Markets, as well as economies, run in cycles—sometimes up, sometimes down, sometimes sideways—each for an uncertain amount of time. Cycles present risks and opportunities for investors. Here are a few things investors should know about cycles, recessions, and recoveries.
By identifying market cycles, investors can gain insights for long-term portfolio strategy
Market cycles, as the term suggests, happen again and again over history, and cover a lot of turf: bear markets and bull markets, selloffs and rallies, expansions, recessions, and recoveries. That’s just a quick spin through the concept, though. Market cycles come in different shapes, sizes, and durations, and no two are exactly alike.
What is a market cycle? By understanding definitions of market cycles, learning how to identify market cycles, and seeing how market cycles have played out over history, investors can gain valuable insight for portfolio strategy. In general, cycles refer to the fact that stock markets—stock prices, more specifically—are constantly going through a process of ups and downs and buying and selling amid shifting beliefs and opinions over valuations for equities and other assets.
Here are a few other important things to know about market cycles.
A bull market is a long-term uptrend marked by optimism and a robust economy. In contrast, a bear market is a prolonged downtrend, usually marked by declines of 20% accompanied by widespread negative sentiment. The record bull run in U.S. stocks, which began in early 2009 and ended in March 2020, is a recent example of a long-term market cycle.
Long-term cycles can also include several shorter cycles—say, short-term selloffs that didn’t turn into bear markets or periods of largely sideways price movement. Check a monthly chart of a benchmark like the S&P 500 Index (SPX) for the past 20 years and see if you can spot longer-term market cycles (see figure 1).
Markets can be thought of as big, open forums for never-ending debates over the “right” price for equities, bonds, and other assets. As cycles unfold and investor enthusiasm ebbs and flows, asset valuations can move from “fair,” to elevated or overvalued, to undervalued or cheap, and all points in between.
Market cycles are also heavily influenced by outside, real-world events: elections, economic trends, wars, pandemics, and more.
Cycles are closely tied to business and economic cycles. As the economy picks up, equity markets usually do, too. The markets may even precede pickups in economic activity (as is happening now with a market rally that coincides with declining economic indicators). As investor enthusiasm or excitement grows, equity valuations increase. As a rally extends, valuations may get a little “hot,” or elevated. If economic indicators get too strong, the markets may actually begin a decline in anticipation of monetary policy changes designed to prevent overheating. An economic slump or recession can bring one market cycle to an end and start another market cycle.
Is this the right time to buy or sell a certain stock, or hold back? Identifying four stock cycle stages can help investors develop discipline and patience. These four stages are:
Market cycles can also apply to sector investing.
Emotions drive market cycles on the way up and the way down. Fear, in particular, plays a big role at both ends of a market cycle. There’s fear of “missing out” on a rally and fear of “losing it all” during a slump.
During a market slump, continuing price declines fuel emotions among both retail and institutional investors, and these negative emotions feed on themselves on the way down—sometimes leading to full-fledged panic selling.
As people get increasingly emotional, they tend to forget that market cycles are common occurrences that happen all the time. Each time it feels like something new, even though it’s not. It’s easy to look back at the end of a cycle and see that, yes, that was a cycle. But when you’re in the moment, it’s tough to take a step back and get perspective.
On the other hand, if you jump out of the markets entirely, you could miss some of the best days, and that could have an outsize impact on your returns (see figure 2).
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The most recent bear market in U.S. stocks might have been the “fastest” ever. After closing at a record 3,386.15 on February 18, the S&P 500 Index took about 16 trading days to tumble 20%, the official bear market boundary. The U.S. benchmark fell as much as 34% before a recent recovery.
In today’s technology-driven media and market environment, with information circulating faster and faster, market cycles tend to compress. Millions of investors are tuned in to markets every day through the internet and mobile devices. Plus, for retail investors, the traditional barriers to rapid trading—including commissions—have mostly been eliminated. Commissions used to be a mental speed bump.
Recovery periods from bear markets also appear to have shrunk over the past several decades. For S&P 500 bear markets since 1929, the time to return to “breakeven” averaged about 44 months, according to research by CFRA. For bear markets since 1946, the break-even period for the S&P 500 averaged 25 months (the average decline was 32.5%).
Everyone experiences emotional highs, lows, and points in between. But investors who can separate their emotions from investing decisions and strategy can improve their odds for long-term success.
Markets can and will swing suddenly and unexpectedly and go through elevated volatility, so investors should have a firm grip on their risk tolerance. When markets are whipsawing, consider taking a step back, divorcing yourself from the moment, and try to put things in historical perspective. Consider possible outcomes when investing in a certain stock or other asset, and consider certain triggers, such as price targets.
For example, identify a price target for a certain stock a certain percentage above or below where you bought it, then set up an alert or auto order in advance. Try to be as methodical as you can. Know where your entry and exit points may be, and know what steps you may take depending on various outcomes or market developments.
The market’s recent activity further underscores how these rare “black swan” events can drive market cycles. It’s always good to expect the unexpected. This might be the time to be more disciplined than ever, rather than get swept up in the moment.
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