In this post, we’ll unpack all you need to know about the Market Cycle, defining exactly what it is, the 4 phases, why understanding it is important, how to leverage it and more.
What Is The Market Cycle?
The Market Cycle (MC) refers to the long-term cyclical pattern that financial markets undergo that is characterised by specific phases.
The 4 Phases Of The Market Cycle
All markets go through 4 distinct phases: expansion, peak, contraction and trough. Each phase feeds on the next and signifies different market conditions and investor behaviours.
The expansion phase is characterised by rising market prices and rising optimism. The peak phase is characterised by the highest market prices and maximum optimism. The contraction phase is characterised by falling market prices and rising pessimism among investors. The trough phase is characterised by the lowest market prices and maximum pessimism.
“…success carries within itself the seeds of failure and failure the seeds of success. As any system grows toward its maximum or peak efficiency, it will develop the very internal contradictions and weaknesses that bring about its eventual decay and demise.” ― Howard Marks
How Long Does The Market Cycle Last?
A complete market cycle spans from one peak phase to the next peak phase.
According to the National Bureau of Economic Research (NBER), the average peak-to-peak length of a market cycle between 1945 and 2020 was roughly 6.25 years.
However, it’s important to note that the duration of each cycle can vary significantly due to various factors. In other words, past performance is not always indicative of future performance.
The Presidential Cycle
The Presidential Cycle Theory suggests that stock market trends can be influenced by the four-year U.S. presidential term.
Historically, this cycle indicates that markets tend to show weaker performance in the first half of a president’s term and stronger performance in the second half of a president’s term.
How To Determine Where We Are In The Market Cycle
There are a number of characteristics we can use to determine where we are in the Market Cycle. They are summarised in the table below.
| INVESTORS | OPTIMISTIC | PESSIMISTIC |
| ASSET OWNERS | BUYING | SELLING |
| SELLERS | FEW | MANY |
| BUYERS | MANY | FEW |
| MARKETS | CROWDED | EMPTY |
| CAPITAL MARKETS | LOOSE | TIGHT |
| CAPITAL | ABUNDANT | SCARCE |
| RECENT PERFORMANCE | STRONG | WEAK |
| ASSET PRICES | HIGH | LOW |
| POTENTIAL FUTURE RETURNS | LOW | HIGH |
| RISK | HIGH | LOW |
| INTEREST RATES | LOW | HIGH |
However, it’s important to understand that assessing the current phase of the cycle won’t tell us what will happen next, but what is more and less likely.
Since market cycles vary from one to the next in terms of the amplitude, pace and duration of their fluctuations, they’re not regular enough to enable us to be sure what will happen in the future based on what has happened in the past. Thus, from any given point in the cycle, the market is capable of moving in any direction. Either up, flat or down.
Scepticism calls for pessimism when optimism is excessive and optimism when pessimism is excessive.
Why Understanding Market Cycles Is Important
Skilful analysis of the Market Cycle can give investors a better understanding of the market’s likely tendency. This can enable them to more appropriately position their portfolio for what lies ahead.
Thus, understanding the MC can help investors make more informed investment decisions and maximise investment profits.
How To Leverage The Market Cycle
Successfully positioning a portfolio for future market movements depends on what you do (based on turning aggressive or defensive) and when you do it (based on superior timing).
Therefore, leveraging the Market Cycle for investment success involves firstly identifying the present phase of the cycle and then secondly adjusting your portfolio accordingly so you can benefit from future phases.
During expansion phases, investors may want to have more capital invested. During contraction phases, investors may want to have less capital invested.
One Caveat
Studies show that Time In The Market is a more effective strategy for investors when compared to Timing The Market.
In other words, staying invested over the long-term generally yields better returns over trying to predict and capitalise on short-term market fluctuations.
Summary (TL;DR)
The Market Cycle refers to the long-term cyclical pattern that financial markets undergo that is characterised by specific phases.
There are 4 phases to the MC. First is expansion characterised by rising market prices and rising optimism. Second is peak characterised by the highest market prices and maximum optimism. Third is contraction characterised by falling market prices and rising pessimism. Fourth is trough characterised by the lowest market prices and maximum pessimism.
The key to leveraging the Market Cycle is to firstly identify the present phase of the cycle and then secondly adjust your portfolio so you can benefit from future phases.
However, it’s important to note that staying invested over the long-term tends to yield better returns when compared to attempting to predict and capitalise on short-term market fluctuations.
