The Elusive Full Market Cycle

If you spend much time looking at investment policy statements of asset owners or advisory firms — or at the marketing materials of asset managers — you’ll often come across the phrase “full market cycle.”  As frequently as it is used, it is almost never defined.  Even academic papers sometimes employ the phrase without explanation.

A general sense of the ambiguity is reflected in a page of “Stock Basics” from FINRA:

This cyclical pattern — specifically, the pattern of strength and weakness in the stock market and the majority of stocks that trade in the stock market — recurs continually, though the schedule isn’t predictable.  Sometimes, the market moves from strength to weakness and back to strength in only a few months.  Other times, this movement, which is known as a full market cycle, takes years.

You will occasionally find a definition that includes some specific metrics for marking a cycle.  While it doesn’t include the word “full,” this is how Campbell Harvey’s glossary defines “market cycle”:

The period between the two latest highs or lows of the S&P 500, showing net performance of a fund through both an up and a down market.  A market cycle is complete when the S&P is 15% below the highest point or 15% above the lowest point (ending a down market).

That would result in more frequent market cycles than what you normally see cited, especially in the 2010s, which most people consider one long up move in U.S. stocks.

Purpose

Does the uncertainty around the use of the phrase matter?  Let’s look at its supposed purpose.  Here are excerpts of documents from different kinds of organizations:

Advisory firm:  Our investment philosophy is to grow wealth and manage risk throughout a full market cycle.

Asset manager:  The strategy seeks to outperform the Barclays US Aggregate Bond Index with a similar risk profile over a full market cycle.

Consultant:  A multi-strategy fund seeks to add alpha over a full market cycle, while providing significant risk reduction through diversification of manager and investment styles.

OCIO:  These investment objectives are expected to be achieved over the long term and are measured over a full market cycle.

Public pension plan:  Tracking error relative to the Custom Fixed Income Benchmark is expected to be below 50 basis points on an annualized basis over a full market cycle.

“Full market cycle” is almost always used in relation to performance attributes of one kind or another.  If that’s the point, then there should be a shared understanding among the parties involved regarding the meaning of the term.  It rarely exists.

Reporting

Furthermore, when was the last time you saw any of those metrics reported for the period of a full market cycle (whatever that is)?

Ryan Leggio and Steven Romick of the FPA Funds wrote this (published in 2015 by Advisor Perspectives among others):

A full market cycle can be defined as a peak-to-peak period that contains a price decline of at least 15% from the previous market peak, followed by a rebound that establishes a new, higher peak.  Few publications or data providers publish, let alone highlight, full market cycle returns, yet we believe understanding them can help the return of your portfolio over the long-term.

The definition is similar to the one from Harvey’s glossary, with the additional requirement that a “new, higher peak” must be attained for a new cycle to start.  The second sentence gets at the need to improve industry practice.

The most recent factsheet of FPA Crescent Fund, for the period ending September 30, does indeed show market cycle performance, so the firm is living up to its views.  However, the period shown for the most recent market cycle — from 2007 to the date of the factsheet — is at odds with the definition above.  (A different description for a full market cycle appears in the footnotes; it excludes other declines during that period, notably the sharp one related to the pandemic.)

Other considerations

The notions of market cycles have changed over the years; some even consider those of late to be “fake” in some respect given the unprecedented actions of central banks.  And the relationships between economic and market cycles look different, as do strategies that were honed during a different time — remember sector rotation?

And what of assets other than equities in the United States?  One university endowment lists goals for each segment and manager of the portfolio, all to be evaluated in the context of those full market cycles, with no clarity on what that means specifically for the disparate kinds of investments.  (As an exercise, how would you mark the cycles for a portfolio of sovereign bonds from different countries?)  We can make this very messy if we want to delve into the nuances.

The important thing is that this notion of full market cycles has to go from being a convenient but mostly worthless concept to something that’s actually understood and used.  Otherwise, it should be tossed onto the ash heap.