If market volatility is like an annoying summer week when the temperature goes from 65 degrees to 90 degrees and back – and you don’t know whether to wear a sweater or a swimsuit – the market as a whole is like the parade of seasons.
According to Goldman Sachs’ Chief Global Equity Strategist Peter Oppenheimer, history tends to repeat itself in economies and financial markets. In other words, the stock market tends to follow a definable cycle. Some seasons may be longer or shorter than usual, but you can feel pretty confident each one will be followed by the next in line until it all starts over again.
In his book, "The Long Good Buy," Oppenheimer describes four phases of the stock cycle: despair, hope, growth and optimism. Why are these market phases named for human emotions? Because Oppenheimer believes that feelings are important drivers of market cycles. After all, most investors are human. The fact that traditional forecasting overlooks investor sentiment, according to Oppenheimer, “partly explains why turning points in the economic and financial cycle are not well anticipated.”
So, let’s take a look at the four phases and how they relate to the way investors think and feel:
Back to volatility. It tends to calm down as we move from Hope to Growth and rev up as we move from Optimism to Despair. Why? Because market volatility is related to changing investor expectations and uncertainty.
What’s going to happen next? Should we sell? Should we buy? When the answers aren’t simple, the market has trouble finding a clear path. And we feel most uncertain and off-balance when we’re moving from confident Optimism through a period of doubt and disappointment to the edge of the trough of Despair.
Back to our cycle of seasons for a moment. We always have spring, summer, fall and winter. They are always in that order. But some winters are longer. Some summers are shorter. It may snow more or rain less or be hotter or colder than usual.
But to break the metaphor, the market cycle year isn’t always the same length. In fact, it usually spans multiple years, which makes it harder for us humans to recognize and adapt. Yet recently, Covid sent us spinning through phases at a rate that made many of us a little motion-sick.
After enjoying one of the longest market cycles in history, we plunged into one of the shortest. We went from the beginnings of Optimism in 2019 to sudden Despair in February 2020 when the virus hit. This Despair season was much shorter than average, lasting little more than a month, and the following Hope phase was much stronger (although it lasted a very typical 9-10 months). 2021 was a year of Growth (a phase that averages 4 years in length).
Now it’s 2022. Volatility has increased and the market as a whole is down. It’s possible that we’re still in the Growth phase but experiencing a correction, which isn’t uncommon in this phase. But sometimes it’s hard to identify exactly what part of a cycle we’re in while we’re in it, and this is one of those times.
Today, we’re facing disillusionment with some new not-yet-profitable technologies, rising interest rates, high inflation, a tight job market and a turnabout from globalization to regionalization. These factors are different from the last cycle, so maybe it will snow more or we’ll need a warmer coat. But then, once again, the season will change.
Knowing there’s a cycle based on investor feelings may help you understand when and how emotions can get involved in the markets and in your own investment approach.
If you want to minimize the effects of emotion on your portfolio, a disciplined long-term approach could help. Some investors rely on automated strategies to support long-term discipline.
Dollar-cost averaging, for example, is a simple strategy that aims to reduce the impact of emotions and volatility. By systematically investing equal (or roughly equal) dollar amounts at regular intervals, investors may be able to buy more shares when prices are low and fewer shares when prices are high. This can mean paying a lower average cost per share over time and help limit losses in market declines.
Portfolio rebalancing is another disciplined strategy that can help protect investors from excess risk. As prices change, rebalancing regularly adjusts the holdings in a portfolio to keep them aligned with a chosen allocation of asset classes (stocks, bonds, etc).
So try taking a fresh look at changes in the market with cycles in mind. When you know spring is coming, you’re less likely to panic at a heavy snowfall. And when you know fall is on its way, you probably don’t expect summer blooms to last forever. You can appreciate opportunities and take the challenges in stride – even volatility.
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