Understanding Market Cycles: Insights from a Junior Analyst

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In every market phase, we often witness certain asset classes thriving while others falter. The profitability of assets is intimately linked to market cycles. So, what exactly are market cycles? Let’s explore in this article!

What Are Market Cycles?

Market cycles, or stock market cycles, are a broad term referring to trends or patterns observed in different market phases or business environments. Within a cycle, certain types of securities or assets outperform others because their business models align with growth conditions. Market cycles represent the time between the most recent peak and trough of a broad market index, such as the S&P 500, capturing the performance of investment funds over both bull and bear market periods.

How Do Market Cycles Operate?

A new cycle emerges when trends in a particular sector or industry evolve due to innovations, new products, or legal issues. These cycles or trends are often long-term. During this phase, revenue and net profit may grow across many companies in a cyclical industry.

Market cycles are often challenging to identify until they have fully transpired. They seldom have specific starting or ending points, leading to confusion or debate surrounding policy evaluation and strategies. Nonetheless, most seasoned market participants believe in the existence of market cycles. Many investors pursue trading strategies ahead of directional changes in the cycle to benefit from them.

Note: There are anomalies in the stock market that cannot be explained but occur from year to year.

Key Insights

A cycle can range from a few minutes to several years, depending on the market in question, with different types of markets requiring varied analysis periods. Each person will consider different aspects of the scope. An intraday trader may focus on 5-minute charts, while a real estate investor will assess a cycle of up to 20 years.

Phases in a Market Cycle

Market cycles typically consist of four distinct phases. In different stages of a complete cycle, various asset classes will react to market conditions differently. For instance, during an uptrend, luxury goods stocks typically outperform as people are comfortable spending on discretionary items. Conversely, in a downtrend, essential consumer goods industries tend to rise as people cannot cut back on toothpaste or toilet paper consumption during economic downturns.

The four phases of the market cycle include:

1. Accumulation Phase: Accumulation occurs after the market hits bottom and early adopters in the industry, as well as early buyers, begin to accumulate positions as they believe the worst is over.
2. Uptrend Phase: This occurs when the market stabilizes for a period, and prices rise.
3. Distribution Phase: Sellers begin to dominate the market as stocks reach their peak.
4. Downtrend Phase: Downtrend occurs when stock prices fall sharply.

Market cycles observe both fundamental and technical analysis, using stock prices and other indices as measures of cyclical behavior.

Some examples of cycle measures may include business cycles, semiconductor/materials cycles in the technology sector, and price movements of interest-rate-sensitive financial stocks.

Duration of Market Cycles

Market cycles typically last on average from 6-12 months. However, fiscal policies in the United States or global markets can significantly influence cycle duration. The average is 6 to 12 months, but for example, if the Federal Reserve drastically lowers interest rates, it could extend the market uptrend for several years.

Conclusion

Markets often follow the same cycles, and while there is an average period for each cycle, the length of the stages depends on policy conditions. Financial markets experience many short-term cycles, while major market cycles tend to occur on a monthly or yearly basis.