Cycles are unique phenomena that have fascinated man all through civilization. A cycle represents the completion of a periodically repeated phenomenon; it is an event-happening one after the other in a certain order. No matter what sector, cycles have similar characteristics, but may have different time or life span. All the cyclical variables have four common stages which go up-expansion, peak-prosperity, go down-contraction and then bottom out-recession. Cycle stages are intertwined and this makes it difficult to predict exactly when the next phase of a cycle commences or ends.
The following are variables whose cycles have a direct bearing on the investment sphere:
Economic cycle: Economic cycle generally captures the reoccurring and fluctuating levels of economy driving indices such as gross domestic product (GDP), interest rates, levels of employment, rate of inflation, prices among others. Apart from random shocks to the economy, such as wars and technological changes, the main influences on the level of economic activity are investment and consumption. Other factors that drive the economic cycles include; volatility of investments spending, technological innovations, fluctuations in government spending, monetary policies and fluctuations in exports and imports. Business cycles are usually of shorter duration than economic cycle, are industry or market specific and can be more easily influenced by money supply and monetary policy.
Market cycle: A market cycle basically reflect the entire range of activity or event over a given time period in a given market and though market cycles reoccur periodically, they do not occur in predictable schedule. The length of each full cycle can vary from several months to several years. It represents the movement from a period of increasing prices and strong performance-bull market, through a period of weak performance and falling prices-bear market, and goes back again to regain strength.
Trends may exist in a given market environment allowing some securities to outperform others due to advantages created by certain innovation, new product line and regulatory environment. Though market cycles are often hard to pinpoint and rarely have a specific beginning or ending point, investment experts believe they exist and pursue investment strategies that aim to profit from them by trading in securities within the swing of the cycle.
A unique feature of market cycle is that it generally runs ahead of the concurrent economic cycle. For example, investors begin to sell stock because they anticipate a recession, or turn bullish in the early stages of a recovery. Also within the market cycle not all cycles operate on the same schedule, a good example is the stock market which tends to operate on a different cycle from that of the bond or commodities markets. These overlapping but distinct cycles are the basis of the investment strategy known as asset allocation backed by fundamental and technical analysis.
Stock cycle:Stock cycle defines the period between the early uptrend in the stock’s price to a high and eventually to a downtrend. In effect, it represents an expansion and contraction period, somewhat like the economic cycle. It can be deployed for portfolio management allocation, allowing for more investment during accumulation and mark-up phases and less investment during the distribution and markdown phases.
The study of stock cycle is very critical to the success of investment decisions and will give investors invaluable insight into trending conditions for a stock whether sideways, up or down. Though the stock cycle can repeat itself, it is not necessary to predict it, having the right strategy however is essential to take advantage of what the price is doing to maximize profit taking.
To maximize investment or trading returns, investors must recognise that stock markets are cyclical and pose a significant challenge to investors aiming to time or predict the top or bottom of the market.
The following are four stages of the market investors must study and master to avoid being caught off guard or getting sucked into the market bubble:
Accumulation stage: This phase occurs after the market has bottomed out and savvy investors made-up of value investors and risk inclined investors begin to take position in the market, believing that the worst season is over. Valuations are usually very attractive to investors, who invest in securities over a period of time in order to build a portfolio of desired value. Though reports on the performance of these stocks may be gloomy and general market sentiment may still be bearish, the accumulation phase presents the best time to buy as prices are usually flattened due to sellers throwing in the towel. Overall market sentiment begins to switch from negative to neutral.
Mark-up stage:At this stage, the market has achieved some level of stability and is beginning to move higher. The early majority of mature investors join the bandwagon for several reasons including; fear of being left out, seeing that the market is putting in higher lows and higher highs and recognition that market direction and sentiment have changed.
As this phase begins to come to an end, the late majority run into the market and volumes begin to increase substantially. At this point, the greater fool theory prevails: the late majority are getting in, the savvy investor who entered at the accumulation stage begin to unload their stock holding. But as prices begin to level off, or as the rise slows down, those late-comers who have been sitting on the fence see this as a buying opportunity and jump in en masse. Prices make one last parabolic move, known in technical analysis as a selling climax, when the largest gains in the shortest periods often occur. But the cycle is nearing the top of the bubble. Sentiment usually goes from neutral to bullish to downright euphoric during this phase.
Distribution stage: In the distribution stage of the stock market cycle, sellers begin to dominate. This part of the cycle is identified by a period in which the bullish sentiment of the previous phase turns into a mixed sentiment. Prices can often stay locked in a trading range that can last a few weeks or even months. The distribution phase is a very emotional time for the markets, as investors are gripped by periods of complete fear interspersed with hope and even greed as the market may at times appear to be taking off again.
Mark-down stage: The final phase in the cycle is the most painful for those who still hold positions. Many hang on because their investment has fallen below what they paid for it. It is only when the market has plunged 50 per cent or more that the late-comers, many of whom bought during the distribution or early mark-down phase, give up. Unfortunately for them, but fortunately for savvy investors, this is a buy signal and a sign that a bottom is imminent.
Political cycle: One of the best examples of the cycle phenomenon is the effect of the four-year presidential or political cycle on the stock market, real estate, bonds and commodities. The theory about this cycle states that economic sacrifices are generally made during the first two years of a president’s mandate. As the election draws nearer, administrations have a habit of doing everything they can to stimulate the economy so that voters go to the polls with jobs and a feeling of economic wellbeing.
The stock market benefits from increased spending and lower interest in the year of an election. Evidence abounds on the immediate and lasting impact of politics on market forces and cycle.
The most constant thing about cycles is their ever changing character. This presents a challenge to investors whose expectation of earning of good returns is dependent on their understanding and ability to ride the various cycles mentioned above without getting swept away by the resultant forces at play.
• Olisakwe is the head of corporate social responsibility at Investment One Financial Services Limited
