Understanding Market Cycles

If you know anything about my philosophy, you know that I consider investing to be one of the key aspects of a healthy financial life. You’ll also know I don’t sugar-coat the fact that with the amount of material out there, and the number of highly skilled players, navigating the markets can feel incredibly daunting. 

If you want to know what markets are going to do next, you have to understand the different types of cycles the market goes through. There are three primary types of cycles—we’ll dig into each and how to use them in your investing process.

Source: Real Vision

Secular Trends

Secular is the cycle with the biggest scope (we’re talking governments, technological advancement, etc) and because of this, it has the longest run time of the three. A secular trend cycle in the market will typically last for 10+ years.

Some Secular Trends are:

• Debt (Government debt is rising)

• Technology (Technology leads to deflation)

• Demographics (Demographics point to a declining population)

• Government policies (Government spending has been increasing)

• Large macroeconomic trends (Globalization is declining, Nationalism is increasing)

Cyclical Trends

Cyclical has a smaller scope (policies, current events) and therefore a shorter timeframe than secular. A cyclical trend cycle in the market will typically last for months to years.

Some Cyclical Trends are:

• Liquidity (amount of money in the system)

• The business cycle (expansion ➔ contraction of an economy's growth (GDP))

• Central bank policies (are interest rates going up or down?)

• Global events (wars, pandemics, natural disasters)

Tactical Trends

Tactical Trends are short duration trends resulting from events which have a significant effect on the market environment for a short period of time—typically days to weeks. 

Some Tactical Trends are:

• News (Chinese balloon)

• Economic Data Releases (housing, inflation, and jobs data)

• Company Earnings Reports (quarterly earnings)

• Market Volatility (fear and greed index, put/call ratio)

• Market Sentiment (market breadth, moving averages)

• Market Momentum (VIX, historic volatility)

Okay, now you have an idea of the different cycles the market goes through, an idea of how long those might last, and some examples of what trends play into each type of cycle. Taking all of this into account can give you insight into where the market is right now, and where it might be going in the future. 

Knowing all of this is just the first step of using it in your investing strategy. Remember—we’re not about one-size-fits-all investment advice here. A critical thing to keep in mind for your own strategy, is your time horizon. 

• Changing your portfolio every 5 years? Focus on the secular trends

• Changing your portfolio every year? Pay attention to the secular and cyclical trends

• Changing your portfolio every month? Watch the cyclical and tactical trends

Say you notice one or more of these triggers coming into play. What you should do depends on the different trends you’re seeing for each cycle and how they affect each other, as well as your current time horizon for your investment. 

For example, I like to look 6-24 months out into the future to base my investment decisions. This means I am currently thinking about the following:

• We are currently coming down from the peak of the business cycle - where exactly we are is much harder to say but in my opinion we are trending down and are potentially getting close to a bottom

• I am looking for signals that would indicate the business cycle is headed back up

• This would mean overall market conditions are favorable

• Favorable conditions means it’s time to get bullish

• Interest rates are rising

• Are we in the middle of the rise or at the top? Or will they stagnate? 

• Bonds do well with declining rates - if rates are going to start declining, locking in high rates for bond positions will be favorable

• There will also be upside for bond funds if rates come down

• Where is overall market sentiment?

• Are people generally bullish or bearish?

• Markets tend to do the opposite of what everyone thinks they will do

• Usually you want to be on the opposite side of sentiment

• How strong are worries about recession? 

• What is the market pricing in relation to a potential recession?

• Do I disagree with the market positioning?

Combining these markets gives me a general idea about if the overall market outlook is positive or negative. From there, I can dive deeper into specific investments.

• On a secular level: 

• Energy has been dramatically underinvested for decades. It seems likely that it will return to more historic averages.

• Commodities and precious metals historically do well in high inflation environments

• Previous cycle leaders are usually not the next cycle’s winners

• Technology stocks have performed very well for the last 10 years or so while value stocks have underperformed - that might be changing

Keep in mind that nothing is certain. These indicators simply help us to understand if we are near the top, middle, or bottom of a cycle and by knowing where you are at in the different cycles, you can make better decisions in regards to your positioning. Always be looking for arguments against your reasoning. You want to be constantly trying to disprove your theory, at that point, it is time to get out.