Market cycles


Market ups and downs can’t be predicted accurately – though they often can be explained in hindsight.

The ups and downs of a market, like the ups and downs in the value of an individual stock, are driven by investor behavior. If investors are putting money into the market, it gains value. If they’re pulling money out, the value drops.

Most of the time the strength or weakness of the stock market as a whole is directly related to economic and political forces. For example, when earnings are strong and interest rates are low, indexes tracking stock prices tend to rise. But when corporate earnings fail to meet expectations or investor confidence is shaken, stock prices drop, or the market is flat, or stagnant.

When people invest

Economic, social, and political factors affect investment. Some factors encourage it and others make investors unwilling to take additional risk.

Positive factors:

  • Ample money supply
  • Tax cuts
  • Low interest rates
  • High employment
  • Political stability or expectation of stability

Negative factors

  • Tight money supply
  • Tax increases
  • High interest rates offering better return in less risky investments
  • High unemployment
  • International conflicts or pending elections

Bull and bear markets

The stock market moves up and down in recurring cycles, gaining ground for a period popularly known as a bull market. Then it reverses and falls for time before heading up again. Generally, a falling market has to drop 20% before it’s considered a bear market. Sometimes market trends last months, even years. Overall, bull markets have tended to last longer than bear markets.

But drops in the market tend to happen quickly, while gains take more time. It’s much like the law of gravity: It takes a lot longer to climb 1,000 feet than to fall the distance. Markets also experience corrections, or across-the-board losses, that aren’t as severe or sustained as a real bear market.

Moving with the cycles

Pinpointing the bottom of a slow market or the top of a hot one is almost impossible — until after it has happened. But investors who buy stocks in companies that do well in growing economies — and buy them at the right time – can profit from their smart decisions or their good luck.

One characteristic of expanding companies is their ability to raise prices as the demand for their products and services grows. Increased income means more profit for the company and may also mean larger dividends and higher stock prices for the investor.

It’s generally difficult to predict which companies will falter during a downturn and which ones will survive and prosper. No economic cycle repeats earlier ones exactly. So the pressures that companies face in one recession aren’t the same ones they face in another. In most cases, though, long-term financial success depends more on the internal strength of the company and the goods or services it provides than on the state of the economy.

Opposites attract

Stocks typically produce their strongest returns in the recognizable economic climates because of the way they respond to particular market stimuli. For example, when interest rates are high, cash equivalents, such as Treasury bills, tend to provide stronger-than-average return and stock returns tend to be disappointing.

Correlation is a measure of how similarly or differently two asset classes behave in a particular climate, ranked on a scale from -1 to 1. If the values of two classes always rise and fall together, their correlation is 1. If they always move in opposite directions, their correlation is -1. In addition, some asset classes, such as stocks and nontraded REITs, are noncorrelated because their returns are influences by different factors rather that different reactions to the same factors.

The strategy called asset allocation stresses the importance of including negatively and noncorrelated assets in an investment portfolio as a defense against the cyclical downturns that affect each of the asset classes at certain times.

Investment activity

When the DJIA closed above 1,000 in 1972, it broke what had been considered a nearly absolute ceiling. In March 2015, it closed at 18,289. The bear market that followed the Internet bubble took the DJIA from 11,723 in January 2000 to 7,286 in October 2002. An even greater drop followed the Great Recession, from 14,000 in July 2007 to 6,547 in March 2009.

 

 

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