Markets can seem chaotic, but learning to identify the cycles of change can help you keep your head on straight and your portfolio healthy.
Although you may be familiar with the cycle of bear and bull markets, there’s a lot more to the ebb and flow of fluctuations in the stock market. Understanding the kinds of changes the market regularly goes through can help investors to better recognize what stage the market is in, and how to manage the normal emotional reactions during each phase that can potentially throw off your long-term strategies.
What Drives the Cycles?
Economics is sometimes called “the queen of the social sciences,” because analyzing economic trends ultimately translates to studying the general emotional state of a whole society, aggregated together. Markets tend to lead the wider economy by six to 12 months on average, but they’re both reflecting an even more widespread mood.
A bull market indicates a general feeling of optimism or even, in Alan Greenspan’s famous phrase, “irrational exuberance.” At the top of the market, even questionable investments can feel like deals too good to pass up. “Feeling happy can give us false expectations that good times will continue,” explains Northeastern University psychologist David DeSteno. The overall feeling is one of euphoria, where every move seems correct (even if they’re not – this is also known as the “point of maximum risk”).
When the bear rules the bottom of the market, the fear of missing out has, on average, given way to pessimism about putting any money out there at all, causing emotion-driven investors to pass on what could be excellent buys. The overall feeling is of despair, where every move seems wrong (even if they’re not – this is also known as the “point of maximum opportunity”).
Between those two phases – the emotional high of the bull and the despondent low of the bear – are a number of intermediate phases.
Coming off the high of an expansive bull market is a downturn. Since the middle of the 20th century, bull markets have tended to last a little less than five years on average. The buying spree comes to an end either due to “the wall of worry” (a succession of negative events that don’t directly affect market fundamentals) or “the wallop” (a single negative event that directly affects GDP, like the invasion of an allied country or the outbreak of a previously unknown illness). A bull market can climb over the wall, but the wallop can send the market into a longer-lasting decline.
For emotional investors, regrets over recent losses can lead to unreasonably gloomy outlooks. There are general feelings of anxiety and denial, mixed with envy for those who “got out in time.” A rational response, however, is to persevere with our long-term plan or to rebalance your portfolio for greater efficiency.
The opposite of the downturn is the rebound. Since 1946, a bear market has typically lasted no longer than 16 months, much shorter than a bull. Signs of a coming rebound might include low interest rates, rising corporate profits, and a general feeling of relief and hope, as if the sun is finally peeking out from behind storm clouds. These could indicate that it’s a good time to check with a financial advisor about possibly investing more than you have in recent months, since stocks bought at the beginning of a rebound can see a steep rise in value.
Finally, a rebound on its way back up to the top of the market will pass through a rising bull phase. The investors around you might seem to be more confident than usual, or even greedy, snapping up investments almost too quickly for comfort. The general emotional state moves from hope to excitement and thrill-seeking. The only fear most feel is fear of missing out, and many portfolios run the risk of becoming too stock-heavy without the right mix of bonds and other investments to act as a safe counterbalance against possible turbulence.
Stay on Target
The market rises and falls in waves, but experienced investors and financial advisors have learned how to detect the signs of each of the above phases. They know how feelings of hope, fear, euphoria, and excitement can help make the right investment decisions, or tempt investors into the wrong ones. Capital Financial Solutions, monitors the markets to watch for signs of the next rebound, downturn, or any other stage of the market cycle. The right advice at the right time can keep successful investors disciplined and focused on investment goals rather than short-term (and often illusory) gains. An experienced advisor can help adjust an investor’s portfolio precisely as needed, not overreacting but ready for whatever phase comes next.
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The views stated in this piece are not necessarily the opinion of Cetera Advisor Networks LLC and should not be construed directly or indirectly as an offer to buy or sell any securities. Due to volatility within the markets, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results. Re-balancing may be a taxable event. Before you take any specific action be sure to consult with your tax professional.