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Stock Market Timing Based On Economic Cycles

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Stock Market Timing In a Nutshell

Economic Cycle
Stock market traders and investors from all backgrounds have spent countless hours trying to figure out stock market timing strategies that work to bolster their returns.  Timing stock market turning points is excessively difficult because there are so many variables that affect stock prices.  However, looking back at past stock market performance, there are some stock market timing indicators based on economic cycles that work quite well in predicting future stock market price action.  If a trader or investor is involved in trying to time the stock market, they would be wise to learn how these market timing strategies can help them make better market timing calls.

It is important to make clear what stock market timing is and what it is not.  Stock market timing is not an attempt to pick an exact top or bottom in the stock market, since doing so is in the realm of impossibility, due to the wide range of variables that affect the stock market levels at any given time.  Rather, stock market timing is about taking into consideration economic and stock market indicators to assess when the stock market may be nearing a mid-range turning point.  In other words, nearing a point at which the market is ready to transition from a bull market to a bear market or vice versa.  In the long-term, the stock market always goes up, but holding stocks for the long-term (decades) is the realm of buy and hold investing, rather than market timing.

Stock Market Timing Using Economic Cycles

Stock Market Indicators
The performance of the stock market is remarkably predictable over the years, when United States Federal Reserve interest rate policy and the state of the economic cycle are taken into consideration.  For the purposes of trying to time the stock market using the economic cycle, consider these four Stages of Federal Reserve interest rate and monetary policy.

Stage 1 is when the economy is initially recovering from a recession.  The Federal Reserve typically keeps rates low and expands money supply.  Economic growth is relatively tepid during Stage 1 and inflation is typically on the low side.  The stock market typically makes its biggest gains during Stage 1, as money rushes back into the stock market in the wake of a recession, anticipating better economic times ahead.

Stage 2 is when the economy is experiencing a sustained recovery and the Federal Reserve gradually raises interest rates off of their recent lows.  This is done to counter rising inflation pressures, as the economy improves.  The stock market will continue to progress higher during Stage 2, but gains are less dramatic.  Market timers need to prepare for the transition to Stage 3, which is the stage in which a stock market top occurs.

Stage 3 (Sell Stage) is well into an economic recovery.  The Federal Reserve continues to raise interest rates towards the high end of the range and reduces money supply, in response to concerns about inflation spiking higher.  Commodity prices rise during Stage 3 and corporate profit margins narrow, due to commodity and labor inflation pressures.  Stage 3 is when the stock market makes a mid-term top and transitions from a bull market to a bear market, as the Federal Reserve’s increasingly tight interest rate and monetary policies cause the economy and the stock market to top out.  A recession begins towards the end of Stage 3.

Stage 4 (Buy Stage) is when the economy is in recession.  The economy is in recession and the stock market is in full correction mode, and will possibly enter bear market mode, if the sell-off exceeds 20 percent.  Stage 4 may last for many months or even longer than a year.  During Stage 4, the Federal Reserve will lower interest rates and loosen monetary policy.  The Federal government may also take measures to stimulate the economy.  Stage 4 is when the stock market makes a mid-term bottom and transitions from a bear market to a bull market.
Stock Market Timing
How do you use the Stages provided above to time the stock market?  First off, you need to keep track of the state of the economic cycle and what the Federal Reserve is doing in regards to interest rates and monetary policies.  Once you have identified the current Stage that the economy and Federal Reserve are in, you need to act accordingly.

The time to sell is during the middle to later part of Stage 3.  The Federal Reserve raises interest rates so high and tightens monetary policy so much during Stage 3 that the economy is forced into a recession.  You want to sell stocks before the stock market participants catch onto a looming recession, which is why picking an exact top can be exceedingly difficult.

The time to buy is during the middle of Stage 4.  The Federal Reserve lowers interest rates and loosens monetary policy during Stage 4.  The Federal government will also typically provide economic stimulus during Stage 4 to boost the economy, in the form of tax cuts or temporary spending.  The time to buy during Stage 4 is when the recession is at a low-point, when the economic indicators, such as the unemployment rate and new unemployment insurance applications, are no longer getting any worse.  The stock market typically forms a bottom at the same time as the economic indicators reach a bottom, many months before a recession is officially over.  This is at the mid-point of a recession.  If a recession lasts 12 months, you would want to buy back into the stock market during the sixth month of the recession, rather than wait for the economy to fully emerge from the recession.

Be patient and do not ignore the indicators – The biggest mistake market timers make is that they are not patient enough or do not pay proper attention to economic indicators to time the stock market properly.  The reality is that stock market timing events only occur every few years.  One has to patiently watch the indictors for years at a time and act when they indicate a medium-term market top or bottom is approaching.

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