Ups and downs of financial markets

How are financial markets like a washing machine?

You can get soaked, spun around and wrung out by their cycles.

Market cycles can be erratic and impossible to foresee. A market peak or valley may not be obvious until months after it happens.

Therefore, it's important to understand market cycles and how they can affect your portfolio performance.

No investment is immune

Every asset class – stocks, bonds, cash and real estate – can be affected by cyclical patterns.

However, different types of investments tend to move in opposite directions as a result of changes in the market: History shows that when stocks increase in value, bond prices typically decline – and vice versa.

Economy and politics drive cycles

What makes markets go up and down – market volatility – is often affected by economic and political conditions.

For instance:

• Stock and real estate markets typically do well in a growing economy. Cuts in taxes and interest rates, high employment, political stability and increased corporate profits also can mean rising stock values.
• Bond markets historically do well during times of political uncertainty. Moderate inflation, international conflicts, a volatile stock market and tight money supply often are a boon to bond markets.

Three ways that markets can react

• A correction
  A sudden drop of 10% in the major market indexes – like the Dow Jones Industrial Average* or the S&P 500^® Index**.
  
  After a correction, stock prices tend to more realistically reflect a company's growth and earnings potential.
  
  Investors may not be happy about the decline in stock values, but they should know that the market sometimes rebounds quickly after a correction.
   
• A crash
  What happens if the market keeps dropping - say, 20% or more in a short period and accompanied by widespread selling?
  
  That’s a market crash. We’ve had two major crashes in the 20th century: a 23% fall over two days in 1929, and a 22.6% one-day fall in 1987***.
   
• A bubble
  That’s when overly optimistic investors drive stock prices to unsustainable levels.
  
  It last happened in the stock market in the late 1990s: The bubble burst, investors began to sell and stock values plummeted.
  
  Although it may take a while, post-bubble stock prices often deflate – giving investors the opportunity to buy at bargain prices.

Another kind of cycle – cyclical stocks

Investments in certain economic sectors typically experience predictable ups and downs because their performance is closely tied to what's happening in the economy.

So-called cyclical stocks do well in a strong economy, but may suffer during an economic downturn. Examples: Airlines, housing and automobile manufacturing.

Conversely, stocks in pharmaceuticals and utilities are more apt to weather an economic downturn because their products and services generally aren’t tied to the economy.

The next step

Talk to your investment professional about helping you choose investments that may suit your needs.

For more ideas that may help you manage market cycles, learn about:

Understanding the Risks

Diversify Your Investments

Asset Allocation

Evaluating Your Investments

^{*The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq.
**Standard & Poor's 500® (S&P 500) Index is an unmanaged, market capitalization-weighted index of 500 widely held stocks of large-cap U.S. companies that gives a broad look at how the stock prices of those companies have performed.
***FactSet Research Systems, Inc}

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