The equity cycle is divided in 4 distinct phases
The equity market moves in cycles. In order to develop a frame of
reference for investors, we show how the cycle from one peak of the
market to the next is divided into four distinct phases, which we
describe as: Despair, Hope, Growth and Optimism. Here, in Part I of this
series, we analyze the economic context and the drivers of stock market
returns for each phase. In Part II, we will analyze asset, style and sector
performance. We believe Europe is currently in the Hope phase and will
move into the Growth phase in the early part of 2010.
We analyze when earnings growth is paid for
Most earnings growth is not paid for when it occurs during the Growth
phase, but when it is correctly anticipated during the Hope phase, and
when investors get overly optimistic about the future growth potential
during the Optimism phase. The Growth phase sees the highest rate of
earnings growth, but the second lowest rate of return over the cycle.
…and tie these patterns to the economic cycle
The phases are related to the economy. Generally, the Despair phase is
associated with a recession. The output gap troughs and the
unemployment rate peaks during the Hope phase, while the Growth
phase sees sharp improvements in both variables. Investors’ real
required return rises during the Despair and Growth phases and falls
during the Hope and Optimism phases.