Investing > Complete Guide to Market Cycles

Complete Guide to Market Cycles

Understanding market cycles can help you buy and sell stocks at the right time by managing expectations and risk.

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Updated January 09, 2023

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Have you ever been worried that the market will crash just after you buy a stock? How about throwing in the towel on a losing investment, only to see the price recover and go on to make new highs?

These are problems that all investors face, and they may have more to do with the overall market than individual stocks. Specifically, we are talking about the cycles that cause the stock market to keep rising and falling over time. 📊

Sure, the stock market has proven to be the best performing asset class over time. As Warren Buffett pointed out in the last Berkshire Hathaway shareholder letter, the average annual return for the S&P 500 index over the last 50 years was 10.5%. But that’s the average return — the return for any given year can be a lot higher or lower.

The reason that annual returns vary so much has a lot to do with market cycles. These cycles cause the entire market to rise and fall at any given time, despite delivering good long-term gains. The majority of stocks that make up the market are influenced by the current market cycle.

When it comes to investing, we can’t predict the future. But we can put the odds in our favor, and one of the ways to do that is by understanding market cycles. There are times to be bullish, times to be bearish, and times to take a wait and see attitude. In this article we will show you how you can identify the most likely current stage of the cycle and adjust your bias.

Ready? Let’s jump in! 👇

What you’ll learn
  • The Definition of a Market Cycle
  • Understanding Market Cycles
  • Different Stages of a Market Cycle
  • Difference Between Bear and Bull Market
  • How Long Does a Market Cycle Last?
  • Market Cycle: Examples
  • Conclusion
  • Get Started with a Stock Broker

The Definition of a Market Cycle 📚

A market cycle is a recurring pattern that occurs in the stock market as stock prices rise and fall over time. Cycles have four distinct phases or periods that characterize the behavior of market participants: accumulation, mark-up, distribution, and mark-down. A market cycle is usually defined as the period between two major lows for a broad market index like the MSCI World Index or the S&P 500.

Over the long term, the S&P 500 index has generated average returns of around 10% a year, but market cycles can result in very different returns during any given year. Market cycles are influenced by the business cycle, economic conditions and investor sentiment. Major cycles are closely related to the economic or business cycle, but smaller cycles can also occur within a larger cycle.

The global stock market experiences market cycles that last for years at a time. But individual markets, sectors, industries, and stocks go through similar cycles. These cycles are influenced by the broad market cycles as well as factors that are unique to each market or company. 

Other various asset classes such as real estate, commodities, bonds, and even cryptocurrencies experience similar cycles.

Understanding Market Cycles 📘

When it comes to buying and selling stocks and forecasting the market’s next move, market cycles can help you put the odds in your favor. So, understanding them is quite beneficial.

How Are New Cycles Formed? 🤔

Each market cycle is set up by the previous cycle, as well as the current economic and business environment. The first stage of the cycle begins when valuations are relatively low and sentiment is bearish. Often, a new cycle—or a new stage of a cycle—begins when central banks initiate a new round of interest rate hikes or cuts.

Cycles gather momentum when economic and corporate news improves. This causes improvements in business, consumer, and investor confidence. For specific sectors and companies, new innovations and product launches can trigger a new cycle. Regulatory changes can also influence or trigger a cycle. A good example is Chinese technology stocks which faced a series of regulatory challenges in 2021.

Market Cycles vs. Business Cycles ⚔

Market cycles are similar to economic or business cycles, but do not occur at the same time. Equity markets typically anticipate the business environment 6 to 18 months ahead, so market cycles usually lead economic cycles. Investors look for indications of where the economy will be in the future by keeping tabs on central bank policy and economic data.

An economic cycle also has four stages: expansion, peak, recession and trough. These stages are closely associated with GDP growth, interest rates, inflation and consumer confidence. Longer cycles are also influenced by demographic changes and innovation.

How is a Market Cycle Determined? 👨‍🏫

With the benefit of hindsight it’s usually possible to identify the various stages of the previous cycle. However, it’s not that easy to identify the current stage of the current cycle. One of the reasons for this is that investor behavior shapes the cycle, and investors’ behavior often reflects a lot of uncertainty.

