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Market Cycles – How They Work And How To Use Them To Your Advantage

Most of us have heard of the business cycle and I think most all of us have heard of the term “market bubble”. The term bubble is just a fun way to say end of a market cycle. If you google search the term "cycle" you see the dictionary definition as “a series of events that are regularly repeated in the same order” or “a complete set or series”. Pretty straightforward right? Over my career I have self-conducted extensive study of market cycles and I have been lucky enough to have a great mentor shed decades of knowledge onto me to then apply in real time.

Understanding The Bigger Picture

Let's first start with the bigger picture. Cycles occur naturally throughout the universe. There are four seasons in a year and three distinct cycles in the life of a dragon fly, these are just two examples. To go a step further, you also have cycles that are a result of another cycle. For instance, the tide height of the ocean is a direct result of the Moon and it’s interaction with the Sun and Earth. When the Sun and Moon are aligned it creates greater gravitational pull which results in very high and very low tides. Conversely, when they are not aligned the opposite occurs and less dramatic tides result. To go even one step farther, I hypothesize that the “myth” of the full moon’s effect on human mood actually has relevance. After all, our body is 55-60% water and the moon affects the ocean tides, why would it not also affect us? So it seems all things are somehow tied together in some way. Even on a grand scale cycles are occurring. Think of the birth and death of stars throughout the universe as an example. These cycles last billions of years!

Science is fascinating but why does it matter to the markets? Well, just like cycles occur throughout nature they also occur in markets. No matter what market you are referring to, all have similar characteristics and go through similar phases. They go up, they peak, they go down and they bottom. When one cycle ends another begins. So if you can understand where we are in each market’s cycle, you might have a better chance of managing your risks and perhaps do a bit better than average.

Where it gets confusing for most is that there are smaller cycles within larger cycles. Often times one can mistake the level or severity of the peak or the trough. One might think a large market cycle has peaked when it is a cycle peak of a smaller degree. An example of a severe peak to trough would be the market cycle of 2007-2009 where 2009 marked a severe low. A severe low should be more infrequent than the minor ones. So in theory it is possible that low marked the beginning a new “large” cycle.

How To Apply It

This can be challenging for some. But the idea is to overweight asset classes that are likely to be in favor and underweight assets that are out of favor. I will give you examples that are relevant at the current time.

1. Equities - Likely in an up cycle

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2. Gold - Likely in a down cycle

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3. Bonds - Likely near the end of an up cycle, turning to a down cycle

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Now these are just a few major asset classes. The list could go on and on. If one is to keep a longer term mind set, weight their holdings to align with the asset cycle and maintain diversification, I would argue your likelihood of success could be better.

How To Identify Cycles

I will use equities as an example but this can be applied broadly. These are some of the tools to help identify where we are in the equity cycle but there are many ways to attempt to quantify the cycle.

  1. Earnings Trend

  2. Price trend

  3. The slope of the yield curve

  4. Investor sentiment

Often times it takes years of study and practice to get a handle on this. As I mentioned, I have been lucky enough to have had a great mentor who is much older than me but even still, no one is perfect or bats a 1.000 average.

It is not always obvious but cycles do exist in markets as they do throughout the universe. Some people are more talented than others at identifying them. Macro cycles can last as long as 10- 15 years or more. If you can get these larger cycles correct, then you can stand to manage your risk and hopefully improve your chances for long term success.

If You Would Like Help

If you would like to ask me additional questions or if you would like for me to analyze your investments and how they are aligned relative to the current market cycles, please schedule a call with me. You can access my calendar here to schedule a phone session.

Cheers to continued success.

Dsiclosure: Asset allocation does not ensure a profit or protect against a loss. Exchange Traded Funds concentrating in specific industries are subject to higher risks and volatility than those that invest more broadly. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

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