Ask The CFP® Practitioner
“The only investors who shouldn’t diversify are those who are right 100 percent of the time. For those properly prepared in advance, a bear market in stocks is not a calamity but an opportunity.”
— Sir John Templeton, 1912-2008
Question: Would you explain market cycles and why they matter?
Answer: Understanding market cycles and keeping the ups and downs in perspective can be a challenge especially when discussing market or economic activity. There’s no doubt that markets are cyclical, and that often makes it difficult to adhere to a long-term investment strategy.
The term “cycle,” as in market cycle, economic cycle, interest rate cycle or sentiment cycle, gets plenty of use among financial professionals. Cycle typically refers to propelling something forward by pedaling as with a unicycle, bicycle or tricycle, depending on your stage of life. The broader definition of the word describes sequences, phases, progressions and rotations. Like most professions, finance is chock-full of potentially confusing jargon. Some fundamental ideas, like economic, market and sentiment cycles, are relatively easy to comprehend.
The objective is to recognize and coordinate economic cycles with your life cycle. Matching long-term and short-term goals with an investment policy statement provides the opportunity to reflect your comfort levels and anticipate your needs while constructing a portfolio and monitoring of those investments.
As individual economic units, we start out as youngsters by learning, then transition into our earning years, and with proper planning hope to avoid yearning during our later years. Businesses and economies also pass through three distinct stages or cycles: 1) start-up, 2) growth and 3) maturity. Individuals, corporations and economic entities share a common goal — to avoid decline and deterioration.
Let’s focus on three key financial cycles that provide a view of where global markets are and where they may be headed.
Economic cycle analysis provides assessments of trends during growth and expansion periods as opposed to contraction or recessionary market phases. Since the 2009 stock market bottom, global markets, the United States and emerging economies have been on an impressive run. Current valuations appear to be in the proper range of historical averages, suggesting that there is potential for additional upside movement in global markets. Gross Domestic Production (GDP) is low but shows some growth; inflation is low and is expected to remain so for the near-term; and government debt levels in all regions are flattening after being at historically high levels for the past three years. All this points to the conclusion that the global market appears to be improving.
Market cycle movements analyze where markets are positioned in relationship to the ongoing ebb and flow of valuations. The categories are early-recovery, increasing growth, late-cycle decreasing growth and recessionary declining growth. Current factors indicate that the economy is at a crossroads between early-recovery and moving into a mid-cycle growth phase. Economic and monetary indicators, such as interest rates, corporate profits, and manufacturing activity, influence market cycles.
Sentiment cycles explore how both investors and markets actually perceive and then react to current conditions and expectations. Consumer sentiment or confidence significantly influences day-to-day market activity as well as affecting longer-term trends. Currently, confidence levels appear somewhat mixed by region. This may be due to ongoing policy changes in the Asian Pacific area that could alter attitudes in the latter half of 2014. Fear, hope and greed drive psychological market cycles.
It’s advantageous to have a game plan in place ahead of time to deal with any anxiety that these cycles may cause. If you’ve thought through how you may react in various situations, it may make it easier to stick to your plan and use rational decision-making techniques. Removing emotion from the equation may help you fight the temptation to react impulsively in ways that may not match your long-term goals.
Begin by checking your asset allocation to see if it has changed and decide if this is the time to rebalance. A market downturn may provide an opportunity to do so.
Remember, you don’t have to do everything at once.
Finally, make use of market cycles to view potential opportunities as well as obstacles. Analyze any disappointments and learn from them. Determine what went wrong, why it occurred, and what, if anything, might have been done differently. Determine if your portfolio is positioned to handle volatility through your life cycle. Everyone experiences setbacks; good investors learn from the tough times. Stay focused and invest accordingly.
This information is general in nature, it is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or solicitation to buy or sell any particular investment. There is no guarantee any particular investment strategy will be successful. Opinions expressed herein are those of the author and subject to change at any time. Investing in stocks involves risk, including the possibility of losing one’s entire
This article provided by Darcie Guerin, CFP®, Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041,[email protected] or www.raymondjames.com/Darcie. Please contact Darcie with any questions you would like to have answered in this column.