Market cycles, much like the changing of the seasons, occur between economic activity, corporate profits, interest rates, and confidence. Predicting every turning point precisely is difficult, but a simple approach is needed: a cycle isn't a one-off event, but rather a series of overlapping changes that propagate across assets like stocks, bonds, and commodities. Investors navigate this cycle not by luck, but by their perception of the environment, their understanding of their goals, and their control over risk. The Cambridge Dictionary defines a cycle vividly: "A set of events occurring in a specific order, one after another, and this order often repeats."
"Unlike the symmetrical cycles in the physical world, the symmetry of economic cycles only applies to the direction of rises and falls; the magnitude, timing, and speed of these rises and falls are not necessarily symmetrical."
There is currently no universally accepted understanding. However, it can be considered a framework and method used by top investors to think about the entire investment world. Just as using a DCF valuation model to calculate company valuation is a way of thinking about company value, there is no right or wrong answer, no standard solution; the final analysis depends on each individual's understanding.
Why Study Market Cycles?
Essentially, people want to study historical events through market cycles, summarize lessons learned, and make better investment decisions to increase profits. Howard Musk believes that "students who understand cycles, like those who don't, don't know what the future will actually hold." However, understanding cycles doesn't guarantee profits, but it increases the probability.
Four Basic Stages of Market Cycles
Expansion Stage:
The economy gradually recovers, corporate profits improve, consumer and investment confidence rises, and stock market and economic data often rise in tandem. Interest rates are low or gradually rising. Investor sentiment is optimistic, and funds are willing to take greater risks.
High/Peak Stage:
Growth has reached its peak, profit growth slows, but price and interest rate pressures may begin to emerge. The market often diverges, with some leading sectors continuing to perform strongly while cyclical sectors see their gains weaken. Risk appetite begins to decline, and valuation elasticity is limited.
Readjustment Stage (Recession or Slowdown):
Growth slows, corporate profits are under pressure, the credit environment tightens, and market anxieties intensify. Funds will gravitate towards defensive assets, leading to increased volatility and widespread downward pressure on asset prices.
Recovery/Trough Phase:
The recession gradually bottoms out, and interest rate and monetary easing help the market find new support levels. At this point, investors begin to focus on signs of improvement, preparing for the start of a new upward cycle.
How to Navigate Cycles?
The key is to understand where the psychological and valuation cycles of investors are currently positioned. Psychological cycles can be roughly judged by observing investor behavior. Valuation cycles can be determined using tools such as the price-to-earnings ratio.
Different Views and Positions of Investors on Cycles
Attempt to identify turning points using macroeconomic data and statistical signals, aiming for "timely entry" at cycle turning points. This approach is common in trend- and indicator-driven trading but is easily influenced by noise.
Focus more on long-term structural factors, such as demographic trends, productivity, and the lasting impact of technological changes on industries. Their focus is often not on short-term price levels but on the impact of cyclical changes on long-term portfolios.
Emphasize stability during cyclical fluctuations, favoring low-volatility, stable cash flow assets such as high-quality bonds, defensive sectors of quality stocks, and, when necessary, cash allocation to mitigate the impact of systemic risk.
- Growth and Opportunity Investors:
Tend to seek out industries and companies with strong earnings resilience, reasonable valuations, or high growth potential in the early stages of cycles and recovery phases. They are willing to accept higher volatility in exchange for higher potential returns.
- Diversified and Passive Investors:
Smooth out the impact of cycles through broad asset allocation, relying on long-term market trends rather than point-in-time operations, and focusing on the overall risk exposure and return stability of the portfolio.
