline…

The economy has shifted toward intellectual property and software, which depreciate far faster than physical assets. Globalization offshored a lot of capital-intensive manufacturing. An aging population naturally reduces investment intensity. A clear focus on asset prices has redirected capital toward financial engineering and dividend extraction from corporate profits rather than reinvestment in physical capital formation. And larger government budget deficits are crowding out private investment.

The long-term implications are serious. Net investment is the basis of future productivity. Lower investment today means a smaller capital stock tomorrow, and ultimately slower wage growth since real wage improvements are tied to productivity enhancements. In addition, supply constraints emerge more frequently because capacity wasn’t built when needed, and the economy becomes more fragile.

This is the kind of structural problem that doesn’t show up year to year but rather compounds over decades.

The ongoing and growing concern over living standards, affordability, and general economic advancement is all tied to an insufficiency of net investment and worse productivity growth.

Changing this trend will be extremely difficult with large federal budget deficits, a corporate sector that favors dividend extraction from profits over reinvestment, and a low household savings rate due to constraints of expenditure and aggregate profit accounting identities.

But if it doesn’t change, many of our current societal struggles will persist.

This is why the frustration over stagnant real wages isn’t going away. Real wages rise when productivity rises. Productivity rises when workers have more and better capital to work with. And that requires net investment—not just replacing what’s worn out, but genuinely expanding productive capacity.

At 3.7% of GDP, we’re not doing that.

Well…not nearly enough…

At EPB Research, we separate the economy or GDP by categories of cyclicality. Some parts of the economy experience large booms and busts, while others are extremely stable, showing little difference in growth between recessionary and non-recessionary periods.

In a recent post, we discussed what we call “Cyclical GDP” and showed how 20% of the economy drives 100% of recessions.

Using the same framework, we can examine the Q3 GDP report in greater detail to identify the main drivers of the strong headline number.

Nominal GDP clocked in at 8.2% in Q3, but it was powered almost entirely by the non-cyclical parts of the economy, which expanded at a 9% annualized pace.

Cyclical GDP grew at a 4.3% annualized rate in nominal terms, while the even narrower subcomponents of Cyclical GDP actually contracted at a 2.6% annualized rate.

The cyclical share of GDP declined in Q3 after two years of stability. That stability has offset near-term recession risk, but negative momentum in interest rate-sensitive sectors resumed in the back half of 2025.

The divergence becomes even more striking when you decompose cyclical GDP into its three segments. Durable goods consumption and residential investment continue to struggle under the weight of higher interest rates. But equipment investment has been surging.

Specifically, business investment in computer equipment tied to the AI boom has shown remarkable growth rates, upwards of 50% in real terms in recent quarters, with its share of total GDP nearly doubling.

This growth is real and cannot be ignored. However, it’s clear that the AI-driven investment surge in narrow computer equipment is masking what would otherwise be a broad contraction in the traditional cyclical and interest rate-sensitive sectors.

This creates a challenging environment for monetary policy. Some sectors clearly need support, while others are printing historic growth rates. The Fed can't set one policy rate for two separate economic situations.

The Federal Reserve has penciled in just one rate cut in 2026. The gravity of negative momentum in the cyclical sectors may pose a challenge to that optimistic economic forecast.

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While most economists, Fed watchers, and media pundits focus on headline GDP, which was growing over 6% in nominal terms in 2000, business equipment investment was beginning to collapse.

In December 2000, the unemployment rate was 3.8%, and in March 2001, the unemployment rate was 4.3%, lower than today’s level.

Just like the 2008 recession, the 2001 economic downturn was predictable by focusing on the correct sectors, the 20% of the economy that drives 100% of recessions.

In previous posts, we highlighted the importance of Cyclical GDP: three narrow sectors of the economy that drive all the economic booms and busts.

In this post, we highlight why monitoring cyclical GDP helped predict the 2001 downturn and how focusing on the headline statistics used by most economic watchers was a costly mistake.

What Everyone Watches (And Why It’s Wrong)

The two most popular metrics, frequently cited by the Federal Reserve and major financial outlets, are GDP and the unemployment rate. These two metrics are used as barometers of economic health, and to some extent, this is true.

These are not flawed metrics in the sense that they are incorrect, but they do not tell us where the economy is heading. In fact, they tell you how the economy was doing slightly in the past.

Throughout the year 2000, leading up to the March 2001 recession start date, nominal GDP growth averaged over 6%. Wall Street consensus confidently declared the economy was booming.

These calls were emboldened by the fact that the unemployment rate was 3.8% in December 2000, just four months before the recession officially started.

The Federal Reserve, misled by these measures into conducting forward-looking policy, raised interest rates through March 2000 and did not begin lowering them until January 2001, when the recession was already entrenched.

Even worse and more dangerous, something done frequently today, is conducting monetary policy or making economic forecasts based on the stock market.

In September 2000, the S&P 500 was at an all-time high, and the high-flying Nasdaq was only down about 13% - a drawdown level that we’ve seen three times in the last three years.

Waiting for these metrics to sour, as many often do, will lead to a very late recognition of economic changes, as shifts in the economy occur beneath the surface, in only a few interest-rate-sensitive parts of the economy that respond forcefully to prior changes in monetary policy.

The Data That Matters

Headline GDP is an aggregate measure that includes some highly stable areas of the economy, such as healthcare spending, education, and government services.

These stable parts of the economy are often the largest in size, so they can mask weaknesses that develop in the smaller yet more cyclical parts of the economy.

Cyclical GDP, as we define it at EPB Research, is the combination of:

• durable goods consumption

• business equipment investment

• residential fixed investment

Every downturn in the economy is driven by at least one of these areas - very often more than one - but at least one.

The 2001 recession was unique in that it was one of the few economic downturns in which residential fixed investment did not contribute.

The 2001 recession was driven by investment in business equipment.

Yes, there was a technology component as information processing equipment, a smaller component of business equipment investment, collapsed in 2000 and 2001.

But there was also a major downturn in the equipment investment category of transportation equipment, which is business investment in cars, trucks, airplanes, buses, and ships.

In fact, one of the earliest cyclical signs in the 2000s cycle was the downturn in transportation equipment seen as early as 1999.

When companies dramatically pull back on investment, they are preparing or responding to lower demand.

