Stocks can go through phases of growth and contraction, which may result in reaching new highs in one year and all-time lows in the next. Such cycles or fluctuations are typically influenced by company-specific factors, including management decisions, new product launches, earnings reports, and high levels of debt.
In a similar vein, benchmark indices such as Nifty and Sensex also see periods of rallies and steep falls, driven by a range of factors such as macroeconomic conditions, changes in government policies, corporate earnings, and investor sentiment. These fluctuations create patterns, known as "market cycles" or "stock market cycles," which are common in the stock market.
In times of economic expansion or a bull market, the Nifty and Sensex usually experience an upward trend as investor confidence increases. This trend can be attributed to the rise in demand and revenue growth of companies, mainly due to higher consumption in the economy.
Conversely, during an economic contraction or a bear market, both indices tend to fall as investor sentiment deteriorates, and companies may struggle with lower demand and revenue.
In this explainer, we will take a closer look at different types of market cycles and some examples of those that the Indian stock market has experienced in recent times.
Types of Market Cycles
The market cycle is typically divided into four stages: accumulation, markup, distribution, and markdown. Each stage is marked by specific characteristics that can affect investor sentiment and market behavior.
Accumulation stage: The accumulation stage is the initial phase of a stock market cycle, where investors and institutions begin to identify undervalued stocks that have the potential to grow in the future. This stage can be seen as a period of quiet accumulation by informed investors who are aware of the underlying value of certain stocks.
During the COVID-19 pandemic, the accumulation phase was seen in the Indian stock market as investors looked for opportunities to buy stocks that had taken a hit due to the pandemic's economic impact. For instance, when the pandemic began, many companies' stock prices dropped significantly as the economy faced uncertainty. However, some investors saw this as an opportunity to buy undervalued stocks that they believed would eventually recover.
In the accumulation phase, the smart money is typically invested in stocks that are underappreciated or have growth potential. Investors who are aware of the underlying value of certain stocks start to buy them at a lower price, causing the stock to start showing some momentum. This stage is also marked by a lack of public interest, as most investors remain cautious and unsure about the stock's potential.
Markup Stage: The markup stage is the second stage in a typical market cycle, following the accumulation stage. During this stage, stock prices start to rise, and investor sentiment becomes more positive as they become convinced that the market has bottomed out.
As vaccine rollouts progressed and the number of COVID-19 cases started to decline, investors became more optimistic about the future of the economy. This optimism fueled a surge in demand for stocks that were expected to benefit from the economic recovery.
For example, in India, stocks in sectors such as pharmaceuticals, IT, and consumer goods gained momentum during the markup stage as investors became bullish on their growth prospects. Companies that were involved in vaccine production or had a strong digital presence saw their stock prices rise rapidly.
Distribution Phase: The distribution phase in the market cycle is when the market has reached a peak and investors begin to sell off their positions, causing a gradual decline in stock prices. This phase is typically characterized by high trading volumes and a shift in investor sentiment from optimism to caution.
The Indian domestic benchmark indices experienced a markup stage and reached record highs in December last year. This was likely due to a combination of factors, including strong participation from retail and domestic institutional investors, favorable government policies, and a rise in credit demand.
However, the ongoing tension between Russia-Ukraine concerns, rate hikes from major central banks, a consumption slowdown in India due to high levels of inflation, and expensive valuations of stocks have led to a correction in the Indian stock market. This correction indicates that the market may be entering a new phase in the market cycle, which may lead to increased volatility and uncertainty in the short term.
Markdown stage: The markdown phase in the market cycle is the fourth and final stage, following the distribution phase. During this phase, the market experiences a sharp decline, and investor sentiment turns negative. This often happens due to a combination of factors, such as an economic recession, a decrease in corporate earnings, or a significant global event that shakes investor confidence.
Market Cycles Vs. Market Trends
Market cycles are a natural occurrence in the financial markets, characterized by periods of growth and decline in stock prices. Market trends, on the other hand, refer to the direction in which the market is moving over a period of time.
The market trend is classified into two parts: bull and bear markets. A bull market is characterized by rising prices, high investor confidence, and strong economic growth. On the other hand, a bear market is characterized by falling prices, low investor confidence, and weak economic growth.
In conclusion, market cycles are an inherent part of the stock market. Understanding these cycles is critical for investors to make informed investment decisions. While market cycles may bring volatility and uncertainty in the short term, they can also present opportunities for investors to identify undervalued stocks and potential growth areas.