Market Cycles: Definition, How They Work, and Types

What Are Market Cycles?

Market cycles, also known as stock market cycles, is a wide term referring to trends or patterns that emerge during different markets or business environments. During a cycle, some securities or asset classes outperform others because their business models are aligned with conditions for growth. Market cycles are the period between the two latest highs or lows of a common benchmark, such as the S&P 500, highlighting a fund’s performance through both an up and a down market. 

How Market Cycles Work

New market cycles form when trends within a particular sector or industry develop in response to meaningful innovation, new products, or regulatory environment. These cycles or trends are often called secular. During these periods, revenue and net profits may exhibit similar growth patterns among many companies within a given industry, which is cyclical in nature.

Market cycles are often hard to pinpoint until after the fact and rarely have a specific, clearly identifiable beginning or ending point which often leads to confusion or controversy surrounding the assessment of policies and strategies. However, most market veterans believe they exist, and many investors pursue investment strategies that aim to profit from them by trading securities ahead of directional shifts in the cycle.

Special Considerations

A market cycle can range anywhere from a few minutes to many years, depending on the market in question, as there are many markets to look at, and the time horizon which is being analyzed. Different careers will look at different aspects of the range. A day trader may look at five-minute bars whereas a real estate investor will look at a cycle ranging up to 20 years.

Types of Market Cycles

Market cycles are generally considered to exhibit four distinctive phases. At different stages of a full market cycle, different securities will respond to market forces differently. For example, during a market upswing, luxury goods tend to outperform, as people are comfortable buying powerboats and Harley Davidson motorcycles. In contrast, during a market downswing, the consumer durables industry tends to outperform, as people usually don't cut back their toothpaste and toilet paper consumption during a market pullback.

The four stages of a market cycle include the accumulation, uptrend or mark-up, distribution, and downtrend or markdown phases.

1. Accumulation Phase: Accumulation occurs after the market has bottomed and the innovators and early adopters begin to buy, figuring the worst is over.
2. Mark-up Phase: This occurs when the market has been stable for a while and moves higher in price.
3. Distribution Phase: Sellers begin to dominate as the stock reaches its peak.
4. Downtrend: Downtrend occurs when the stock price is tumbling down.

Market cycles take both fundamental and technical indicators (charting) into account, using securities prices and other metrics as a gauge of cyclical behavior.

Some examples include the business cycle, semiconductor/operating system cycles within technology, and the movement of interest-rate-sensitive financial stocks.

The Bottom Line

Markets generally follow the same cycle and although there is an average period of time for each cycle, political and fiscal policy can either extend or contract certain phases. Financial markets experience many mini-cycles in the short term, but large market cycles tend to occur in terms of months or years.