What is a Market Cycle?

Market cycles represent a trend, either upward or downward, in the financial markets. Either cycle can be triggered by various sets of circumstances and can last several years or more. A prolonged surge of buying activity in the stock market is known as an up market or bull market. Conversely, a period of prolonged decline, during which sellers are out in earnest and buyers are hard to find, is called a down market or bear market. Change in a down market cycle is triggered once a bottom is reached, while an upward market reversal occurs once the securities, such as stocks, peak in price.

Either type of market cycle can last for years, even decades. Financial markets historically have gone through periods of both market environments, although no two cycles are exactly alike. When stocks are entering a bull or bear market, there are certain indicators that market technicians recognize surrounding corporate profits and the economy to pinpoint that cycle. These conditions are tied to several factors, including a company's price-to-earnings ratio. This is a measurement of an entity's trading price per share divided by its earnings, or profits per share, which are reported quarterly and yearly.

In a bullish market, there is a period of widening price-to-earnings ratios that is enhanced by a low interest-rate environment, which means the cost to borrow capital is low. These factors, coupled with a favorable or low inflationary environment, are signs of a bull market. Inflation in a regional economy refers to the level of costs for goods over an extended period of time. Stock market activity is robust during a bullish market cycle as investors enjoy the benefits of rising stock prices resulting from solid corporate profits.

In a bear market cycle, the economic and market conditions are quite the opposite. The average corporate price-to-earnings ratios begin to narrow, interest rates rise, and the inflationary threat becomes greater. For some, a bearish market cycle represents an opportunity to buy securities at a discount, as long as a company is fundamentally strong. The logic surrounding buying stocks during a down cycle is that investors often sell securities when market conditions are depressed, even if the underlying financials in that stock are sound. Therefore, a stock that has been beaten down because of the broader market conditions is more likely to rise again when the economic and market conditions improve.

There typically is an index tied to each region's stock market that represents investor sentiment in that market. In the United States, the S&P 500 is a broad representation of stock market activity because it measures price changes across 500 stocks in major global industries. Performance in this index can be considered a reflection of the general market cycle that occurred over a period of time.