Like winter, spring, summer and fall… the stock market cycles. Now if you are aware of this phenomenon, you can better prepare your investments to reflect this reality. Being unaware of stock market cycles, on the other hand, can make you panic when things don’t go your way.
One of the most important concepts about the stock market is this feature of moving in cycles. Like the seasons that fluctuate repeatedly, the stock market moves between periods of extreme optimism and pessimism. This is where the terms bear and bull market originate from.
The interesting thing about strong bear or bull markets is that they aren’t readily apparent until after the fact. While general prosperity or low stock market returns are occurring, most investors are consumed with issues inside the current season, unaware that a new season might be and often is just around the corner.
This is one of the reasons why being a contrarian is so profitable. It’s also a factor in why value investing works so well. Value investing depends on investor sentiment and emotions wildly mis-valuing securities beyond its logical value. The difference of undervaluation becomes the margin of safety that value investors chase.
There’s two ways to look at the stock market. One is a very black and white approach. Either you buy a stock and it makes you money or loses you money. This is a very frustrating mindset to have, because you have no control over the situation. Anything can and does happen in the markets, and you’re just hoping that you come out ahead this time. It’s a short term and limited approach.
The other way is to recognize that the stock market moves like the seasons. Other than bankruptcy, nothing is permanent and things are changing all the time. Instead of trying to directly profit from our trades, you’re trying to hold for the long term and generally buy companies that are undervalued. This allows you to hold through less advantageous times and see opportunities where others don’t.
One glance at any stock chart will show you how much more the stock price fluctuates than the actual value of the business does. The ability to identify this value and capitalize on it is a major part of finding success.
Another major key to success is staying conscious of what season the market is in and making investment decisions based on this. Let’s examine some key characteristics behind the 4 seasons of the stock market.
Winter: This is the cold chill of a bear market. Periods such as this are often marked with high volatility and company bankruptcies. Sometimes you’ll see financial panic and bank runs, and people often say “this time is the end of the world.”
Of course, anyone paying attention would say that’s ridiculous. The market won’t be in a permanent bear market no matter how bad things get, in the same way that the world won’t freeze over because of a bad winter storm.
Contrary to popular belief, this will be the best time to buy stocks. The media will be filled with reports and studies showing how bad stocks are as investments. This is because they are cherry picking the time period, and using the events to manufacture fear and attract clicks and attention.
It can be hard to buy stocks during this time, particularly because seemingly better opportunities are out there. For example, when interest rates spike and stock prices drop, the interest rate for a CD or bond might be temporarily much higher than the average yearly stock market return you seek.
There was a time 30 years ago when you could get 9% interest on your money outside of the stock market, and so many people didn’t buy stocks. This kept stocks low for quite some time, but the investors who patiently resisted this temptation were handsomely rewarded.
Spring: This is the time between the bear and bull market. The brutal cold of economic recession, unemployment, and general negativity is starting to lift.
Keep in mind that there won’t be a sudden announcement of this new season of the stock market. If you’re following the media, you’ll see that they’re usually a season behind. Economic reporting, outside of unreliable forecasts, is done in the past tense.
This time period presents some of the best opportunities for investing in stocks. Share prices are usually suppressed, allowing for many big quality blue chip companies to be purchased at a steep discount. You’ll start to see the recovery reflecting first in the earnings, and the share price usually follows.
Understand that it’s always darkest before the dawn, and if you’ve struggled through winter remember that spring and summer are just around the corner.
Summer: After several years of recovery comes summer, the strongest part of the bull market. This is when the media begins to recognize stocks as once again quality investments. Blue chips preform quite strongly in this period. New emerging industries tend to spring up during these periods and even rise to bubble levels, such as biotech in the most recent bull.
Investing during this time mostly requires going along for the ride. You can’t just buy any stock and expect it to go up like you might’ve been able to in winter, but you can feel confident that many stocks will continue to rise for the short and even medium term.
Fall: This season marks the end of the bull market. The end of a bull market is easy to spot, but impossible to time. During the end of a bull market, you’ll see lots of IPOs and mergers and acquisitions. Founders of companies desperately try to cash in before it’s too late, while companies increasingly squire and merge with other companies as they start struggling to continue the torrid growth of summer.
This is when you want to be extremely picky with you investments. Search for value and don’t settle with overpaying for stocks. By far, this season is the trickiest to invest in. By searching deeper for value you’ll inevitably come across lower quality businesses. Have the discernment to avoid those stocks while still buying discounted stocks. If you’re struggling with this, my book is centered on this single concept.
Final word: By no means am I advocating you try to time the market and jump into winter and out of fall. You won’t be able to do it. Unlike real weather, there aren’t definite signals for the end of seasons in the stock market.
So, make sure you are dollar cost averaging with your investments. Use this knowledge of seasons to assist you with picking what kinds of investments you want to make, but stay consistent with the amount. This is the proven way to win in the long term with your investing.