Whether it’s the life cycle of organisms, or the rotation of the seasons, things tend to move cyclically. And the economy with regards to investment cycles is no exception.
Although the economic cycle is perhaps more unpredictable than the changing of the seasons, it still tends to move through the same general phases. These phases can vary drastically in length and severity. However, knowing what they are and what they generally mean for the market is a definite boon for investors.
In this post, we will discuss the four phases of the investment cycle (also referred to as the market cycle or business cycle). We will talk about what they mean, how smart investors respond to each phase, and the role that investment cycles play in investing in general.
Investment Cycles and Their Phases
Phase 1: Accumulation (early cycle)
The first phase is the accumulation phase, also referred to as early cycle. The accumulation phase signals that the market has hit its bottom. At this time, prices have flattened and sales growth has started to improve.
For innovators (corporate insiders and value investors) -and early adopters (smart managers and experienced traders) this early phase is incredibly valuable. This is the time for them to buy low into the market.
First of all, valuations are very attractive. In addition, the sharp recovery from recession (the last phase of the investment cycle) has led to an accelerated growth rate.
Phase 2: Mark up Phase (mid cycle)
The phase following accumulation is the mark up phase, also known as mid cycle. The mark up phase signifies that the market has been stable for a reasonable amount of time. This phase is unlike the accumulation phase where only the savvier investors can tell that the market is showing signs of stabilizing.
At this point, these savvy investors (the innovators and early adopters) are exiting the market and cashing out their shares, while others are just entering. The investors that enter the market during the mark up cycle are still fairly ahead of the curve, though.
Other trademarks of the mid cycle phase are:
- unemployment is rising
- growth rate is moderate, but still trending in a positive direction
- credit growth is high
Sales growth also tends to level out, as opposed to the early cycle phase where it was still on an upward trajectory. The mark up phase is typically the longest of the four phases. It is long enough that investors entering it in the beginning are still considered to be early. Meanwhile, investors entering in the middle are just following the trend by that point.
And then of course by the end of the mark up phase even more investors jump in. And they are considered latecomers, and they cause the market volume to increase substantially.
Phase 3: Distribution (late cycle)
The third phase of the economic cycle is referred to as the distribution, or late cycle phase. Early adopters and innovators are bearish by this point. As such, they can tell that the market is headed into a downward trajectory.
For this reason, sellers are ‘king’ of the distribution phase; anyone attempting to invest in the stock market during the late cycle is in for a rude awakening. Prices can often stay locked into a trading range for long periods of time (weeks or even months) during the distribution phase.
Additionally, there is a considerable amount of economic activity, particularly selling, taking place during this phase. So, the growth rate still remains positive, but slows considerably. S&P 500 valuations tend to be increasingly extreme as the late cycle continues. And eventually the market will change directions, signaling the end of the distribution phase.
Phase 4: Recession (mark down)
And finally, it is inevitable that markets cycle through the recession phase as well. This is also often referred to as the mark down phase of the business cycle.
Smart investors will have already sold their assets, but the recession phase is marked by latecomers selling off what they can. Those same early adopters and innovators we’ve been talking about are on the prowl during the mark down phase. In fact, they are keeping an eye out for signs of a bottom (marking the beginning of the accumulation phase) so they can enter into the fray of things. As a result, they start a new investment cycle again.
The recession phase is exactly what it sounds like – a recession. Although the severity of it can vary drastically, of course, the telltale signs of recessions remain:
- a decline in corporate profits
- a lack of credit,
- low interest rates
- everyone trying to sell, etc.
What Investment Cycles Mean for the Investor
So why spend so much time discussing the phases of the investment cycle?
It’s because of the difference when innovators and early adopters entered various stages of the cycle vs when latecomers (or even mid-comers) entered stages of the cycle. As a result, your knowledge of and acumen for the signs of the shifting market dynamics generally plays a huge role in how successful your asset investments will be.
A smart investor wants to avoid getting stuck in so called market bubbles (getting caught up in the groupthink that leads to extremely high stock valuations). Hence, they must know enough about the phases of the business cycle to know what phase the market is currently in and what would come next. In this way, they can make smart decisions about when, where, and how much to invest (or sell).
Of course, we are not suggesting that you should know how long each phase is going to last. The investment cycle reflects the fluctuations of economic activity. As such, the cycle is entirely dependent upon the variables that determine economic activity at any given time.
As proven by the events of 2020, this is sometimes unpredictable and based on circumstances outside of our control. Even the smartest investor does not know exactly how long to expect to be in a given phase. Instead, they observe and let the behavior of the market guide them as it progresses.
Market cycles can last anywhere from a few weeks to a few years. Therefore, instead of focusing your efforts on timing the changing of the phases, we recommend focusing on understanding the phases and how the market will behave during each one.
Being proactive with your investments
A common mistake that occurs when investors focus too much on trying to time the phases is that they end up waiting too long for the next phase to come. The danger in waiting too long is that oftentimes the change will end up happening so quickly that you won’t have time to take action, thus rendering all that waiting time useless.
So instead of waiting, focus on preparing and positioning yourself as best you can for the phase that inevitably lies ahead. The one certainty we do have about the market cycle is that – although each and every cycle we have gone through is unique in its own way – the pattern remains consistent and repeats itself over time.
Once you have familiarized yourself with this pattern, you can use the shifting of the phases to your advantage in making investments. If used correctly, knowledge of the phases of the investment cycle can provide a blueprint for making asset allocation determinations. Generally, the current phase of the cycle (and the makeup of that phase) will provide valuable information on how you can reasonably expect your assets to perform. For those looking for a mid range investment strategy, this can provide an incredibly helpful framework.
Investment Cycles and World Leaders
One condition that has been traced over time as a reliable determinant of the investment cycle is the presidential cycle. Some might even say that the presidential cycle has a strong effect on the phases and behavior of the market cycle.
Presidents seeking re-election want to demonstrate a strong economy, and so make tangible efforts to stimulate the economy during election years, through avenues such as lowering interest rates.
Once again, 2020 serves as a particularly interesting example of this, although interest rates are certainly low. The trade off for a stimulated economy during election years is often economic sacrifices made during the first two years of a given presidency. Typically, as the election year approaches, efforts to achieve better economic performance will ramp up.
And now it’s up to you, the investor, to use investment cycles to your advantage when making investment and asset allocation decisions.
So much of the decision making surrounding investing comes down to your individual situation, of course. Considering:
- your tolerance for risk
- the desired length of your investments (your time horizon)
- when you want to cash out
And this is where we can help you. We are always here to consult individually and help you make smart investment management decisions that will benefit you and your family for years to come.
We Can Help
There are few things that affect as many areas of your life as your wealth. Thinking about retirement, estate, or financial planning? Or will you use your wealth to provide for legacy or charitable purposes? Proper wealth management is what will make it happen.
At Saddock Wealth, our years of wealth management experience can help guide you toward financial prosperity. Schedule a meeting here, and we’ll discuss your best options.