The decline in investment leads to lower levels of production, which lowers the need for employment, prompting layoffs and then recession. This sequence was already in motion throughout 2000.

Cyclical GDP Divergence

In the first quarter of 2000, Cyclical GDP growth began to underperform total GDP growth, indicating that economic momentum was faltering and that gravity would pull the broader economy lower.

The structural components of GDP, such as services, healthcare, education, and government, kept GDP strongly positive despite contraction in key sectors.

While the exact component of Cyclical GDP that drives the downturn is different each time, the overall pattern repeats every cycle.

In a previous article, we discussed how the 2008 recession was predictable using the same process. In fact, the Cyclical GDP divergence was even more pronounced.

Cyclical GDP growth started to contract in late 2006, while total nominal GDP growth was greater than 5%.

In the first quarter of 2008, residential investment growth was -27%, Cyclical GDP growth was -9% and total nominal growth was +2.6%.

Waiting for total GDP growth to turn, or the unemployment rate to rise sharply, or the Fed to acknowledge a slowdown is always too late. The cyclical sectors of the economy often give 6-12 months warning and in some cases like 2008, up to 18 months warning.

The Key Takeaway

The 2001 recession was one of the milder downturns, but it wasn’t unpredictable, and it wasn’t caused by a spontaneous collapse of stock prices.

Growth in the cyclical sectors began to decline in late 1999 and continued to decline through 2000.

(Not to mention, corporate profit margins peaked in Q3 1997.)

Watching headline GDP, total nonfarm payrolls, the unemployment rate, and stock prices will lead to reactive, not predictive decisions virtually every time.

You will always receive advanced warning in the above metrics by focusing on cyclical sectors.

This is the framework, process, and sequence we use at EPB Research - we focus on the 20% of the economy that drives all the booms and busts.

You can (and should) track these indicators, as well as a similar process for employment, inflation, and more. Or, have us do it for you and save the time.

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Throughout 2007, calls for economic improvement, a soft landing, and fears of inflation dominated. In fact, in mid 2008, the Federal Reserve discussed raising interest rates as some participants downplayed the odds of a recession (which was already underway).

Below are highlighted comments from a June 2008 Federal Reserve meeting.

The reality is that using a sequential framework and focusing on the right sectors of the economy revealed weakness as early as 2005 and crisis-level warnings in 2007, long before the official onset of the recession.

In this post, we’ll highlight several charts that predicted the 2008 recession up to 18 months in advance. To be fair, this process did not suggest a global financial crisis was around the corner, but that crisis stemmed from a Business Cycle downturn that was easy to spot with advanced warning by focusing on the correct sectors.

In a previous post, we discussed the importance of “Cyclical GDP” and how recessions always develop through durable goods consumption, residential investment and business equipment investment - highlighted in the GDP breakdown below.

At EPB Research, we focus intensely on the cyclical components of GDP and we even go layers deeper in our premium reports, emphasizing the importance of sectors like motor vehicle consumption, or investment in transportation equipment.

Cyclical GDP is the combination of durable goods consumption, residential investment and business equipment investment - three narrow slices of the economy that are interest rate sensitive and drive all the booms and busts.

The chart below shows Cyclical GDP as a share of total GDP. When the cyclical share of GDP is declining, that is generally a sign that monetary policy has restricted the availability of money & credit and caused a downturn in the interest rate sensitive part of the economy.

A declining share of Cyclical GDP is an early warning sign that the broader economy will cool, since all downturns (and booms) start in the cyclical sectors.

The cyclical share of GDP peaked in Q3 of 2005, long before any discussion of a recession.

Not every recession is seen in all three cyclical sectors, but there is always at least one that drives the downward momentum.

In the 2008 recession, it was, of course, the residential investment component that started declining in 2005 and collapsed through 2010. Equipment investment did not turn down until almost 2008.

In addition to looking at the cyclical share of GDP chart, the first of three charts that predicted the oncoming recession, it’s useful to look at the composition or breakdown of the three cyclical sectors to identify where the focal point of the downturn is.

By 2007, it was clear the residential investment share of GDP was in free fall and if you use a process or framework that emphasizes the importance of residential investment, recession watch was in full effect.

Part of the problem is that so many investors or economic pundits look at aggregate numbers like total GDP or total nonfarm payrolls and do not subscribe to the idea that it is the narrow cyclical sectors that drive the booms and busts.

For example, the third chart that helped predict the downturn perfectly highlights why most people miss critical turning points in the economy, even when they happen over a year in advance.

The first picture in this post showed comments from Fed member Lacker, in June of 2008, saying that the labor market has not shown the “accelerating declines” that he feared.

Similar to the cyclical components of GDP, it’s vital to focus on the cyclical sectors of the labor market, namely construction and manufacturing.

By June 2008, the May 2008 labor market report was in hand and it showed more than 1 million job losses for construction and manufacturing employment, declines that started in April 2006, two years before these misguided comments.

By focusing on the 20% of the economy that drives 100% of recessions, spotting economic downturns far in advance is possible.

The 2008 recession was spotted more than 18 months ahead of time by the cyclical share of GDP, the component breakdown highlighting the residential investment focal point, and cyclical employment.

Predicting a global banking crisis is not the purpose of this framework. Rather what a sequential Business Cycle process can do is highlight the brewing vulnerabilities in the parts of the economy that always respond first to changes in monetary policy or the availability of money & credit.

The origin of the 2008 recession in residential construction was as clear cut as it gets. Other recessions originated in durable goods consumption or equipment investment. But in all cases, the combined cyclical part of the economy suffered a downturn earlier and harder than the broader economy.

This framework didn’t stop working after 2008. It’s a consistent, repeatable process built on the foundation of credit-based economic systems.

We use this framework every month at EPB Research to track exactly where we are in the current cycle. The same methodology, applied to current data, plus deep dives on employment, inflation, housing, and more.

If you’d like to see what these indicators are showing right now, and where the cycle is headed next, click the link below to learn more about our premium research services.

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“The consumer is fine.”

“The consumer is holding up the economy.”

“We are a services economy.”

These comments are generally accepted as true, given the frequency that they are repeated, but the reality is that these statements are exactly the opposite of what you want to focus on if your goal is to track and get ahead of major changes in the Business Cycle.

