What are Market Cycles?
A cycle is a wide term referring to trends or patterns that emerge during different market or business environments. During a cycle, some securities or asset classes tend to outperform others because their business models aligned with conditions for growth. More specifically, market cycles are the period between the two latest highs or lows of a common benchmark, such as the S&P 500 which highlights the net performance of a fund through both an up and a down market. A market cycle is complete when the S&P 500 is 15% below the highest point or 15% above the lowest point (ending a down market).
BREAKING DOWN Market Cycles
Newmarket cycles form when trends within a particular sector or industry develop in response to meaningful innovation, new products or regulatory environment. These cycles or trends are often called secular. During these periods, revenue and net profits may exhibit similar growth patterns among many companies within a given industry, which is cyclical in nature.
Market cycles are often hard to pinpoint until after the fact and rarely have a specific, clearly identifiable beginning or ending point which often leads to confusion or controversy surrounding assessment of policies and strategies. However, most market veterans believe they exist, and many investors pursue investment strategies that aim to profit from them by trading securities ahead of directional shifts of the cycle.
Four Stages of Market Cycles
Market cycles are generally considered to exhibit four distinctive phases. At different stages of a full market cycle, different securities will respond to market forces differently. For example, during a market upswing, luxury goods tend to outperform, as people are comfortable buying powerboats and Harley Davidson motorcycles. In contrast, during a market downswing, the consumer durables industry tends to outperform, as people usually don't cut back their toothpaste and toilet paper consumption during a market pullback.
The four stages of a market cycle include the accumulation, uptrend or markup, distribution, and downtrend or markdown phases.
Some examples include the business cycle, semiconductor/operating system cycles within technology and the movement of interest-rate sensitive financial stocks.