Cyclical Markets/Stocks

What are “Cyclical Markets/Stocks”?

In a simple nutshell, cyclical markets (and stocks) are sensitive to the underlying economic conditions and tend to outperform in times of economic prosperity and underperform in economic downturns.

There are cyclical and secular bull and bear attributes of markets/stocks. Cyclical markets/stocks are categorized by returns that fluctuate with the economic cycle. These can be shorter-term trends and repeat over time as the business or economic cycle repeats. Industries that have particularly cyclical markets include automobiles, housing, commodities, and any industry that is driven by demand that is directly related to economic growth. Cyclical markets/stocks can be both positive or negative (i.e. bullish and bearish respectively) in their performance.

Bull and Bear Markets

A bull market is characterized as a sustained period of increase in the prices of various asset classes. This is a term most commonly used for the stock market or equities’ performance. However, other asset classes – such as real estate, commodities, currencies, or any other asset class – can have bull and bear markets.

Whilst there is no formal criteria or measurement for a bull market, there is an unofficial threshold that suggests a 20% or more rise in stock prices is confirmation of a bull market. Bull markets generally occur during a time period when the economy is experiencing strong growth (i.e. there will be strong GDP growth along with a fall in unemployment and corporate profits will be on the rise) and consequently driving an upward moving stock market.

Conversely a bear market – is characterized by a sustained period of declining asset prices. In the case of bear markets, the unofficial threshold is a 20% or more drop in stock prices. This threshold is informal and does not also include the impact of dividends on the total return to investors.

The specific dates and lengths of bull markets and bear markets for any asset class can only really be known in hindsight, as that 20% increase or drop respectively needs to be reached, to be able to declare a formal bull or a bear market. If a 20% move is not reached, some investors might just categorize it as a short-term correction in prices for that asset class.

Bull and bear markets for US stocks are usually measured by the S&P 500 index, which is generally the most widely followed index for this type of analysis. Historically in the US, bull markets have been longer with higher increases in stock prices versus bear market declines. More specifically, in the US stock market, going back to 1926 toi current, bear markets saw a decline averaging only -45%, versus the bull appreciation of 159% for the timeframe.  Further analysis shows that the bear markets lasted for an average duration of 24 months, while bull markets lasted for an average of 54% longer.

Cyclical Markets Versus Secular Markets

Being able to identify and differentiate between secular and cyclical market trends is extremely important when analyzing financial markets and making market forecasts.

Unlike cyclical markets, secular markets are categorized by returns over a long period of time and are not short-term in nature. They are typically driven by long-term forces. Therefore, secular trends are those that are expected to remain moving in the same direction for a long period of time. Secular trends are generally seen at the industry level versus the broad market level. Further, secular shifts are typically due to technology, but also due to changes in demographics and regulation too.

Cyclical Markets/Stocks and Simple Moving Averages

There are several technical indicators to assess the cyclicality of markets and help comprehend bullish and bearish market trends. This involved looking at the upward (rising) and downward (falling) trends vis-à-vis the broad market indices (or an industry’s stock) respectively. One such technical indicator is the Simple Moving Average (SMA).

Given below is the closing price of Stock A from day 1 to day 20 and the calculation of the SMA (5-day Moving Average). Actually, one should take an SMA of the closing price of a stock (or broad market indices) for a period of 50 days, 200 days, or longer, to identify the upward (bullish) or downward (bearish) trend direction. However, a much shorter period is taken here, to simply illustrate the concept of SMA.

Calculated below is the 5-day Moving Average of stock prices of Stock A, which reveals clearly that the market/stock has an upward momentum i.e. it is in a bullish phase. If this were a much longer example, we could start to analyze whether this was a cyclical bull market, or if there were any fundamental changes in the underlying economic and regulatory conditions that were supporting the stock outperformance.