Any Happy Returns

Chapter 2Equity Cycles and Their Drivers

Wave‐like swings in the mind of the business world between errors of optimism and pessimism.

—Arthur Cecil Pigou

Historically, within financial markets there is a pattern of short‐term cycles and longer‐term super cycles, or secular trends, within which shorter‐term cycles evolve. Although there are long‐term shifts in the return profile of equities that depend on prevailing macroeconomic conditions (in particular, the trade‐off between growth and interest rates), most equity markets show a tendency to move in cycles that relate to some degree to the prevailing business cycle. Because equity markets move in anticipation of future fundamentals, the expected prospects for growth and inflation tend to be reflected in current prices. These market moves can also affect valuation; if investors start to expect a recovery in future profits from a recession, for example, then the valuation of the equity market will rise in the period before the improvement emerges.

Across an investment cycle, there are typically both a bear market (a period when prices are falling) and a bull market (a period when stock prices are generally rising or are relatively stable in price returns). That said, no two cycles, or even secular super cycles, are the same. Some are much longer than others, and some are disrupted mid‐way through, perhaps by a specific shock or event that takes the index back to the inflection point without completing a full cycle. Nonetheless, ...