Equity Market Cycles, Positioning and Seasonality

IG Index Head of Research Anthony Grech offers in-depth analysis into a range of topics so you can improve your knowledge of the financial markets. These free topical reports, accessible to account holders only, track the historic performance of various markets.

Here's a taste of our latest report on the FTSE^® 350 market cycle. You can access the full version in the TradeSense Databank found in the PureDeal platform, or take a look at the research archive for past reports.

Equity market cycles, positioning and seasonality

For many years, economists have noted that economies move in regular cycles of growth and contraction. These cycles can vary in their length; the originator of the concept, French economist Clement Juglar, argued that they usually lasted between seven and 11 years.

Equity markets tend to be a leading indicator of the business cycle. In this report we look at the FTSE^® 350 (the largest 350 companies on the London Stock Exchange, by market capitalisation) and examine how different sectors have performed throughout the cycle. We have identified that the FTSE^® 350 equity market cycle lasts 6.7 years on average, with each cycle exhibiting four distinct periods: Crisis, Rebound, Expansion and Peak.

The FTSE^® 350 equity market cycle

Crisis

The start of a cycle can be characterised by the ‘Crisis’ period, where equity markets undergo a correction usually in excess of 20%. GDP is normally still expanding at the start of the phase, yet growth begins to decelerate and in some cases contract as the crisis unfolds. Unemployment, widely considered to be a lagging indicator, is typically falling during the beginning of this phase. As the ‘Crisis’ deepens, consumer confidence deteriorates and business investment declines. Companies tend to restructure to remove low-profit, low-performance departments, increasing the level of spare capacity in the economy.

Rebound

Prices eventually hit a bottom and equities enter a ‘Rebound’ phase where returns in excess of 30% are common over a relatively short period. The unemployment rate typically starts to recover during this period, however GDP is usually rising and consumer confidence rebounding. Business inventories may still be declining in this phase as companies seek to maximise savings and clear out old stock.

Expansion

In the ‘Expansion’ phase, economic activity gathers pace, interest rates are typically rising (or expected to rise) and consumer confidence is on the mend. GDP would normally be growing at around trend pace, business production improves and new technologies emerge. Business investment increases throughout this period, which further supports economic growth. During this stage equity markets are rising and merger activity picks up again. We believe that current equity markets have entered the ‘Expansion’ phase.

Peak

Eventually economic growth begins to slow as the cycle enters the ‘Peak’ phase but consumer confidence remains high, equity prices reach new records and businesses have the confidence to invest in longer term projects. As a result, growth in construction orders tends to accelerate. Equity market volatility starts to pick up and shares eventually undergo a sharp correction, bringing the equity market cycle back to the ‘Crisis’ phase.

Sector performance

As well as examining the general equity market cycle, it has been noted that individual sectors of the economy go through changing periods of outperformance and underperformance relative to the overall stock market.

Sector rotation is a long-established practice among fund managers; these industry professionals seek to maximise the returns on investments by shifting their allocations between sectors as the equity cycle progresses. As one phase of the cycle moves into another, managers will reduce their holdings in sectors that have, historically, tended to underperform the wider market, and move the funds into areas that are expected to outperform. Access the full report for a breakdown of sector performance since 1986, and insight regarding future possibilities.

Follow your views

Whether you believe markets will follow the expected cycle or break the pattern, IG Index gives you the opportunity to back your opinions and profit from them if you turn out to be right. You can take a position on any of the individual sectors or companies mentioned above, on the commodities which influence sector performance, on the broader indices or on a wide range of global forex pairs.

To read the full report, open an account and get set up in minutes. For details of the markets available through an IG Index spread betting account, please see our Range of Markets pages.

The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.