Knowing stock market cycles – benefitting from bull markets
Bull markets are not uncommon after global crises. The sharp rise in market prices after the COVID-19 crisis is an impressive example. Stock market cycles provide one explanation for this. Those who want to benefit from future bull markets should know the phases of a stock market cycle.
Déjà-vu: Stock market cycles repeat themselves
Major stock exchange cycles, with their booms and bubbles, are a fascinating mirror of human and social behavior. You learn the ups and downs of stock markets from experience. This may precisely be the privilege of experienced investors. They sometimes understand major stock market cycles better, can participate in bull markets for longer, and still get out before everyone else.
The phases of speculative stock market cycles of the US national economist Charles Kindleberger provide a guide to understanding such cycles:
Phase 1: A new market narrative emerges. Technological and economic upheavals are often followed by the creation of a new, relevant narrative. This narrative fires up the imagination of many market participants – slowly at first and then more and more. Such market narratives are by no means just pipe dreams. They refer rather to relevant developments – otherwise they would not last long.
Phase 2: A boom sets in. The new market narrative is increasingly accepted and priced. To a certain extent, this creates a self-fulfilling prophecy, draws more and more capital, and thus initiates an – initially unnoticed – stock market boom. Occasional corrections give the boom additional resilience and extend it at the same time. This is because corrections confirm to investors that the market is still "healthy" and not "out of control."
Phase 3: Euphoria and profit-taking occur. In the third phase, all eyes are on the stock exchange. Everyone wants to jump on the bandwagon – a typical trap for inexperienced investors: They jump on and off too late. Greed and unrealistic promises blow up the process.
While experienced investors get out with a profit, inexperienced ones want to hang on, even though various signals already indicate that the peak has passed. However, inexperienced investors grant the already dying bubble one last breath through supporting purchases.
Phase 4: Panic and capitulation follow. In the end phase, the liquidity that previously seemed endless dries up. After that, everything goes very fast. The cost of capital goes up in leaps and bounds. More and more companies experience a credit crunch. Flotations are canceled. Other dominos fall – and suddenly every investor is looking to get out.
But when everyone wants to sell, it's already too late. The stock market is in free fall, investors capitulate. Those with cash and a cool head are now ahead of the curve. After all, it is a well-known fact that the best investments are made in the darkest hour of capitulation.
Why market prices are going up
The crisis and the stimulus following the COVID-19 crisis have led to staggering asset inflation worldwide. And said inflation is receiving an unabated boost from the following influences:
- Global liquidity glut of central banks
- Unrelieved investment crisis experienced by almost all pension funds
- Record levels of profits and margins
- Record levels of private financial assets in developed countries
- Continued recovery in share repurchases
Precisely because a tailing-off of these powerful driving forces is hardly foreseeable, the current financial bull market still seems intact and not out of control.
How investors should take advantage of a bull market
Even though all phases of a market cycle are interesting, the bull market following the COVID-19 crisis in particular raises a legitimate question: What is still cheap nowadays? Are price and value even still relevant categories? Yes, they are. What seems more important, however, is that excessive bond valuations almost inevitably pull the valuations of equities in their wake. But fortunately, equity markets have been driven so far by profit growth rather than valuations. Therefore, investors should take three things to heart during a bull market:
- The best way to benefit from the current boom is through discipline, diversification, and a suitable strategy.
- Market corrections strengthen the resilience of markets. Investors should use them to invest available liquidity in suitable strategy investments.
- When bonds are cheap, the bull market is probably at its peak.