Despite popular opinion, most segments of the economy do not contract and are generally extremely stable. That stability makes them useless for understanding where we are in the cycle—and where we’re headed next.

In this post, we’ll walk through the structure of the economy, explain why conventional analysis is always late to the major inflection points, and highlight the sequential Business Cycle framework we use at EPB Research to track the segments that actually drive every boom and bust.

Breaking Down GDP

The economy has four primary categories: personal consumption, private investment, net exports, and government expenditures.

It’s true that personal consumption, or “the consumer,” accounts for about 70% of total GDP.

But that fact leads to an incorrect conclusion: that the consumer drives the ebbs and flows of the Business Cycle.

Within personal consumption, we have durable goods, nondurable goods, and services.

Within private investment, we have residential investment and nonresidential investment, which further break down into business equipment investment, nonresidential structures investment, and intellectual property investment.

Most analysts spend their time watching total consumption or total GDP. But not all of these categories behave the same way across the Business Cycle.

The Three Sectors That Actually Matter

The Duncan Leading Index was made popular by economist Wallace Duncan, and it was designed around a simple but powerful concept: changes in the economy stem from a few select categories.

The Duncan Leading Index involves tracking durable goods consumption, residential investment, and nonresidential investment.

At EPB Research, we’ve modified the original Duncan Leading Index to make it more cyclical and timely. We track three specific categories:

1. Durable Goods Consumption

2. Residential Investment

3. Business Equipment Investment

We call this combination “Cyclical GDP,” and it’s truly the only part of the economy you need to watch if your goal is to understand the Business Cycle.

In our modified version of the Duncan Leading Index concept, we exclude nonresidential structures investment and intellectual property investment from our framework.

That’s intentional.

These categories are not leading indicators, and in most business cycles, they’re lagging.

Nonresidential structures (hospitals, office buildings, shopping centers) often peak during a recession and bottom well after a downturn is over. Including them would add noise, not signal. These structures are less sensitive to short-term fluctuations in demand, having longer construction timelines, and include many government or quasi-government projects that are less sensitive to pure economic conditions.

Why These Three Categories Are All That Matter. Really.

Most economic observers simply do not realize that the non-cyclical part of the economy, the part that comprises over 80% of GDP, almost never contracts.

Since 1960, Cyclical GDP has contracted in 21% of all quarters. Total GDP has contracted in just 4.2% of quarters. And the non-cyclical remainder? Just 3.8%.

All the signal is in Cyclical GDP. All the noise and the narrative is everywhere else.

By focusing on “the consumer,” you are really focused on an area of the economy that doesn’t often contract, other than the narrow slice of durable goods, which is the only segment of consumer spending worth devoting extra attention.

The difference becomes even more clear when we compare growth rates during recessions versus expansions.

During non-recessionary periods, Cyclical GDP grows at an average rate of 8.0% in nominal terms (including inflation). During recessions, it contracts at -5.2% on average.

Now look at Non-Cyclical GDP. During expansions, it grows at 6.6% on average. During recessions? It still grows—at 6.2%.

The consumer is almost always fine, right up until the moment they’re not. And by then, Cyclical GDP has already been flashing warning signs for quarters.

Cyclical GDP as a Leading Indicator

Importantly, Cyclical GDP, plotted as a % of total GDP, has been a historically reliable leading indicator.

As with all leading indicators, lead times vary. These are not stock market timing tools, but rather signals for when momentum in the economy shifts, helping to anticipate changes in monetary policy, corporate profits and trends in unemployment.

When the cyclical share of GDP starts declining, that is usually a signal that monetary policy tightness is slowing the interest rate sensitive parts of the economy.

Conversely, big increases in the cyclical share of GDP indicate an economy that has building momentum.

The chart below shows the three individual components of Cyclical GDP : durable goods consumption (orange), business equipment investment (green), and residential investment (blue) - each expressed as a % of GDP.

In many recessions, like the 1991 recession, all three components decline simultaneously.

In some recessions, like 2001, weakness is concentrated in one component, like equipment investment, while other areas such as residential investment remain strong. In these cases, recessions tend to be more mild and only occur when one component declines enough to offset the strength elsewhere in the Cyclical Economy.

The chart below is the same as above, but with the pre-recessionary periods highlighted for emphasis.

After the pandemic boom, the cyclical components experienced a hangover, mainly durable goods consumption, but over the last 2.5 years, there has not been much deceleration in the durable goods share or the residential share, and the equipment share has actually been rising.

While durable goods and residential investment have not been weak enough to create recessionary conditions (yet), the real story is the rise in equipment investment which is unusual in the face of a monetary tightening cycle.

If we look at the main categories of equipment investment, we can see that there’s been a large upswing in information processing equipment and transportation equipment.

Information processing equipment is the AI story. Large capital expenditures for AI investment have driven an increase in computer and processing equipment.

While the AI story is a major driver of the strength seen in the broader equipment investment category, the rise in transportation equipment is also important and perhaps even more unusual.

Transportation equipment is highly cyclical but the normal sequence in this sector was disrupted during the pandemic supply chain crisis. Transportation equipment, a cyclical sector, collapsed as the economy was booming in 2021 and 2022 - a very unusual occurrence.

In 2023 and 2024, transportation equipment investment had to catch up even as the broader economy started to cool.

If we zoom in on the main categories of cyclical GDP, we can see stability in recent quarters for durable goods and residential investment but a surge in equipment investment.

Equipment investment has powered ahead on the heels of AI capital expenditures but also an unusual dynamic in the transportation sector that’s been unfolding since the early days of the pandemic.

The motor vehicle manufacturing sector is now shedding jobs so the residual strength in transportation equipment is almost certainly set to fade in the quarters ahead.

That leaves the AI story as the lone driver of equipment investment and the open question as to whether equipment investment can continue to rise and offset the flat-to-down trends we are seeing the share of durable goods consumption and residential investment.

Through the second quarter of 2025, we can see the nominal growth rate of the cyclical components of GDP is 5.7%, a healthy pace and one that precludes the economy from entering recession.

The fate of the economy in 2026 rests with the developments in the cyclical sectors.

The Bottom Line: Focus on What Moves, Not Just What’s “Big”

Most economic analysis is highly lagging and is reduced to nothing more than trend following because it focuses on the wrong things.