If we all knew the exact stage of the cycle, we would all buy stocks during the accumulation stage and sell them during the distribution stage. But, if we were all certain of the current stage of the cycle, prices would respond, and the cycle would immediately move to the next stage. One of the key aspects of these cycles is that there is always some uncertainty.

Chances are you won’t be able to accurately call a market cycle top or bottom. But, if you understand the stages you can be more cautious when a distribution stage is likely, and avoid panic selling during an accumulation stage. Familiarizing yourself with a few technical analysis concepts such as the Dow Theory, will help you stay on the right side of the major trends. In fact, many of the widely used charting concepts are variations on wave cycles.

The Effects of Market Cycles on Asset Valuation 📜

Ultimately, the value of a stock depends on the profits that company generates. But the price of that stock on any given day depends on much more than the company alone.

Cycles affect the valuation of assets in two ways. Firstly, economic conditions and business fundamentals often improve and then deteriorate during the course of the cycle. This means the intrinsic value rises and falls.

The second way valuations are affected by the cycle is psychological and emotional. When prices are rising, narratives develop to support even higher prices. When market peaks occur, valuations are often completely detached from reality. The opposite occurs when prices fall, and investors expect conditions to continue to get worse.

Different Stages of a Market Cycle 🗃

As mentioned, a market cycle has four stages. Each stage has certain characteristics that you can look out for. In addition, some sectors and asset classes perform better than others during various stages of the cycle.

A market cycle consists of four stages: accumulation, uptrend or markup, distribution, and downtrend or markdown.

Accumulation Phase 🔋

The accumulation phase begins when the mark-down phase of the previous cycle ends. At this stage, valuations are attractive but sentiment is still negative. The only investors brave enough to get back into the market are company insiders, value investors and contrarians. Other market participants still believe that prices will fall further and use any strength as an opportunity to sell.

Large funds and institutions also use this stage to invest. They do this because they can only buy into weakness — or they will simply drive the price higher without filling their orders.

During the accumulation stage news flow tends to be mixed with some good news and some bad news. Some analysts will become optimistic, while other analysts remain bearish. Prices often trade in a range during the accumulation stage, with a series of minor rallies and declines.

Mark-Up Phase 📈

The mark-up stage begins as sentiment switches from neutral to bullish. Economic and corporate news improves, and asset prices begin to rise. This causes investor confidence to improve, and attracts momentum and growth investors — including retail investors.

In the early stages of the mark-up phase value stocks outperform. As the rally gathers momentum, new narratives about the future evolve and growth stocks may outperform value stocks. The mark-up often consists of several smaller cycles, with confidence growing with each cycle. During this phase buying the dip keeps working.

Cyclical stocks may also outperform the various stages of the mark-up phase. Consumer discretionary stocks benefit when consumer confidence improves, and the stocks of insurers and the top stock brokerages rise as portfolio values rise. Banks also benefit if interest rates rise as margins are higher when rates are higher.

Distribution Phase 📰

The distribution phase occurs when sentiment and opinions become divided. By this stage valuations will usually be high relative to historic averages. News flow also becomes mixed, with some companies disappointing investors when they report earnings, while others continue to perform well. Volatility often increases despite a lot of investors remaining bullish.

Typically investors that focus on valuation and invest during the accumulation phase will begin to sell. Meanwhile, those who missed out on the rally, will continue to buy as they anticipate an extended rally. In essence, early investors will be selling to late comers during this stage.

Headline indexes like the S&P 500 struggle to make new highs during the distribution phase, but some sectors may continue to perform. Commodity producers often outperform late in the cycle along with commodities and gold, which can thrive during periods of high interest rates or inflation. A good sign that the market has entered the distribution phase is that the ‘buy the dip’ strategy stops working.

