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The Four-year Cycle

One of the most consistently reliable economic cycles over the last seventy years is the Four-year Cycle. Its premise is that approximately every four years, the market presents us with a major buying opportunity. Normally, the opportunity develops at the end of a bear market, but there have been exceptions such as 1986 and 1998, when the opportunity occurred after a quick decline or extended consolidation. In these instances, the “low” represented a correction in what turned out to be an ongoing bull market. The vertical lines in Chart 6 flag these cycle lows since the 1930’s. Sometimes the low occurred at the end of the year preceding the expected low; e.g. 1953, and sometimes a little after; e.g. 1935. This explains why the lines in the chart are not equidistant. The previous four-year low was in 2002, while European markets bottomed in early 2003. That means that cyclically, either this year, or early next, is set to be a low. The chart also shows that in most cases, the market peaks in the year prior to the expected cycle low.

Chart 6. Vertical lines show 4 year cycle lows - See Chart 6A for more detail.

Chart 6A. Vertical lines show 4 year cycle lows.

In quite a few instances though, when the market tops out in the same year, the decline is short, quite sharp, and invariably unexpected. This scenario took place in 1946, 1990, and 1998, although 1986 was the exception.

The Typical Stock Market Cycle

The four-year business cycle has been reliably tracked since the beginning of the 19th century, when statistical data first became available to track it, cycling through a set series of chronological sequences beginning with an improvement in the financial indicators. The process continues with a revival of leading interest-sensitive indicators such as housing right through to lagging sectors such as capital spending. The financial markets (bonds, stocks, and commodities) also form part of this sequence. Figure 1 displays how the various components have usually peaked and troughed throughout its 200-year history.

Figure 1.

The sine curve represents the path of economic growth or contraction, and the horizontal lines separate expansionary periods from contractionary ones. Because historically, an economy undergoes a chronological sequence of events during a complete cycle, it’s possible to identify turning points for various financial and economic indicators as well as bonds, stocks, and commodities. Figure 1 shows the idealized periods for the three financial markets; bonds, stocks, and commodities. The financial market sequence usually develops without fail, even when the growth path reverses from above zero as it did in the 1960’s, 1980’s and 1990’s. The major difference between these “growth recessions” and actual economic contractions is that there is usually less volatility within the three markets. (These topics are discussed at great length in, The Investor’s Guide to Active Asset Allocation.)