By Peet Serfontein
Market cycles are a fundamental aspect of financial markets, encapsulating the ebbs and flows of equity prices over time. These cycles are a manifestation of a wide array of factors including economic fundamentals, investor sentiment, geopolitical events, and policy changes, which together contribute to periods of optimism and periods of pessimism among investors.
Typically, these cycles are expressed in two main phases: bull markets and bear markets. Bull markets are characterised by rising equity prices, often driven by strong economic indicators, improving corporate earnings, and investor optimism about future growth prospects. Bear markets encapsulate periods of declining equity prices, usually triggered by economic downturns, reduced corporate profitability, and widespread pessimism among investors.
Market cycles impact different industries in different ways. Sectors such as technology, consumer discretionary, and industrials may thrive in bull markets due to increased consumer spending and investment in innovation. In bear markets, more defensive sectors like healthcare, utilities, and consumer staples often outperform. Additionally, external factors such as interest rates set by central banks and changes in consumer behaviour also play critical roles in shaping the performance of these sectors during different phases of market cycles.
Bull markets
During bull markets, an atmosphere of optimism encourages investors to pursue higher returns by taking on more risk. This risk-taking behaviour is particularly evident in growth-oriented sectors like technology and consumer discretionary. Companies in these sectors often benefit from favourable economic conditions, as consumers have more disposable income to spend on technology and non-essential goods and services, and businesses invest in technological advancements and expansion activities. As a result, equities in these sectors can experience rapid price increases, driven by expectations of continued growth and profitability.
Moreover, the momentum of bull markets can be further fuelled by speculative investments and a phenomenon known as "FOMO" (fear of missing out). This can drive equity prices even higher, sometimes leading to overvaluations.
Bear markets
The onset of a bear market reflects a shift in investor sentiment from optimism to caution and fear, leading to widespread selloffs and reduced investment activity. Investors' appetite for risk diminishes significantly and there is a marked shift towards more conservative investment strategies, with a preference for less risky assets such as bonds or equities in defensive sectors like healthcare and utilities. These sectors are considered safer during downturns because they provide essential services that remain in demand, regardless of the state of the economy. For instance, people continue to require healthcare services and utility services like electricity and water, even during economic downturns, making companies in these sectors more resilient to market volatility.
Selected sectors in focus
Technology sector
Healthcare
Energy
Building a resilient, well-diversified portfolio
It makes sense for investors to have companies across a variety of sectors in their portfolios to benefit from market up-cycles, but to also guard against excessive losses during market down-turns. Investors can tilt their portfolios within cycles as well.
As an example, when equities have run hard and valuations in sectors like technology are stretched, it may make sense to take some profit off the table and while maintaining exposure to this sector, tilting your portfolio in favour of more defensive sectors like healthcare or consumer staples (which will mainly include grocery retail, beer, and cigarettes). Conversely, when markets have sold off substantially, it could signal an opportunity to begin tilting your portfolio more in favour of cyclical sectors like technology, energy, and consumer discretionary (which will include mainly clothing and durable goods retailers).
