Howard Marks makes a point in his book, Mastering the Market Cycle, that cycles are messy. The repetition of cycles is not like a metronome — up and down, up and down — sounding off regular intervals. The repetition is only in a very general sense.
It’s not that B follows A and C follows B, but A leads to B because a multitude of factors influenced the how, why, when, and where of the next leg of the sequence causing B to happen. Then a multitude of factors causes C, and so on.
The point Marks is making is that cycles aren’t clean and uniform in the real world, but more of a jumbled messy interaction between human behavior, markets, businesses, economies…and so forth:
The events in the life of a cycle shouldn’t be viewed merely as each being followed by the next, but — much more importantly — as each causing the next. For example:
- As the phenomenon swings toward an extreme, this movement gives it energy, which it stores. Eventually its increased weight makes it harder for the swing to continue further from the midpoint, and it reaches a maximum beyond which it can no longer proceed.
- Eventually it stops moving in that direction. And once it does, gravity then pulls it back in the direction of the central tendency or midpoint, with the energy it has amassed powering the swing back.
- And as the phenomenon in question moves from the extreme back toward the midpoint, the swing imparts momentum to it that causes it to overshoot the midpoint and keep moving toward the opposite extreme.
In this way, a cycle in the economic or investment world consists of a series of events that give rise to their successors. The process described in the three bullet points above sounds like a physical one, governed by forces such as gravity and momentum. But as I mentioned above and we’ll see later on, the most important deviations from the general trend—and the variation in those deviations’ timing, speed and extent — are largely produced by fluctuations in psychology.
If you consider the human psyche — rather than physical attributes — to be the source of much of the energy or momentum, these three points do a pretty good job of also explaining the swings and oscillations that investors are challenged to deal with…
It’s extremely important to note this causal relationship: that the cycles I’m talking about consist of series of events that cause the ones that follow. But it’s equally significant to note that while cycles occur in a variety of areas due to these serial events, cyclical developments in one area also influence cycles in others. Thus the economic cycle influences the profit cycle. Corporate announcements determined by the profit cycle influence investor attitudes. Investor attitudes influence markets. And developments in markets influence the cycle in the availability of credit…which influences economies, companies and markets.
Cyclical events are influenced by both endogenous developments (including the cyclical events that precede them) as well exogenous developments (events occurring in other areas). Many of the latter — but far from all — are parts of other cycles. Understanding these causative interactions isn’t easy, but it holds much of the key to understanding and coping with the investment environment.
For instance, the cycle that ended in the ’08 financial crisis wasn’t because all cycles must end but rather because the excesses in the housing market were taken to such an extreme that an end occurred. The excesses of debt, bank (and other company) failures, rising fear, then panic, and more drove an extreme swing in the opposite direction.
It was inevitable only in the sense that a multitude of factors coalesced to produce that outcome. Hindsight makes it seem obvious but the outcome was hardly guaranteed at the time. Change one or more of those factors and the severity and timing of all of it might be different.
A better, broader, example was given by Peter Bernstein, which I shared a few weeks (for reference, he said this in 2002):
Goodness knows what we are going through at this moment in the capital markets is a consequence of the foolishness of 1998-2000. And that, in turn, was the climax of a bull market that grew out of the dark days of the 1970s and our ability to overcome the problems of the 1970s: high rate of inflation, the war and the consequences of war in Vietnam and so on. Those high rates of inflation developed from the sense that we were never going to have the Great Depression again and we knew how to deal with those problems and that government could create and maintain full employment no matter what. So that great period grew out of the Depression and the Depression itself was a consequence of what had happened during World War I and the aftermath of World War I and so on, going back to the beginning of time. Each episode is a result of the preceding episode and it makes for a very heterogeneous bunch of stuff.
The reverse chronological order makes it easier to follow how each sequence evolved from the last. So too should be how the comingling of cultural changes, behavior, economy, government, business, and markets impacted the next sequence.
John Stuart Mill on Cycles and Panics
Howard Marks: Lessons from a Crisis
What Drives Cycles to Extremes?