Total GDP, total consumption, or the aggregate labor market show where the economy has been or at best, where it is today, but certainly not where it’s going.

The three sectors that make up Cyclical GDP - durable goods consumption, residential investment, and business equipment investment - generate all the fluctuations in the economy.

This sequential breakdown of Leading, Cyclical, and Aggregate components of the economy is the foundation of the EPB Research framework.

We never react to headlines or random stock market gyrations. We track the sequential progression of the Business Cycle through the sectors that actually drive it.

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This post is a snapshot and a high-level breakdown of how to track the Business Cycle using a consistent and repeatable framework.

EPB Research subscribers receive updates on the entire Business Cycle Sequence and more granular breakdowns of key themes like employment and inflation, so you’re always in a position to anticipate the next turn, not react to it.

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The Employment Situation report contains thousands of data points on the labor market, but it is most known for the monthly nonfarm payroll figure and the unemployment rate.

Laughably, financial media analyzes the entire report within seconds after attempting to “guess the number,” commenting only on whether the monthly nonfarm payroll number “beat” or “missed” consensus expectations. Secondarily, there is a passing comment about the unemployment rate.

Of course, this type of instant analysis is ridiculous, but it is common across all economic data releases.

In this post, we’ll highlight a sequential approach for analyzing the jobs report, one that provides layers and offers a dynamic view of the labor market, deeply assessing the health of the employment situation with forward-looking information and monetary policy considerations.

The Economy (and Labor Market) Moves in a Sequence

The economy moves in a predictable sequence, which is the basis of the Four Economy Framework that we use at EPB Research.

The economic cycle sequence has remained the same in every Business Cycle, from the inflationary 1970s to the more modern 21st-century recessions.

Some sectors of the economy are more sensitive to interest rates and credit conditions, meaning they must react first to changes in monetary policy.

The labor market, therefore, follows the same pattern and offers the most critical insights about where the economy is today, and where the momentum is heading over the coming quarters.

The two most interest-rate and credit-sensitive sectors in the economy are construction and manufacturing, broadly speaking. The labor markets of these industries are responsible for the vast majority of recessionary job losses.

As a result, when analyzing the jobs report, it’s far more informative to analyze the health of construction and manufacturing rather than total nonfarm payrolls because you will spot trend changes and inflection points first, as they always occur in these sectors before bleeding into the aggregate statistics.

As the chart below shows, private payrolls can be divided into construction & manufacturing payrolls and all other (non-cyclical) payrolls.

The narrative today is that the labor market is weakening, but this is not evident in non-cyclical sectors; it is only in construction & manufacturing payrolls.

Within construction there is residential and nonresidential. Within manufacturing there is durable goods and nondurable goods.

Residential is more cyclical than nonresidential, and durable goods are more cyclical than nondurable goods.

The chart below shows the growth rate in employment for residential construction & durable goods manufacturing (blue), total construction & total manufacturing (orange), and total nonfarm payrolls (purple).

Clearly, the most cyclical grouping, residential construction & durable goods manufacturing, can be seen contracting first heading into the last few business cycle recessions. Focusing on total nonfarm payrolls can leave you years behind when inflection points occur.

Important information can also be gleaned from when the growth rate in the cyclical sectors (blue) breaks away from total nonfarm payrolls (purple).

Notable inflection points occurred in March 2000, July 2006, July 2019, and March 2023.

The chart below shows the Federal Funds Rate with these four inflection points noted.

Nothing in Business Cycle analysis is meant to be used as a trading timing tool, and this breakdown is no exception. However, the sequential deterioration of the most leading labor categories is an important signal for future monetary policy trends.

So when the jobs report is released, the monthly payroll addition is completely irrelevant. What matters is the trending growth rates and sequential breakdown across leading, cyclical, and lagging sectors. This is where the information lies.

Unemployment Rate: The Gold Standard

The sectoral breakdown of payrolls mentioned above comes from the “Establishment” survey of employment. The benefit of the Establishment Survey is its granular breakdown of labor sectors, which enables sequential analysis. The drawback is that the survey comes with substantial revisions.

The “Household” survey of employment is the opposite. It does not hold granular sectoral breakdowns, but it does not come with heavy revisions; in fact, revisions are often minimal, making the unemployment rate, which comes from the Household Survey, the gold standard measure for the labor market at any given moment.

This is not a leading indicator, and it does not offer any information about where the labor market is going in the future, but we can see the current status of the labor market and the trending momentum.

Charted above is the U3 unemployment rate, which clearly demonstrates a worsening trend, a cycle high in the unemployment rate, but a level of unemployment that is not yet alarming, 4.44%.

However, coupling the two surveys and looking at the report more dynamically helps plug the holes. The unemployment rate is rising, it is at a cycle high, AND we see the worsening coming from the common and predictable cyclical sectors after a monetary policy tightening cycle. A more three-dimensional view of the labor market becomes clear.

Adding The Layers

The jobs report holds even deeper information, including full-time and part-time employment.

The chart below measures full-time employment as a share of the labor force.

When the labor market is hot, and companies need a lot of work, they hire more full-time workers. At the peak of the pandemic boom in 2021, full-time employment reached nearly 81% of the labor force, the highest level ever.

That has since cooled to below 79% as demand softened and companies need fewer labor hours.

People can work part-time for “economic” reasons or “non-economic” reasons.

Economic reasons essentially mean you want a full-time job but can’t find one.

Non-economic reasons are a choice that you want to work part-time.

The chart below shows the share of total employment working part-time for economic reasons.

At the peak of the pandemic boom in late 2021, less than 2.5% of employed people were part-time for economic reasons. That has increased to roughly 3%. Not a dramatic increase, but directionally a bit weaker.

Many of the trends discussed so far were present at the start of 2025 and, by the spring and summer of 2025, were certainly evident, allowing us to predict that the labor market would continue to weaken in our post, “Cracks Are Spreading in the US Labor Market.”

The softening labor market has now become a consensus viewpoint at the Federal Reserve and a daily talking point on financial TV.

Today, the unemployment rate sits at a touch over 4.4% and in the FOMC Summary of Economic Projections, a move above 4.5% is not expected by a vast majority of committee members (highlighted in blue).

