Navigating market cycles

By iA Private Wealth, October 25, 2022

If you invest in stocks, either directly or through mutual funds and ETFs, you know the market never rises steadily without periods of decline along the way. That’s how the “market cycle” works, and the better you understand the inevitability of this cycle, the more you can succeed as an investor.

What’s a market cycle?

Over a period of time and based on prevailing economic conditions (among other factors), markets go through distinct phases. The four main phases are accumulation, mark-up, distribution and decline.

• Accumulation. This phase typically arises from a period of severe market decline. Stock valuations tend to be attractive after falling from higher levels, but it takes courage to invest in this phase as the “wounds” from a sharp decline are still fresh and it’s not yet clear the market has “turned the corner.”
• Mark-up. In this phase, some time has passed, upward trends are being established and investors are generally convinced the market has bottomed. More people begin jumping back into the market amid wider optimism for future gains.
• Distribution. Markets are rising in this phase and early buyers begin capturing their gains by selling to latecomers who waited for clear signals confirming the market’s upswing. Amid high stock prices, the market also experiences a growing number of valuation “pullbacks” as overenthusiastic investors have bid some stocks too high relative to their value.
• Decline. This phase starts to bring the market full circle, as an “overbought” market is filled with stocks that are ripe for a sharp decline. Some overconfident (or simply greedy) investors linger in this phase longer than they should, assuming that falling stock prices will quickly rebound.

Investors and the market cycle

Given these different phases, how should people invest? It helps to acknowledge that the duration of each phase will vary, but generally market analysts can only define and “time-stamp” phases after the fact, once data has been studied.

Accordingly, it makes sense for most long-term investors to avoid trying to time the market. Yes, stock markets tend to follow patterns. It’s tempting to think you’ve identified the end of a “decline” phase and should start buying stocks again. However, market timing usually isn’t a successful long-term strategy because it’s virtually impossible to predict how markets will fare over a particular time period.

Understanding bulls and bears

Markets are prone to rise and fall – that’s just the way they react to macroeconomic and geopolitical circumstances. When the market rises 20% above its recent low levels, it’s commonly referred to as a “bull market.” When the market declines 20% below recent high levels, it’s known as a “bear market.”

Although both market types are inevitable, historically the long-term trend has been to move higher. In fact, according to data from Bloomberg as at December 31, 2021, the average bull market lasts about 78 months and generates an average return of 193% over that period. Meanwhile, the duration of the average bear market is only about 11 months, and the average return is -32%.

Armed with this knowledge, most long-term investors are best served by recognizing stock market cyclicality but not jumping in and out. If your timing isn’t perfect – and that’s a safe assumption unless you own a crystal ball – you risk selling when stock prices are still rising, and buying when stocks are declining.

Either way, you could be creating “permanent loss of capital” that will interfere with achieving your long-term financial goals.

Benefits of staying the course

It requires discipline to remain invested through the down phases of a market cycle, just like it does to resist the temptation to be greedy when you think stocks have nowhere to go but upwards. However, sticking to your investment strategy is a proven way to build long-term wealth. An Investment Advisor can help you stay true to your wealth plan and keep emotions out of investing. A good advisor has the skill and experience needed to guide you through the market cycle so you can ignore short-term “noise” and focus on the future with confidence.

We can provide the sound financial advice you and your family need under any market condition, so contact us today.

This article is a general discussion of certain issues intended as general information only and should not be relied upon as tax or legal advice. Please obtain independent professional advice, in the context of your particular circumstances. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.