With the current volatile economic conditions with high interests rates and talks of a market crash looming, are we really at the edge of a stock market crash right now? And should one continue to DCA into index funds or stocks?
Understanding market cycles and investor sentiments during these times can help you to form a better thesis on the current macroeconmic environment, as well as develop a sound strategy for your investing journey.
The Four Stages of a Market Cycle
Stage 1: Decline (Despair)
A period of decline or what many may qualify as a “market crash” is typically preceded by a period of heightened optimism and inflated stock prices.
You know the saying, “what goes up must come down?”. That’s why you often here people saying that a “correction” is incoming because stock prices are just too high to sustain growth.
When the stock market falls, it falls hard. One reason is also because people tend to be overextended when they are in a “greed” mode and rely heavy on leverage to maintain their positions. When prices come crashing down, they are forced to liquidate their positions which causes even greater downward pressure on stock prices.
Many people often look at this stage as a time of great sadness and despair. Be in actual fact, market crashes are a good opportunity for patient investors to wait out and seive through good buying opportunities.
Stage 2: Accumulation (Hope)
When the stock market hits it’s bottom (we won’t really know where exactly until looking back in retrospect), that’s when the accumulation phase starts. This may be typically a slow and boring period of time as investors slowly start to find their footing again and get to buying stocks at cheap prices.
It’s actually a great time to start picking up good stocks that you’ll be comfortable with holding for a while.
Stage 3: Mark-Up Phase
During this phase the bullish sentiments start to kick in as prices start to rise more drastically. Valuations may start to hit much higher numbers as the market starts to get heated. Investors sentiments also start to turn towards greed.
At this stage of the market cycle, investors greed is high and you will likely see many bullish news blasted on different media outlets. Whilst everything seems green and confident in the market, this is actually the time to be more fearful.
Stage 4: Distribution (Optimism)
At this point with valuations soaring at record highs, a lot of mixed sentiments might start to creep in. Bears come out of their caves to start calling for market corrections, whilst bulls continue to accumulate stocks at high prices.
Keep close watch of market indicators like the Fear & Greed index or Margin Debt index to monitor market sentiment.
Of course, you will never know when the market will enter into decline and should never try to time the market top. It is advisable to continue dollar-cost averaging into safe stocks like the S&P index, but at the same time keep some cash on hand for safety. This is not the time to be fully invested into the market.
Be fearful when other’s are greedy and greedy when others are fearful– Warren Buffett
How Long Does a Market Cycle Last?
Depending on the definition of a “market cycle”, it can last for a few months to years. As a long-term value investor, I tend to take a broader long-term approach when looking at the current market cycle.
In this graph, bear markets are defined by price declines of 20% or more, whilst bull markets are all other periods of price accumulation.
The average bull market yields approximately 265% returns on the S&P and spans over a period of 67 months. That’s not to say that there wont be periods of significant decline in prices during a bull market (as can be seen from the graph). However if you are holding for the long-term, then you won’t be too affected by relatively small price decline in the short-term.
Use this information only as a very rough gauge as the actual duration of the current market cycle can vary quite differently.
Latest Market Bottom
At the time of writing, my latest identified market bottom was on 14 October 2022 when the S&P was at it’s low. Assuming we are actually in a bull market right now, that would mean we still have a quite abit of runway left in the bull.
As for me, I will be continuing to DCA into S&P index funds as well as buying undervalued stocks that have good growth potential of at least 25% for my risk appetite.