It’s highly likely the unemployment rate exceeds the 4.5% level, given the sequence of deterioration (starting with the cyclical sectors), the throttling of labor intensity in the form of less full-time and more part-time work, and the trending momentum that already exists in the U3 rate.

For an FOMC that has clearly shown a preference or bias for labor over inflation, further adjustments lower in the Fed Funds rate should be expected.

Do More Than “Guess The Number”

When the jobs report comes out, do more than guess the number. Look at the sequence of payroll gains/losses, the trends in the unemployment rate, metrics of labor intensity, and more. This will offer much more granularity and clarity about the current state of the labor market and the likely future direction.

If you enjoyed this level of analysis, the full jobs report is reviewed inside EPB Research via our Operator Access Package each month.

Each monthly employment update includes a complete breakdown and sequence of nonfarm payrolls, historical data revisions, unemployment rate trends, and leading employment indicators.

Each report is analyzed through the lens of the Business Cycle Sequence, presented in written chartbook format as well as with animated video.

You can access the complete monthly jobs report, in addition to our flagship Business Cycle Trends report and our Weekly Economic Briefings, by subscribing to the EPB Operator Package at the link below.

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Fast forward to 2025, and core nominal growth has declined to 4.3%, the slowest pace since the lockdowns and a pace equal to the average pre-pandemic period when the labor market was far weaker.

While there are clear signs of a cooling labor market, such as a low hiring rate, a reduction in full-time employees, and a rise in the unemployment rate, the economy has been able to avoid large-scale layoffs and thus avoid recession despite three years of decelerating economic activity.

How have companies been able to handle these slowing economic conditions for almost three years without resorting to more aggressive layoffs?

In this post, we’ll see how elevated profit margins are giving businesses more room and time to absorb slowing economic conditions without resorting to wide-scale layoffs - but we’ll also show how cracks are clearly visible and how some industries may be running out of breathing room before layoffs become unavoidable.

Historic Profit Margins

In a purely capitalist, free market economy, profit margins are supposed to be a highly mean-reverting series. If profit margins get too high, new competition enters the market and “competes” for those margins, compressing them down over time.

This was broadly true for the US economy for many decades, but there’s been a subtle change to profit margin dynamics after the 2008 crisis.

Profit margins found a floor near 10% for five business cycles in a row, spanning from the late 1970s to the early 2010s, but after the 2008 recession, profit margins never fell below 15% aside from one quarter in the pandemic.

Elevated profit margins for more than a decade are not natural in a purely free market-driven economy, and after the pandemic, this issue only got worse.

Across the entire economy, pre-tax profit margins are running near 20%, a staggering number that has given businesses plenty of breathing room to absorb slowing business conditions without resorting to layoffs.

If economic conditions slow, a business can absorb the margin hit with a large cushion, or it can implement a few first-line defenses to preserve margins, such as reducing full-time work, slowing hiring, and cutting back on hours - all measures we’ve seen businesses take already.

But it’s clear that at 20% margins, businesses don’t have the sense of urgency to initiate mass layoffs that they do if margins are 10% and falling.

Yes, It’s Big Tech - But That’s Not The Whole Story

When presented with data on this secular increase in margins, the most common response is that the mega-cap technology companies are responsible for the change.

While this is true to some degree, it does not explain the whole story.

This chart shows that the cumulative operating margins of the six major tech companies are higher than the economy-wide average and still rising to a record 30%.

There is no doubt that the major technology companies have monopoly-like characteristics and command above-average profit margins, but this doesn’t explain the full story because we have seen this margin expansion in nearly all industries - even the highly cyclical businesses.

Record Margins For Cyclical Industries Now Compressing

A case could be made that the mega-cap technology companies are not highly cyclical, but that argument cannot be made for industries like residential construction and manufacturing.

Profit margins in residential construction exploded to 20%, the highest level on record in 2022, and the same dynamic was seen in manufacturing.

As economic growth peaked in 2022, margins started to compress for these cyclical businesses, which is normal and expected. However, what has been abnormal is that the cyclical industries have been slowing for nearly three years, margins have been compressing, but margins for both residential construction and manufacturing are higher today than before the pandemic.

Focusing on residential construction, profit margins have compressed 600bps from 20% to 14%, a very large decline. At any other point in history, a 600bps compression in profit margins would have likely led to layoffs as companies scrambled to protect rapidly falling profitability.

However, today, a 600bps decline in margins has left companies still more profitable than they were just six years ago - enough to make them throttle labor intensity and stop hiring, but not enough to force wide-scale layoffs.

We can see this dynamic playing out in our Cyclical Employment Index, something we cover each month in our premium Business Cycle Trends Updates.

In the EPB Four Economy Framework, the Cyclical Employment Index focuses on nonfarm payrolls of the Cyclical Economy - the part of the labor market that always moves first and drives the vast majority of job losses during recessions.

The chart shows how in past recessions, Cyclical Employment would lead downturns and fall sharply. Today, we’ve seen a very unusual dynamic that lines up with the profit margin story. Cyclical Employment has gone completely flat for almost three years.

This represents businesses having a complete freeze on hiring and throttling labor intensity, but not moving to the deep layoffs that drive the recessionary process.

It also explains some of the more complicated economic dynamics in the post-pandemic world, where the economy has been slowing for multiple years, and it has been very harsh on key cyclical industries like residential construction, manufacturing, and transportation. Still, the broader economy has been able to march along without the downstream pressure created by layoffs in the Cyclical Economy.

Cracks Are Forming & What To Watch For

While payrolls have been moving sideways for three years, we can objectively see businesses taking the early steps or the “cracks” forming in the labor market by looking at labor intensity metrics.

This index compiles several measures of labor intensity, including full-time employment, the ratio of part-time employment by reason for part-time employment, and the short-term layoff rate.

Labor intensity has been dropping since 2022, when margins peaked and started to compress.

This is somewhat surprising because, despite margins peaking at levels that were double the pre-pandemic average for cyclical industries, businesses wasted no time at all and throttled labor intensity immediately at the first sign of slowing demand.

This resulted in a profit margin compression of approximately 600bps over three years for residential construction, providing them with more than three years of cushion to absorb slowing economic conditions while maintaining a higher level of profitability than before the lockdowns.