Mark-Down Phase 📉

The mark-down phase begins when the entire market turns bearish. Often the decline starts with a catalyst like lower-than-expected corporate earnings or weak economic data. As prices fall, the level of fear increases causing more investors to sell. If investors pull their money out of mutual funds, fund managers are also forced to sell stocks whether they want to or not.

During the mark-down stage, overvalued and speculative stocks fall the most. Defensive sectors like healthcare and consumer staples, and value stocks may outperform — but their prices still fall. Even stocks that are undervalued may fall as decisions are driven by fear rather than logic.

The mark-down phase ultimately results in capitulation — when panic selling takes over and investors give up.

The Difference Between Bear and Bull Market

You probably know that prices rise during a bull market and fall during a bear market. But, a bear market is not simply the inverse of a bull market. Bull and bear markets have distinct characteristics.

Characteristics of a Bull Market 🐂

Bull markets usually start when economic and business fundamentals are improving. But emotions often take over. The emotion that is most often associated with bull markets is greed. Investors start seeing the market as a way to make money fast. This can lead to excessive risk taking, and in some cases to the use of leverage.

Visual representation of the longest-running bull market of the S&P 500 Index
Following the 2008 financial crisis, the S&P 500 underwent the longest-running bull market in history.

Believe it or not, fear also plays a role during bull markets. Specifically the ‘fear of missing out’, also known as FOMO, causes investors to chase each rally.

During a bull market a virtuous cycle develops as narratives develop to justify higher stock prices. The narrative causes prices to rise, and rising prices are seen as proof that the narrative must be correct. Stock valuations are based on future profits, rather than current profits.

Bull markets can continue as long as there is money to keep them going. If interest rates remain low, as they did through the period of quantitative easing, a bull market can keep going for years.

A bull market can turn into a bubble if valuations become unrealistic. Bubbles are usually caused by a large amount of speculative investing and the idea that ‘this time it’s different’.

Characteristics of a Bear Market 🐻

Bear markets begin during the distribution phase and gather steam during the mark-down phase. During this period, fear is the primary emotion driving investors. Investors sell to prevent further losses — even when they think stocks are undervalued.

Visual representation of a bear market which lasted from 2007 to 2009 in which S&P 500 dropped more than 56%
During the bear market linked with the 2008 Financial Crisis, the S&P 500 declined by more than 56%.

Technically, a decline becomes a bear market when an index falls 20% from a peak. If it falls 10 to 20%, it’s a correction. Bear markets are usually much shorter than bull markets and usually last less than 18 months.

One of the main differences between bull and bear markets is volatility. Volatility is much higher when prices are falling, with large daily moves in both directions. In fact, the biggest rallies occur during bear markets. These are known as bear market rallies.

Bear markets are usually accompanied by economic events like a recession, rising unemployment or a sudden increase in interest rates. However a bear market will usually begin when investors think one of these events will happen soon — rather than when it actually occurs.

How Long Does a Market Cycle Last? ⏳

The major market cycles typically last a few years. These cycles are loosely aligned with economic cycles which average 3 to 5 years according to the National Bureau of Economic Research. Of course cycles can last a lot longer, as we saw with the cycle from 2009 to 2020.

Secular cycles which are driven by technology and demographic shifts can be much longer, and include several market cycles. There are also much shorter cycles that occur over a period of days to months. Individual stocks and industries also experience shorter cycles.

Market Cycle: Examples 📝

The following three examples of market cycles illustrate that in reality cycles vary quite a lot. There isn’t always a clearly defined accumulation or distribution period. Sometimes distribution occurs before and after the peak, while accumulation can occur in the later stages of the mark-down period.

S&P 500 Index 2008 to 2020 💹

The major market cycle of the last 15 years started in 2009 (after the Global Financial Crisis) and ended in 2020 (when the Covid-19) pandemic began. This was an historically long cycle, with a decade long bull market supported by very low interest rates.

This cycle had some of the classic traits of a major cycle. The previous cycle ended after the S&P 500 index fell 56%. At that point everyone seemed to think the world was ending, and that stocks would continue to fall. Nobody, at least that we are aware of, predicted that the index would rise by 376% over the next 11 years.

