What are market cycles?

Canada Life - Oct 31, 2023
The natural cycle of markets is to rise and fall. Long-term trends show that stock prices are continually rising.
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Understanding the highs and lows of the stock market can feel like trying to predict the weather. One minute it’s sunny and the next it’s raining. While weather changes might seem random, if you look closely enough, you’ll begin to see patterns. While it’s sad to see summer leave, you know it will be back.

The stock market also has patterns or cycles. The natural cycle of markets is to rise and fall. When the markets fall, like during the COVID-19 pandemic and the global financial crisis of 2008, it can be scary. But historically the stock market continues to cycle and rise again. Cycles can last days or even years, but once you understand the patterns it’s easier to focus on the longer term. 

Why do markets “cycle”? 

Stock prices reflect the value of the companies they represent.

With technological improvements, companies and their employees can become more productive and produce more products and services as time goes by. If demand for a product or service increases, its value increases – and so does the overall value of the company that produces it.

While historically stock prices have been shown to rise over the long-term, that doesn’t mean there won’t be dips in the market along the way. There are several reasons stock prices fall – access to labour, interest rate changes, geopolitical disruptions, changes to consumer purchasing choices or a global shortage of a key commodity, like oil.

Even things like investor expectations or perceptions can affect stock prices. Investors can also misjudge the value of companies and how profitable they’ll be in the future. You may have heard of a stock market bubble – this is when investors rush to buy stocks and bid up prices beyond what the companies are worth. When this bubble bursts, stock prices fall.

Even when markets fall, some investors see this as a good time to start investing. Typically, after a fall, increases in spending, fewer layoffs and other related factors can help bring things full circle – prompting the markets to rise once again. 

What’s a bull market? 

A bull market refers to a period when stock prices consistently rise – as they did in the U.S. stock market from 2009 to 2020. The economy had recovered from the 2008 bear market and while individual stock prices and the market fell in value during this time, overall, it was the longest modern era bull market. It lasted until the COVID-19 pandemic.

Many people use bull market to refer to strong and rising markets. The most common definition is when stock prices rise over 20% during a specific period without dropping an equal amount. For example, even if the market fell 11% during this period, as long as prices rebounded and kept rising, the bull market wouldn’t end.

During a bullish period in the market cycle, investors can get very optimistic and confident, leading to irrational exuberance. This can cause people take on more investment risk by buying stocks when markets are peaking, leaving their carefully planned, long-term strategies.

Rising stock markets often happen with increasing corporate profits, a growing economy, higher wages and lower unemployment. 

What’s a bear market? 

The opposite of a bull market is a bear market. When most people think of bear markets, they think of a continued fall in prices. A bear market happens when stocks fall 20% or more without rising an equal amount.

Sometimes declines might not be categorized as a bear market, A decline from highs of approximately 10% is a correction and not a bear market. It happens when stocks fall around 10% and can be a result of an overreaction to a specific event. It’s a common cause of panic because it creates shorter-term bouts of market volatility and can lead investors to take their eyes off the prize.

Falling prices can lead to stress and worry. Sometimes, people make investment decisions based on emotions instead of facts. Investors often sell otherwise quality stocks at low prices.

For example, a company with a good business model and smart management may see its stock price fall because the market did. But nothing changed at the company to cause a fall. Investors might be tempted to sell these stocks or mutual funds instead of holding out for the long term.

A bear market isn’t the same as what’s called a stock market crash. A stock market crash is used to describe dramatic plunges in the market that happen in a day or two, such as the famous Wall Street Crash of 1929. A bear market is a longer, drawn-out fall in prices. 

How long do market cycles last? 

There’s no simple answer. A full market cycle is usually defined as the period between two highs. In other words, a bull market, then bear market and then another bull market.

No one can predict the exact timing of these cycles, which is challenging. However, it’s counterproductive to focus on this question. Timing the market is often a zero-sum game. Historical data shows you have a greater likelihood of making a higher long-term return by staying invested and riding out market ups and downs.

A well-planned, long-term strategy can help you stay focused on your investing goals. I can help you create an investment strategy suited to your needs.