Cyclical industries like residential construction and manufacturing always move first in terms of demand, profit margins, and job losses. The margin compression in residential is already 600bps and is not slowing down despite the hiring freezes and throttling of labor intensity.

Tariffs hit the goods economy particularly hard, so margin compression may accelerate in the second half of the year, which could tip the scales from hiring freezes and reducing hours worked to layoffs, something we just started to see in the last few jobs reports for residential workers.

While this post did not have the time to dive into all the reasons why margins have been so high and sticky after the 2008 crisis, it offers a clear view into why the layoff cycle has been slower than usual and also why key cyclical sectors could be running out of breathing room in the coming quarters.

If you want to follow this entire sequence as it unfolds — with more detailed updates, animated video presentations, and forward-looking business cycle comments— you can subscribe to the EPB Business Cycle Research Package below.

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At EPB Research, we closely monitor the business cycle sequence using our Four Economy Framework and provide structured updates to profit margins, employment trends, and the resulting asset market implications.

Many investors and market participants fail to understand that residential housing moves in sequence, like the overall business cycle, and that residential construction does not directly mean home prices.

A sequence evolves through the housing sector that starts with changes in monetary policy, moves through sales volumes and permits, then into actual construction activity and employment, and finally into home prices.

Home prices lag, like inflation, so a downturn in residential construction does not immediately cause a drop in home prices.

In this post, we will go through this sequence, starting with changes in monetary policy, moving through to building permits, analyzing construction activity, breaking down the movements in construction employment, and lastly discussing some national and regional home price trends.

Changes in Monetary Policy

A tightening of monetary policy ignites a downtrend in the residential cycle. This chart shows “real true money supply”, a measure of inflation-adjusted money supply we use at EPB Research.

Peak monetary easing was in February 2021, and major tightening began in mid to late 2022. Monetary policy has been tight, as evidenced by contracting real money supply, but the stock or excess money relative to the pre-COVID trend is likely what has made this downcycle drag out longer than usual.

As the Fed has kept policy tight, excess money, even relative to the muted pre-COVID trend, has been virtually eliminated, which should accelerate the downward momentum that’s already in place.

Permitting Activity

After monetary policy tightens, the first thing to move is sales volumes as well as applications for new building permits.

The peak in easy monetary policy was in February 2021, and building permits peaked three quarters later in December 2021.

Due to the excess money referenced in the above chart, it’s been a slower grind down, but building permits have not stopped with the downward momentum.

As monetary policy remains tight, as evidenced by the still contracting money supply, sales volume will remain weak, and applications for new permits will continue to drop.

Actual Construction Activity

Building permits can change on a dime since it’s simply an application. The number of housing units under construction takes time to turn since construction activity continues until it’s completed.

Peak monetary easing was in February 2021, building permits peaked in December 2021, and housing units under construction peaked in October 2022.

This is the clear residential housing sequence in motion.

While the level of activity remains somewhat elevated with just under 1.4 million units under construction, the downward momentum is precipitous.

Since monetary policy is still tight, sales volume is anemic, and building permits are still dropping, the number of housing units under construction will continue to slide.

From Activity to Employment

Residential construction employment is split between two major categories, building employment and contractor employment.

Building employment is new building plus general contractors for remodeling, while contractors are the sub-contractor specific industries like plumbers and electricians.

Neither category has dropped sharply, but the sub-contractor employment level peaked in late 2024, while building employment has been more firm.

Why Has Employment Remained Stable?

In addition to a strong remodeling cycle, the second and equally important reason as to why employment has held up better than production in the residential sector is profit margins.

Profit margins for the eight largest homebuilders exploded to the highest level in recorded history after the pandemic, hitting 20% in 2022.

As production or activity levels fell but employment did not, profit margins compressed 600bps down to 14%. Any other time in history, a 600bps compression in margins would have led to layoffs.

However, margins were so high that 600bps compression still left companies with a more profitable position than pre-COVID.

Margins are accelerating downwards, and based on the sequence referenced, it will continue. The extremely important wildcard is tariffs.

The tariff impact has not been extreme in the first half of 2025, but if tariff pressure increases in the second half and companies cannot pass the cost through, margin erosion could potentially intensify further, bringing margins below pre-COVID levels and accelerating the job losses that are just begging to appear in the residential construction sector.

Home Prices: Last In The Sequence

At the end of the residential cycle comes home prices – the last to move, just like inflation in the broader business cycle.

Changes in monetary policy lead to a pullback in sales volume and new permits, followed by a downturn in construction activity, a decrease in profit margins, and then a fall in employment. After employment, home prices suffer, which is what we are now starting to see mildly.

On a 3M annualized basis, home prices are dropping 1.5% but as we know, changes in home prices are extremely regional, and national averages don’t capture the full story.

This cycle has come with the most extreme regional differences in history.

Home Price Trends Are Regional

This chart shows the change in active housing inventory by state for 2025 compared to the average of 2018/2019. Orange colors mean higher inventory levels and prices are susceptible to fall, while green colors mean very low inventory and likely still price increases.

Florida and Texas used to have the highest change in inventory, but Colorado has shot to the top of the list.

Biggest Increase in Inventory (2025 vs. 2018/2019):

•Colorado: +37%

•Texas: +34%

•Washington: +30%

•Florida: +30%

•Utah: +27%

Biggest Decrease in Inventory (2025 vs. 2018/2019):

•Connecticut: -72%

•Illinois: -63%

•New Jersey: -61%

•Vermont: -56%

•Rhode Island: -56%

Disparities extend beyond the state-level data and into the metro-level data.

To show one example, the state of Florida has very high inventory in 2025 compared to pre-COVID, with homes moving much more slowly.

Across the entire state, inventory is 30% higher than in 2019 – but that’s not the case in all metro regions.

Key West, Miami-Fort Lauderdale-West Palm Beach, and Naples still have the same or lower inventory compared to pre-COVID.

The inventory explosion in Florida is mainly on the west coast in places like Punta Gorda, Panama City, and Fort Myers.

One more example is California. On average across the state, inventory is 4% lower than pre-pandemic, but differences across metro regions are large.

We can also look at the relative change in home prices for major cities compared to the national average.

In other words, when the line is moving up, it means that city has home prices that are outperforming the national average. When the line is moving lower, that city has home prices underperforming the national average.

