In our journey through the cycles of economy and markets, we just arrived in stage 3. In other words, the economy is in full recovery, the markets are looking ahead and paying attention to the upcoming economic recession.
Recovery vs recession – in the markets, this fight translates into a tug of war between bulls and bears. The bull is a symbol for rising markets and someone who is positive for the markets is called ‘bullish’, whereas his more pessimistic counterpart is called ‘bearish’.
At the beginning of this fight, the bulls, represented by financial institutions and the many new investors of the recent run up in stocks, are able to compete with the bears, mainly the experienced investors.
The bulls see the outside world, a booming economy, and are convinced that stocks will rise further. Besides, the banks generates a lot of fees from this new investors and support the bulls with countless investment ‘ideas’ and optimistic market comments.
The bears, labeled as pessimists, let the bulls run around like a spanish torero. As the torero knows, that the bull is tired at one point, the bears patiently wait for the bull run to end.
The patience is based on the inevitable market retreat coming up and the knowledge, which sector will outperform in this market cycle, called ‘bear market‘.
Why is a market retreat in this phase inevitable? Well, there are economic and technical factors.
Economic: the full recovery-status will sooner or later lead to rising costs for companies, particularly in labor and commodities. The economic boom also leads to higher credit-volumes in the private sector, namely for housing. To tame the risk of overheating, the central bank will rise the interest rates. From the many effects this hike has, one is to highlight. The cost of capital for companies will rise.
In other words: higher labor costs, higher commodity costs and higher cost of capital are taking a hefty bite into the next earning pie and this is sending the stocks down the hill.
Another factor: to maintain higher stock prices, it’s necessary to constantly attract new investors into the market. But when the general public is already in and others have no interest or no money – there are simply no more buyers around to maintain the bull market.
Now the bears are taking over. A retreat from the market top to the tune of 15 to 20 percent, is called a ‘bear market’. In this market, all stocks are affected, some more (usually the big gainers of the past) and some less. The best performance in a bad situation is often realized by the so called defensive sectors as food or pharma.
There is almost no place to hide completely in a hefty bear market, so a lot of investors move the cash from the recent gains into the bond market, who profits from higher rates. There is also the possibility of ‘shorting’ the market, meaning to bet on falling prices and it’s common among professionals. For private investors this is a high-risk-gamble, since the risk of a short-strategy is theoretical infinite. So I would advise to stay away from stocks for a while, because the worst is yet to come.
The last stage in the stock market-cycle is the darkest. At least, it’s also the shortest. They way to the market bottom is the last part in our journey through the cycles of markets end economy: http://www.theleader.ro/capitulation-comeback/