Asset markets move in cycles, flipping between periods of growth and decline (or consolidation). You can see these cycles in pretty much every asset class and on multiple levels due to the fractal nature of markets. This means there is a short-term cycle within an intermediate-term cycle within a long-term cycle, and so on. You can even drop down to see similar movements and patterns within an intraday chart.
For stocks in particular, cycles tend to last between 3 to 5 years. A push in the dominant direction of the trend is usually 2 to 3 years and the counter-trend consolidation (pullback) can last anywhere from 6 months to 2 years. Most people will utilize charts to identify trends and will draw trend lines on the price chart itself. However, I’ve found that utilizing momentum is a better way to track trends as it often points to a change in trend earlier than the actual price chart, and that can mean better entry and exit points. I like to track various levels of momentum but always start with the long-term momentum on a monthly chart. Here’s a 10 year, monthly chart of Apple (AAPL) as an example, with trends in momentum at the bottom.
Apple (AAPL) – 10 years
And here’s the same chart with momentum trend changes indicated by the vertical lines.
As you can see, AAPL tends to move in pretty clear cycles as indicated by the trend structure of it’s long-term momentum. As a long-term investor, my preferred approach is to hold a core position based on the fundamental outlook of the company for the benefits of compounding and will add to the position during uptrends and reduce back to the core position once the trend in momentum breaks. I do it this way for the benefits of long-term compounding but also because the stock of companies experiencing secular growth will often consolidate sideways, meaning the break in momentum is just a pause and once a new uptrend emerges the stock price is often a lot higher than where the previous trend broke so it’s not worth the risk to completely jump out with the hope of getting back in at lower prices. Here’s a chart of O’Reilly Auto Parts (ORLY) to illustrate. As you can see, from 2009-2016 there were multiple breaks of upward momentum but each one has resulted in a sideways consolidation before beginning another climb higher. It wasn’t until the break of the horizontal line of support toward the end of 2016 that a more pronounced downtrend in price began.
O’Reilly (ORLY) – 15 years
Cyclical businesses on the other hand often due experience more of an up and down cycle. This can be seen in sectors like transportation.
Dow Jones Transportation Average – 20 years
The key takeaway from this post, though, is to recognize that assets (including stocks) go through periods of consolidation that tend to last much longer than people expect. Even Apple’s consolidations tend to last longer than a year. Novice investors tend to become impatient after an investment doesn’t “do anything” for a certain period of time. The thinking often goes something along the lines of “this stock hasn’t moved for over a year, why do I own this?” They end up selling right before it’s about to breakout in terms of momentum into a new uptrend, meaning they sell exactly when they should be buying. To make matters worse, they might even take the money and buy something that had been climbing for the past 2 or 3 years (“this stock is great, I need to own this!”) right when it’s probably going to slow it’s momentum uptrend and enter a period of consolidation. Rinse and repeat… If you’re a long-term investor and you look at charts, you will do much better for yourself if you only look at longer-term charts (e.g. monthly) as an anchor and ignore the day-to-day noise.
A perfect example of a stock that hasn’t “done anything” for a while is Starbucks. It’s been consolidating for nearly 3 years. We purchased stock in Starbucks after their last earnings release based on the fundamental outlook for the company (you can read about it here). However, it also looks like SBUX could be ready to breakout from this long consolidation phase. We’ll need to wait for the close of April to know for sure. I was really hoping to add to the position at lower prices but the chart is telling me I may not get that opportunity.
Starbucks (SBUX) – 20 years
As for the current markets, the drop in February and March cracked the first line of support. This usually means we’re likely to see a bounce here but we’re due for a period of consolidation after that (most likely through the summer). We’ve definitely shifted to a regime of higher volatility with the VIX continually hanging around 20 and high yield bond spreads continuing to widen so any big rallies are most likely not the start of new leg higher. I’m currently viewing upward pushes as an opportunity to lock in gains in any positions that look to have run their course and to set new portfolio hedges. This is not a warning to go out and sell any stock positions you have. As we saw in charts above, a break of an up-trend in momentum doesn’t always mean a huge drop will follow – it could just be a sideways consolidation. We would need to see the next line of support break before I become overly concerned. Plus, this market has been very divided with certain sectors rallying while others fall. Not everything looks bad right now (see SBUX above).
S&P 500 Index – 20 years
Thanks for following!
-Nick