This chart shows the three worst-performing cities from the Case-Shiller 20-city data relative to the national average – the cities dragging down the national average.

Dallas, Denver, and San Francisco have home prices that are performing considerably worse in recent months and quarters than the national average.

On the flip side, Charlotte, Miami, and New York are outperforming.

Charlotte has been a strong outperformer since the early days of COVID.

Miami exploded from 2021 through 2024 in absolute and relative terms, but has just started to mildly underperform the national average.

New York was a laggard, suffering during the pandemic, but now outperforming due to extreme inventory issues.

The Residential Housing Cycle Has Turned

Overall, the residential housing cycle moves in a sequence, and that sequence remains in a solid downturn - although it takes time for the full sequence to evolve and this cycle has been more extreme in that regard.

With employment starting to soften, we see signs of the last phase in the sequence – home price declines – but the declines are extremely different across states.

States with a lot of building have high inventory, and homes are sitting longer, but many parts of the country have inventory issues, which is keeping prices elevated.

The most problematic states include Florida, Texas, Colorado, Washington, Arizona, Utah, and Nevada.

Tight inventory and upward price pressure still exist across the Northeast and Midwest.

The key takeaway from this report is that the residential housing cycle follows a sequence.

It’s critical to analyze the entire cycle as a process rather than select one part of the sequence, like home prices, to make a claim about the residential cycle in general.

If you want to follow this entire residential sequence as it unfolds — with more detailed updates, animated video presentations, and forward-looking business cycle comments— you can subscribe to the EPB Business Cycle Research Package below.

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The residential housing cycle is one of our six critical areas of weekly coverage within the overall US business cycle.

“The consumer is still healthy” is perhaps the most overused phrase in financial TV, and this type of analysis leads to extremely misguided conclusions - particularly the assertion that the consumer drives the business cycle.

In reality, personal consumption or consumer spending is a coincident-to-lagging indicator, reacting to broader economic forces that are already in motion rather than anticipating the changes that investors seek to front-run.

In this post, we’ll break down consumer spending into it’s most cyclical and most lagging components, explore how each segment behaves ahead of recessionary periods and highlight where each segment of consumption fits within the EPB Four Economy Framework, helping you understand what consumer spending patterns can and cannot tell you about the trajectory of the business cycle.

Breakdown of Personal Consumption

Total personal consumption represents nearly 70% of US GDP, approximating $20.5 trillion.

Personal consumption is split between goods consumption and services consumption. Goods consumption is roughly $6.4 trillion, and services consumption is about $14.2 trillion.

Goods can be split once more into durable goods and non-durable goods. Durable goods are $2.2 trillion, and non-durable goods are about $4.2 trillion.

While services consumption is clearly the largest segment by raw dollars, it is the least volatile, least influenced by changes in interest rates, and is generally the least discretionary portion of the consumer spending basket.

Durable goods, the smallest segment, is the most volatile, most sensitive to interest rates, and is the most discretionary portion of consumer spending - linked heavily to housing-related items and vehicles.

EPB Four Economy Framework

In the EPB Four Economy Framework, we sequence incoming economic data into four buckets based on the order of operations in which data contracts ahead of recessionary periods.

Durable goods consumption, the most volatile category, falls into the Cyclical Economy bucket. The Aggregate Economy encompasses the total category of all consumer spending, while the Lagging Economy comprises services consumption, the largest but least cyclical category.

When discussing consumer spending patterns, focusing on durable goods will provide the most useful information with respect to the business cycle. The basket of total spending, and certainly the largest segment of services consumption, is not at all informative.

Spending Patterns Before & After Recessionary Periods

The following chart shows four categories of personal consumption: durable goods, goods, total consumption, and services consumption.

The chart measures the average decline of each category 6 months before the recession start date, 3 months before the recession start date, on the recession start date, as well as 3 months and 6 months after the recession start date.

For example, 6 months before a recession begins, on average, durable goods consumption is down 2.7% from peak, goods consumption is down 0.7%, total consumption is down 0.1% and services consumption is not down at all.

Even on the day the recession begins, while durable goods consumption is down an average of 3.4%, total consumer spending is still near peak.

Three months after a recession begins, total consumer spending is down 0.6%. Given the one-month lag in reporting, it would take four months into the recession's teeth for aggregate consumer spending data to show the first signs of weakening.

Focusing on aggregate consumer spending data is clearly an inappropriate way to analyze the health and momentum of the business cycle.

If there was one category to pay attention to, it would be durable goods consumption, which is why, at EPB Research, we break off durable goods consumption and place it into our Cyclical Economy bucket, along with other housing and manufacturing-related data.

Current Consumption Trends

Currently, with data through May 2025, durable goods consumption is down 2.3% from peak, goods consumption is down 0.8%, total consumption is down 0.3% and services consumption is still at peak.

Consumption data fell strongly at the start of the year and rebounded before taking another potential leg lower.

It’s unlikely the June consumption data will show a 2.5% monthly rise in durable goods consumption, which would be required for a new peak, so durable goods consumption will likely hold below the December 2024 level.

These consumer spending trends are not extremely alarming at face value. Spending data, particularly on goods, is volatile, so ups and downs are expected.

However, grouping the durable goods spending data with other housing and manufacturing-related statistics forms a more balanced and well-rounded picture about how monetary policy impacts the cyclical areas of the economy.

Following The Sequence

Each month, in our flagship Business Cycle Trends Report, we highlight the trends across the Leading, Cyclical, and Aggregate Economy - with a detailed analysis of all the components.

The Leading Economy peaked in January 2022, followed by a peak one year later in the Cyclical Economy.

The downturn in the Cyclical Economy remains modest, and thus, the Aggregate Economy continues to march along without a visible downturn yet.

Contractionary monetary policy actions have sufficiently dented leading variables, which have spread into the Cyclical sectors, albeit mildly.

The Cyclical Economy, driven by residential construction and manufacturing activity, remains in a mild contraction. Growth is negative, but the downturn remains shallow. The Aggregate Economy is still growing at 1.7%, but the sustained weakness in upstream segments suggests downside risks remain active in the future, pending more Cyclical Economy weakness.

If you want to follow this entire sequence as it unfolds — with regular updates, animated video presentations, and forward-looking business cycle comments— you can subscribe to EPB Research below.

