Published September 1, 2023
This week, we offer an educational article from Schwab on market cycles. We hope you will find it helpful in understanding why markets behave as they do.
“Market cycles, as the term suggests, happen again and again over time, and they cover a wide range of types: bear markets and bull markets, sell-offs and rallies, and expansions, recessions, and recoveries. These cycles come in different shapes, sizes, and durations, and no two are exactly alike.
By understanding the various definitions of market cycles, learning how to identify them, and seeing how they’ve played out over time, investors can potentially gain valuable insight for portfolio strategy.
In general, cycles refer to the idea that markets—including stock prices—go through a process of ups and downs and buying and selling amid shifting beliefs and opinions over valuations for equities and other assets. Investors can use knowledge of market cycles to inform their decisions, but there are a few important things to know.
Market cycles vary in length
Names are often assigned to market cycles. A bull market is a long-term uptrend marked by optimism and a robust economy. By contrast, a bear market is a prolonged downtrend, usually marked by declines of 20% from recent highs, 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. For example, within a long-term cycle, there might be short-term sell-offs that didn’t turn into bear markets or periods of largely sideways price movement. As illustrated in the chart below, investors can reference a monthly chart of a benchmark like the S&P 500® index (SPX) for the past 20 years to identify previous long-term market cycles.
Influences behind market cycles
Market cycles are usually marked by fluctuating prices as buyers and sellers come to an agreement over price and valuation of various 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 real-world events, such as elections, economic trends, wars, pandemics, and more.
Additionally, market cycles can be closely tied to business and economic cycles. As the economy picks up, equity markets often do too. In some cases, market sentiment may even rise ahead of increased economic activity. As investor enthusiasm and sentiment increases, equity valuations often increase as well. As a rally extends, valuations might become elevated. If economic indicators become even stronger, the markets may actually begin to decline in anticipation of monetary policy changes designed to prevent overheating. An economic slump or recession can end one market cycle and start another.
Four stages of market cycles
Identifying the four stock market cycle stages can help investors make more informed portfolio strategy decisions. The four market cycle stages are:
Accumulation. This stage is characterized by meandering, sideways price action that stays within a range and can potentially last a long time in individual stocks, sectors, or the market as a whole.
Markup. In the markup stage, prices often “break out” above chart resistance levels and are accompanied by spikes in trading volume as individuals and institutions start clambering on board.
Distribution. This is a “topping” stage for a stock, sector, or broader market, often signaling a “rotation” as early buyers—those who bought during the accumulation stage—begin to sell.
Markdown (or decline). During this stage, prices fall and remain relatively low. With many institutional players having sold stocks, there may be few new buyers to absorb greater selling. Downward momentum accelerates.
Emotions and market cycles
Emotions can also influence market cycles. 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.” For example, during a market slump, continuing price declines can lead to negative emotions among retail and institutional investors, sometimes leading to panic selling.
For investors, selling during a downturn can have consequences, especially if they leave the market entirely. For index investors, staying in the market can potentially lead to gains over time. Additionally, by understanding a downcycle is usually followed by an upcycle, an investor is less likely to miss out on receiving gains during the best days of the market cycle.
Market cycles appear to be compressing
After closing at a record 3,386.15 on February 18, 2020, the SPX took about 16 trading days to tumble 20% into official bear market territory and fell as much as 34% before it began its 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. For some investors and traders, commissions were a mental speed bump in the past.
Market Update
Stocks kicked off the last week of August with a broad-based +0.6% gain as interest rates slipped back. Tuesday brought an even bigger move with the broad market S&P 500 lifting +1.5%. The move came on a sharper drop in interest rates as job openings fell, thus giving investors more confidence that wage inflation will abate. Stocks ended their four-session win streak Thursday with a slim -0.2% dip to bring August to a close as the first losing month since February. The monthly losses were cut by more than half though as a push higher in interest rates early in August reversed course. Investors closed the month feeling that the Fed is likely done raising interest rates while the economy continues to show modest growth; the recipe for a happy stock market. The monthly jobs report affirmed that view Friday with job gains cooling. Wages continued to hold up with +4% yearly wage gains still the norm. That number sent interest rates back up a tick Friday to leave stocks mixed on the day. However, smallcap stocks found buyers in the new month perhaps as investors rebalanced to take advantage of the lagging group. Energy shares pushed higher on stronger oil prices, benefitting from a weaker U.S. dollar as interest rates pull back.
After falling throughout most of August, stocks came back in the final week of the month. The S&P 500 gained +2.55% while the Nasdaq 100 (QQQ) surged +3.73%. Smallcap stocks closed the week up +3.72%.
Warm wishes and until next week.