Market Cycle

Patterns or trends that develop in different markets or economic contexts

The market cycle, often known as the stock market cycle, is a general term that refers to patterns or trends that develop in different markets or economic contexts.

Market cycle

Because their business models are compatible with growth conditions, some securities or asset classes do better than others during a cycle.

The distance between two successive highs or lows of a standard benchmark is what this measure means, which demonstrates how well a fund performs in up and down markets.

Proponents of the theory contend that the stock market exhibits hypothetical patterns known as stock cycles.

Many other cycles have been proposed, such as connecting market volatility to political leadership or commodity price fluctuations.

Some trends in the stock market are generally acknowledged (e.g., rotations between the dominance of value investing or growth stocks). 

On the other hand, many academics and experienced investors are dubious of any theory that claims to be able to detect or anticipate the stock cycle accurately. 

External variables such as the United States monetary policy, the economy, inflation, currency rates, and social circumstances all influence stock returns (e.g., the 2020-2021 covid virus pandemic). 

The present earnings of a company's shares are affected by intellectual capital. The return growth of a stock is aided by intellectual capital.

Charts

Except for substantial supply shocks, economist Milton Friedman thought that company losses are mostly a monetary phenomenon. Despite the term cycle's common use, corporate economic activity changes do not follow a consistent or predictable pattern.

According to traditional theory, a fall in price will result in less supply and greater demand, whereas a price rise will have the opposite effect.

This works well for most assets, but it frequently works in the other direction for stocks since many investors buy high in euphoria and sell low in fear or panic due to the herding impulse.

If a price rise creates an increase in demand, or a price fall causes an increase in supply, the predicted negative feedback loop is broken, and prices become unstable. This might be observed in the form of a bubble or a crash.

What exactly is a market cycle?

It refers to the economic trends in many different business contexts. 

Computer

During an upcycle, a company's revenue and profitability may see a rapid increase and stagnation or downtrend in the top and bottom lines during a down cycle. Temporal patterns can be seen in companies working within a particular industry. These patterns are cyclical.

The accumulation, markup, distribution, and markdown phases are the four phases of a stock cycle.

A new cycle is born when a new technology breakthrough or a change in market rules upsets existing market patterns and produces new ones.

Hence, with the introduction of new goods or a new regulatory regime, the shift is industry-specific, which means that it may or may not affect the market as a whole.

It considers fundamental indicators, such as interest rates, asset prices, and industrial output, among other things.

New cycles emerge when real innovation, new goods, or the regulatory environment create disruptions within a single sector.

Revenue and net profits may show similar growth patterns among numerous firms within a particular industry throughout these upcycle periods.

Stocks

It's sometimes difficult to determine until after the fact. They seldom have a different starting or end point, leading to misunderstanding or debate when evaluating policies and initiatives. 

On the other hand, most market veterans think they exist, and many investors follow strategies aimed at profiting from them by trading securities ahead of cyclical directional shifts.

Anomalies in the stock market can't be explained, but they happen yearly.

It can last anywhere from a few minutes to several years, depending on the market and the studied time horizon. 

Different occupations will examine various components of the spectrum. For example, a real estate investor would be interested in a cycle of up to 25 years, but an intra-day trader might be interested in ten-minute bars.

Stages

These cycles are said to be divided into four main periods. Different securities will react to market dynamics differently at other points of a whole market cycle.

For example, luxury products excel during a market upswing because individuals feel more comfortable buying powerboats and Harley Davidson motorcycles. 

During a market downturn, on the other hand, the consumer durables business tends to succeed, as individuals don't usually cut back on their toothpaste and toilet paper usage.

Stages

The four stages are the accumulation, uptrend or markup, distribution, and downturn or markdown phases.

In general, there are four stages. At each step, securities will react to market conditions in a particular way. Companies are selling luxury goods, for example, increasing rapidly during an upswing or a boom time.

The fast-moving consumer goods industry (FMCG) is projected to excel during a downturn or recession. This is because demand for basic needs and consumer durables such as food and hygiene goods remains stable.

The following are the four stages:

Phase 1: Accumulation

The accumulation begins as soon as the market reaches its lowest point. Value investors, money managers, and experienced traders begin buying shares after they believe the worst is gone, and values become critically important.

This is known as accumulation when investors and corporations re-enter the market and increase their exposure.

The market attitude shifts from negative to neutral over this time frame. The market, though, remains negative.

After the market has bottomed, innovators and early adopters continue to buy, believing that the worst is behind them.

Phase 2: The markup stage

During the markup stage, investors begin to pour in big amounts of money, resulting in a significant increase in market volume. However, while stock prices rise above historical norms, unemployment and layoffs continue to grow.

At the markup stage, market attitude shifts from neutral to positive and, in some circumstances, exuberant. Finally, a selling climax is witnessed due to the participation of fence-sitters and reluctant or risk-averse investors, which is a last parabolic price surge.

Mark-up Phase is when the market has remained steady for a time and then begins to rise in price.

Charts

Phase 3: Distribution

The third cycle is the distribution phase, during which traders begin selling securities.

The market's mood shifts from optimistic to neutral. It is when the market shifts direction at the end of a term.

On the other hand, distribution is a time when investors begin to reduce their exposure to their investments. 

The change is gradual and may take a long time to complete. Over several months, prices tend to remain relatively stable. However, a sudden unfavorable geopolitical upheaval or terrible economic news, such as pandemic lockdowns, may hasten the process.

In the distribution phase, sellers begin to dominate as the stock reaches its top.

Phase 4: The markdown stage

The final part of a cycle is the markdown phase, which is disastrous for investors who still retain equities. Security values had plummeted much below what investors paid when they bought them. 

As this is the last period, it also signals the start of the next accumulation phase, in which new investors will buy discounted assets.

It uses securities prices and other measures to gauge cyclical activity, considering both fundamental and technical indications.

The business cycle, semiconductor or operating system cycles in technology, and the movement of interest-rate-sensitive financial equities are just a few examples.

Key Takeaways

  • Trends or patterns that arise during various business contexts are called cycles.
  • The cycle length is typically different for each person, depending on the patterns they are searching for.
  • Typically, a market cycle comprises four main periods.
  • Different securities will react to market dynamics differently at other points of a whole market cycle.
  • Markets follow a cycle, and while each cycle has an average duration, political and fiscal policies can lengthen or shorten particular periods. In the near term, financial markets encounter several mini-cycles, while significant market cycles often last months or years.

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Researched and authored by Akhilesh Jagtap | Linkedin

Reviewed and Edited by Aditya Salunke I LinkedIn

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