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Real money supply is the ultimate barometer of whether monetary policy is expansionary or contractionary, and currently, monetary policy remains restrictive.

Real money supply is the first step in a chain reaction or a sequence of events that ultimately flows through housing and manufacturing before impacting broader employment and consumption.

We carefully sequence incoming economic data into several buckets - what we call the Four Economy Framework.

Real money supply fits into the “Leading Economy” bucket, which broadly tracks the availability of money & credit as well as soft economic commitments and applications. The Leading Economy doesn’t measure any growth or employment directly, but instead provides foresight into where growth and employment trends are likely to head, which is why real money supply is such an important part of this early moving step.

The Role of Real Money Supply as a Leading Indicator

Real money supply is one of the most influential leading indicators in the Four Economy Framework. Importantly, it's not determined by the Federal Reserve or the Treasury alone, but rather it reflects a dynamic interaction between policy, the banking system, and public demand for money.

When real money supply is contracting, it means monetary policy is tight enough to suppress endogenous money creation, and fiscal stimulus isn’t offsetting the decline. Conversely, if real money supply is rising, policy is loose or being overpowered by direct fiscal injections.

A sustained contraction in real money supply typically leads to weakness in housing and manufacturing, the next dominoes in the economic sequence.

Measuring Real Money Supply

There are many competing measures of money supply, with M2 as the standard monetary aggregate. At EPB Research, we focus on the Austrian money supply measure called True Money Supply-2, or TMS-2.

TMS-2 reflects the portion of M2 that is immediately spendable. The calculation of TMS-2 starts with M2 but strips away components that are not immediately spendable or cannot be spent without delay or penalty, namely money market funds and bank certificates of deposit.

TMS-2 accounts for more than 80% of total M2 with narrow adjustments that make the measure more suitable for providing insight into consumer and business spending capabilities.

It’s important to adjust this TMS-2 measure for inflation to capture the true directional force of monetary policy, leaving Real TMS-2 as the primary money supply measure.

The chart below shows the time series of real TMS-2 back to the early 1990s.

Real money supply is a critically important concept and component of the Four Economy Framework, specifically the Leading Economy bucket.

Real TMS-2 as a Leading Indicator

Starting with the longer-term picture, it is clear from the chart below that whenever there is a significant inflection in the rate of real money supply growth, economic deceleration or contraction follows.

The brisk pace of real money supply growth in the 1990s flattened out in 1999, ahead of the 2001 recession.

Similarly, the solid increase in real money supply in the early 2000s stalled in 2005 and did not grow again until mid-2008, three years of no increase in real money supply - clearly a tight monetary position.

The solid pace of real money supply growth in the early 2010s finally shifted, albeit mildly, in 2017 as the Fed started to raise interest rates, leading to economic deceleration and monetary easing by 2019.

Before discussing the pandemic period and what real money supply is telling us today, let’s take a closer look at the 1990, 2001, and 2008 recessions.

Real TMS-2 peaked in 1987 and contracted steadily through 1991.

It’s important to remember that real money supply is in the Leading Economy bucket so lead times can be very long. Declines in the Leading Economy tell us that the Cyclical Economy of construction and manufacturing will decline. Once declines set in through the Cyclical Economy, then the Aggregate Economy - that part of the cycle that actually defines the recessions - is at risk of contraction.

The sequence needs time to unfold, but with the Four Economy Framework, tracking each sequential step is made easy.

Real money supply contracted in late 1994 and 1995. While this contraction did not lead to a recession because it was not sustained long enough to ripple through the whole sequence, it did lead to an economic slowdown that was felt harshly outside the US. Real money supply is not an infallible indicator and should not be used as such. Rather, it should be used as one component to a broader Leading Economy bucket that informs the path of the highly volatile cyclical sectors of construction and manufacturing.

Real money supply stopped growing in 2005 and did not show any increase until 2008.

It’s very difficult for the economy to grow in real terms or move a higher level of unit volumes with contracting real spendable money. This was not a deep contraction in real money supply, but a long and sustained contraction that exposed malinvestment in the real estate sector.

Real Money Supply Today

The real money supply situation today is more complicated and requires nuance.

In 2017, real money supply growth slowed down - it was still increasing, but at a 1% annualized pace, which is relatively tight. This led to a slowdown in 2019, rate cuts from the Federal Reserve, and a neutral rate that was roughly 2.5%.

The pandemic stimulus efforts pushed real money supply 25% above that 2017-2019 trendline, ushering a boom through the housing and manufacturing sectors, high inflation, and robust economic growth for a short time.

As the Federal Reserve raised interest rates and broadly tightened policy, real money supply started to contract. We can also see that even with the first round of 100bps of rate cuts, real money supply is still declining which tells us monetary policy remains tight enough to prevent increases in real money.

However, the complication with this cycle is that the stimulus from 2020 and 2021 was so great that there is still excess in the system. The current level of real money supply remains above the 2017-2019 trendline.

So while monetary policy is undoubtedly contractionary given the impact on real money supply, the economic impact has been delayed or blunted by the excess that still remains.

The Bigger Picture

The economic cycle sequence is unfolding exactly as normal. Contractions in real money supply and the broad Leading Economy basket did, in fact, translate into a decline in the Cyclical Economy (housing & manufacturing). The Leading Economy bucket peaked in early 2022, and the Cyclical Economy bucket peaked in early 2023 - this one-year lag is within normal historical context.

What has been different is the magnitude of the contraction in the Cyclical Economy, about 1% over 2.5 years, so slow and so mild that the impact has not been felt in the Aggregate Economy, which continues to march along.

Likely, this is due to the fact that monetary policy is contractionary, so the Cyclical Economy is struggling, but the still excess real money is providing a cushion for a more modest and gradual decline.

Should the contraction in real money supply persist, negative economic pressure will continue to move further down the sequence and more deeply into housing and manufacturing.

Real TMS-2 is one of more than 50 individual economic indicators that we track in our sequential business cycle process. The Four Economy Framework clusters these individual data points into four groups, making it easy to monitor and track consistently. This helps investors and business owners allocate capital regardless of their position in the economic cycle.

If you want to follow this entire sequence as it unfolds — with regular updates, animated video presentations, and forward-looking business cycle comments— you can subscribe to EPB Research below.

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