Understanding the investment market
Posted by Northadvisory on April 17, 2020
Whether you are new to investing or a seasoned professional, the current state of the global economy is hard to ignore. With the outbreak of COVID-19 reaching all corners of the planet, the economic impact has been headline news for weeks.
We realise that this can be worrying for many investors, but in this time of heightened uncertainty we want to share some insight into investment market cycles… and while things feel calamitous today, we are confident of a strong return.
Business life cycle
Firstly, we’d like to discuss the different stages within the life cycle of businesses. Each stage has different opportunities for investors, but there are some that are less risky than others.
The first stage is the formation of the company. Often, an entrepreneur will launch the business based on a new idea… perhaps a technological advancement, a never-before-seen invention or a unique business niche. There is potential but there is currently no profit. The startup could be an overwhelming success or a dismal failure. Investing at this early stage is recognised as high risk.
2. Rapid Growth –
Once a company has a validated business model and has started to grow, they move into this second stage. Their brand becomes well-known and this could be the stage where they are publicly listed. Examples here are companies such as Airbnb or Uber. Their profitability is still somewhat questionable… perhaps they don’t have regular profits yet, or they are on the cusp of profitability. Internal focus within the organisation is definitely on maintaining their growth.
3. Market Dominance –
Market dominance is achieved once the company has grown large enough to be recognised as their industry leader. They have proven their strength and are delivering regular profits. Investments are no longer speculative and this is when investors can see a return on their invested capital. These companies are often touted as a rising star, such as Netflix, Facebook or Etsy. However, it must be noted that success in this stage usually means a high share price.
4. Maturity –
Companies reach maturity when they are enjoying their highest profit margins but growth has slowed. During this stage, there are a number of options to support business renewal. They could invest in R&D to create new products or consider an acquisition to boost their growth. Profits at this time are the highest they’ve ever been and regular dividends are returned to shareholders. Companies of this size often expand outside their initial industry niche and some examples would be Apple, Amazon and Google.
5. Decline or Renewal –
This final stage of the business life cycle is where the company is losing market share, either through competition or disruption. If left unchecked the business could eventually fold, but this is where the renewal component of the previous stage can help bring the company back into market dominance and maturity. Decline is sometimes a result of mismanagement and under-investment. This can lead to profits being used to maintain existing dividends rather than vital reinvestment.
Each business will perform differently and will spend varying amounts of time in each of these stages. They might even fluctuate between stages depending on their internal structure and industry competition. But if you are able to identify where your current investments sit within their life cycle, you might have a clearer vision of their expected progress.
From bull to bear and back again
The second element of investing that we want to discuss is the specific market cycles. You’ve most likely heard of the terms “bull” or “bear” markets, which have very clear traits that highlight investor behaviour and influence share prices.
The length of these cycles can vary greatly. We have been experiencing a bull market for over a decade and there are contrasting views amongst industry professionals that say we are currently entering a bear market, or we could see a rapid recovery once this health crisis is contained. Either way, it’s good to understand the key points within the cycle.
- Top of the market – every cycle eventually reaches the top, where the strong growth starts to wane. Typically, there is low unemployment and interest rates are on a downward trajectory. During this time, the risk of recession is increasing and corporate profits are feeling the pinch. It’s not uncommon for investors to be overconfident and “buy high” at this point.
- Bear market conditions – after the top, we move into bear market conditions where the economy is in decline and recession is likely. Market stocks are reducing in value as company profits drop. This is often a time when people are tempted to sell because they are concerned about losses… but this is when you need to keep a long-term perspective. Moving your assets to cash could limit your potential to build your wealth. Diversification is the key here, and depending on the combination of assets within your portfolio, you might even be able to continue investing through the bear market.
- Bottom of the market – when the market reaches the bottom, it is often the most emotional point within the cycle. It can be fraught with concern and doubt and we understand how this can be difficult to endure. Even when you have a firmly executed plan, it’s hard not to feel disheartened. But you can also find opportunities during these dark days. Many stock options are on sale and history shows us that investors who have been able to buy during this time have done well as the market rebounds.
- Market rebound – the bounce back brings us into the beginning of the next bull market. The economy starts to lift and corporate profits begin to turn around. This is when stocks also rise and research indicates that the average increase in the S&P 500 is 47% within the year following the bottom of the market. Unfortunately, many investors miss out on this solid rebound as they have already retreated during the previous points of the cycle.
- Bull market conditions – these are the conditions we have been experiencing since 2009. Economic growth and expansion are robust and stock prices continue to increase. However, when we get close to the end of the cycle, company profits are less predictable and volatility begins to creep in. By this stage, investors are confident and make impulsive decisions. Rather than maintaining a balanced mix of assets… they chase profits, moving too far into stocks. This puts them at risk when the next downturn arrives.
Managing emotions during downturns
It is hard not to feel worried in tumultuous times. We know that the constant media cycle simply fuels anxiety and investor concerns… and we understand that watching the value of your investment portfolio drop can create a feeling of urgency to safeguard what you have.
But we also know that for a solid investment plan to work, you need to stick to it. Weather the storm and keep your eye on the horizon. A strong plan includes a diverse mix of stocks, bonds and cash and is designed to help you reach your long-term goals.
As difficult as it might be, don’t let your emotions lead your investment behaviour.
Seek advice from professionals
Understanding the market cycle is important for any investor, but it can be challenging to navigate on your own. The team at North Advisory are here to help you build a portfolio that suits your needs and provides you with the right mix of assets.