No one has placed as much importance on the behaviour of the market as legendary investors like Benjamin Graham and Warren Buffett. Their focus on understanding the nature of the market is the single biggest factor behind their success. 

This is the most important lesson they can teach us. The reason behind their curiosity is the volatile nature of the market. You might wonder why almost all the markets follow a cyclical pattern rather than a structural uptrend. Indeed, severe ups and downs follow a certain recurring pattern. 

 

A deeper examination of all the bubbles and market manias of the past reveals a recurring theme without fail. We can examine historic ones, including: 

 

• Tulip Mania of 1634

• Mississippi company crisis of 1718 

• South Sea Bubble of 1720 and 

• The Great Depression of 1929 

 

We can also look at modern ones, including: 

• The 2008 global market meltdown and Subprime Crisis 
• Global economic slowdown caused by Coronavirus pandemic 

The recurring theme that characterizes them all is a boom and bust cycle. 

 

A Pendulum that Forever Swings 

Volatility is the sticky nature of the market, which cannot be undone. 

  

The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The Intelligent Investor is a realist who sells to optimists and buys from pessimists. 

• Jason Zweig, The Intelligent Investor  

  

The cyclical nature of the market has never changed, though reasons for optimism and pessimism could be different, and ever changing. That is precisely the reason that something as simple as “Buying Low” has worked wonderfully across market cycles. 

Because of this consistent, recurring swing in markets, it becomes even more important to study market behaviour and market cycles. 

  

The four most dangerous words in investing are: “This time it’s different.”   

–Sir John Templeton 

  

You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.   

–Peter Lynch   

 

 

 

Most of the great investors I’ve known over the years have had an exceptional sense for how cycles work in general and where we stand in the current one. That sense permits them to do a superior job of positioning portfolios for what lies ahead. Good cycle timing — combined with an effective investment approach and the involvement of exceptional people — has accounted for the vast bulk of the success of my firm. 

–Howard Marks of Oaktree Capital Management in his famous book Mastering The Market Cycle 

  

The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions. 

–Seth Klarman 

  

  

In markets, it’s never different. Cycles are permanent and recurring in nature and investors who have ignored cycles have done huge damage to themselves and their investments. 

Benjamin Graham, the father of value investing, believed that the market is your partner in trade. Graham was probably the only guru who dwelt on the behaviour of the market and was able to successfully demonstrate what he believed. An important aspect of his thought was his observation of the cycles of market behaviour, which continues to stand solid as a rock today. 

  

An Edge to Put us in the Winning Seat 

Investing is zero sum game – if one gains, the other must lose. It is thus important to have some advantage of greater knowledge over your competitor. Investors who have knowledge of what they are doing have an edge over investors who do not know or lack enough knowledge about what they are doing. 

 

If we have the same information as others, analyze it the same way, reach the same conclusions and implement them the same way, we shouldn’t expect that process to result in out performance.  

— Howard Marks  

  

  

As investors we do not know the future and have no ability to predict it. Even if the probability of an event is very high, we can never eliminate failure. When we accept that we cannot predict the future, the option that remains for us to win the game is to know more than what others know about the possibilities the future can hold. 

Understanding of the cycle is thus crucial.  It provides an advantage that can put us ahead of our competitors. If we understand the cycles, then our chances of excelling over our competitors improve.  That understanding gives us an edge during events which are likely to unfold in the future. 

The late, great economist Merton Miller aptly said “To beat the market, you`ll have to invest serious bucks to dig up information no one else has yet”. 

In other words, to improve the chances of one’s portfolio getting above average returns, one needs to have access to above average information. 

According to the late, legendary investor John Templeton, every market goes through a life cycle, similar to the natural life of living beings. Markets are born, they grow, they mature, and then they die, and the process repeats itself. 

The successful investor must learn to recognize cycles and assess them. This is especially important because the odds of success changes as the position within the cycle changes. Only if one can combine his data edge with a deep understanding of market cycles can he take appropriate action and expect to do well. 

  

Improve Our Understanding of its Behaviour  

  

Understanding market cycles can help you make better investment decisions 

–Eleanore Szymansk Noted wealth advisor 

  

Stock market cycles are something of a mystery. Even if investors know that the market follows a cyclical nature, these questions arise: Why don’t they act in a timely fashion? Why don’t investors exit their portfolios at the cycle peaks and buy more when the market is down? 

The reason is simple. Most investors lack an understanding of the cycles and the factors that influence them. 

The future holds different possibilities and probabilities. It does not follow a fixed pattern or yield a fixed outcome. It is thus critical to think in terms of probabilities and ranges of outcomes.  We can do this by studying the cycles and improving our understanding of their behaviour. 

If we carefully study cycles, we could be in a position to understand how various factors influence them. The superior investor is the one whose insights into these tendencies give him a sense of where he stands with respect to the cycles. Additionally, he is aware of what should influence his actions. 

The future is uncertain and there is randomness in the behaviour of the market.  Our knowledge of cycles and their historical behaviour can help us deal with it profitably. 

Of great importance is the fact that the average investor is unaware. They lack understanding of the nature of the cycle. Many of them have not even seen or studied enough cycles. Therefore, they don’t know what influences cycles and what significance this information holds in making prudent investment decision. That said, if we have more information than our competitor, our outcome should certainly be better than an average investor. 

  

Armed to Deal Risk 

According to Mr. Marks, risk is simply defined as the possibility of things not going your way, leading to a permanent loss of capital. 

The market is inherently risky and one must be prepared for both upturns and downturns. Benjamin Graham rightly said “Successful investing is about managing risk, not avoiding it”. In effect, one should have an opinion and then gauge the likelihood of the opinion coming true. 

Some events can be predicted with confidence, while others are somewhat uncertain.  Still others are completely unpredictable.  The successful investor is always on his toes.  He is consistently prepared to take appropriate actions in response to market cycle variations. He is the one who invests while keeping a sufficient margin of safety in place to manage the risk and tide over the vagaries of the market. 

In simple words, the sensible investor must take note of whether past patterns seem to be repeating. His experience comes into play in making appropriate judgements, managing risk at relevant stages in a cycle, and then taking action. 

  

Allow Us to Position  

Phillip Fisher, the father of growth investing and legendary investor once said that “The stock market is filled with individuals who know the price of everything, but the value of nothing.” What he was probably referring to is a mistake most investors make. They focus on the stock price of potential investments rather than looking at the value of the firms. 

In investing, this is considered to be the biggest mistake and one that is often condemned by many legendary investors. One must strike the right balance between the price paid and the intrinsic value, and then correctly position their portfolio in the cycle. 

  

You must buy on the way down. There is far more volume on the way down than on the way back and far less competition among buyers.   

–Seth Klarman 

  

 

Understanding cycles allows us to focus on the right elements. If we, as investors, know the cycles and the behaviour of the cycles, then we can maintain a balance between aggressiveness and defensiveness.  All the while, we can constantly evaluate and monitor our portfolios and investments. 

This is the biggest takeaway: Investors are armed not only to deal with the risk but to act appropriately to take the advantage of a given cycle. They can allocate capital appropriately both in terms of its amount and timing to benefit from the cyclical nature of the market. 

  

If we apply some insight regarding cycles, we can increase our bets and place them on more aggressive investments when the odds are in our favour, and we can take money off the table and increase our defensiveness when the odds are against us. 

–Howard Marks in his celebrated book Mastering The Market Cycle. 

Such positioning can only be possible if we study the cycles and correctly identify trends pertaining to the characteristics of a given cycle. 

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