What are market cycles and how can you time one?

What is a market cycle?

A market cycle is a pattern that aims to indicate when new trends in an economy, market or industry have developed. Markets move in cycles along with growth and contraction in the underlying economy. Usually these periods begin with slow growth, which then accelerates and reaches a peak, and is then followed by a sustained bout of economic weakness.

Investors experience these cycles through the medium of markets, which rise and fall as economic growth ebbs and flows. When the economy grows, consumers and businesses spend more, boosting revenues and profits, and then as growth weakens and then contracts, those same consumers and business slow their spending and perhaps stop altogether in some areas.

Rising earnings tend to boost share prices, while the reverse is usually true. Hence the saying, ‘in the long run, the stock market is the economy’.

What are the stages of market cycles?

There are four stages to a market cycle. In the first, accumulation, stage, the economy and market has bottomed out, and brave investors step in to find discounts and cheap valuations. The second stage is the mark-up phase, when confidence has returned and more investors are prepared to put their cash to work. Some early investors may cash out in order to find new bargains. Phase here sees distribution, as prices become more choppy and begin to edge lower, with more investors beginning to cut back on their positions. Finally, phase four sees the mark-down stage, when the last investors exit and prices fall substantially. Some of the early adopters from phase one begin to think about investing once again.

Timing market cycles

Like all investing and trading, timing a market cycle can be difficult, to say the least. The old saying, ‘no one rings a bell at the top’, still holds true, but applies to the other phases as well. No one fires a starting gun on phase one, or signals that we have moved firmly from one to another.

As with most investing, it is always easy to see when cycles began and ended with the benefit of hindsight. Then it is simple to see when each stage began and ended, as well as seeing the entire long-term cycle. But at the time it is all but impossible. Sometimes a long-term uptrend can endure a period of weakness before pushing on higher, or it could be the beginning of a turn lower. And cycles are not the same length, while the gains and losses in the overall cycle are not evenly-distributed across all four periods.

UK market cycles: driven by the price of land

Akhil Patel, of Southbank Investment Research, says that the UK economy is driven by one important variable, the price of land.

He argues that the property cycle, of rises and falls in valuation, repeats itself with a high degree of accuracy, but that most investors fail to follow the cycle accurately, if indeed they know that it exists at all. But if an investor can accurately determine the current stage of the four cycles, then they can more effectively allocate capital, and exit the market before a bigger sell-off takes place.

In the current market cycle, it appears that Brexit is not having a big impact, even if it dominates news and economic data. Interestingly, even a possible Jeremy Corbyn government, which could see significant redistribution of land and other assets, would not seriously change the underlying cycle. Indeed, a Corbyn government could be followed by a boom in property or land prices, as the successor government unwinds the policies of the previous administration.