The movement of the financial markets can seem mysterious — and yet, if we look back over long periods, we can see definite patterns that consistently repeat themselves. As an investor, how should you respond to these market cycles?
To begin with, it’s useful to know something about the nature of a market cycle and its connection to the business or economic cycle, which describes the fluctuations of the economy between periods of growth and contraction. Issues such as employment, consumer spending, interest rates and inflation can determine the stage of the business cycle. On the other hand, the market cycle refers to what’s happening in the financial markets — that is, the performance of all the different types of investments.
The market cycle often anticipates the business cycle. In other words, the stock market may peak, or hit bottom, before the business cycle does the same. That’s partially because the financial markets are always looking ahead. If they foresee an event that could boost the business cycle and help the economy, such as the Federal Reserve lowering interest rates, they may become more “bullish” on stocks, thus driving the market up. Conversely, if the markets think the business cycle will slow down and the economy will contract, they may project a decline in corporate earnings and become more “bearish” on stocks, leading to a market drop.