Chart showing the recovery of the S&P 500 Index over the course of 11 years
Following the 2008 financial crisis, the S&P 500 Index recovered, rising 376% from 2009 to 2020.

When there is a very severe mark-down period and prices become very oversold, the market sometimes rebounds very sharply. This is known as a V-shaped recovery and often means there isn’t much of an accumulation period. This happened in 2009, and again after the bear market in March 2020.

You can also see that there were several smaller cycles during the mark-up period. This is very common during prolonged bull markets.

Nasdaq 100 Bubble June 1998 to Sep 2002 🌐

The ‘dotcom bubble’ was one of the most famous bubbles in history and occurred between 1998 and 2001. This was of course just after the internet went mainstream, and investors began to realize the potential of internet companies like Amazon. Unfortunately, the optimism resulted in valuations becoming detached from reality.

Visual representation of the famous "dotcom" bubble
The “dotcom” bubble lasted from 1988 to 2002, in which the NASDAQ reached a peak of over $5000 in the ’00s, after which the NASDAQ collapsed after the bubble burst.

When the Nasdaq bubble burst, all the gains of the previous two years were given up. This particular cycle didn’t have a clearly defined start, but there was a small correction in 1998, which some would consider the beginning of the cycle. By the time the index bottomed in September 2003 it was below that starting point.

U.S. Growth Stocks Bubble 2020 to 2022 📊

The ARK Innovation ETF (ARKK) became very popular in 2020 as software companies like Zoom (ZOOM) and DocuSign (DOCU) led the remote working trend. Money flowed into the fund when its performance started to stand out. The fund then invested this money in the same stocks, causing them to rise even further, which attracted even more investors.

Visual representation of the ARKK ETF performance from 2019 to 2022
Performance of the ARKK ETF from 12 Dec 2019 to 15 Apr 2022.

Eventually the prospect of higher interest rates halted the rally and the cycle reversed. In this case, poor performance led to withdrawals from the fund — forcing the fund to sell the same stocks. In this way the virtuous cycle reversed with poor performance leading to redemptions, and forced selling leading to more poor performance.

This cycle didn’t have a clearly defined accumulation period, but the distribution stage is easy to see. As of April 2022 it appears that an accumulation period is now under way, though it may be too early to tell. It’s always easier to determine the stages after the fact, rather than in real time.

💡 Interested in further reading? Learn how mark to market works to assess the value of a portfolio.

Conclusion 🏁

We can’t always be certain of the current stage of the market cycle. But, we can use a process of elimination to identify where we may be — and we can use that information to make better investing decisions. The idea isn’t to make predictions, but to manage your expectations and risk as the cycle develops.

How Do Market Cycles Work: FAQs

  • What is Considered a Market Cycle?

    A market cycle is considered to be the period between two  major market lows. The cycle includes four stages: accumulation, mark-up, distribution and mark-down. Market cycles typically include a bull market and a bear market or a smaller correction.

  • Why is it Important to Understand Market Cycles?

    Understanding market cycles and their stages is important as it helps investors manage expectations and risk. If you know the stage of the cycle the market may currently be in you can avoid buying too late or selling too early.

  • What Are the Stages of the Stock Market?

    The market cycle’s four stages are accumulation, mark-up, distribution and mark-down. The accumulation and distribution stages are transition periods between bull and bear markets.

  • What is the Duration of a Market Cycle?

    Market cycles last for three to five years on average. They can be as short as one year or longer than ten years too.

  • Are Market Cycle Lengths Always the Same?

    No, market cycles aren’t always the same length. The last major cycle lasted 11 years, from 2009 until 2020. However, most are considerably shorter than that. The length of a cycle depends on many factors including the business environment, monetary policy, innovation and demographic shifts.

  • What Are the Market Cycle Indicators?

    Investors can use technical and fundamental analysis to indicate whether a new cycle is developing. Usually during a cycle a major index will rise above its 200-day moving average and then fall back below it again. Valuations may also rise until they are substantially higher than average and then fall until they are substantially lower than average.

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All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.