Skip to main content

Stock Market Timing Based on the Economic Cycle

I have been involved in trading and in investing in stocks for four decades. I enjoy learning and writing about financial topics.

One of the simplest ways to time the stock market is by trading in and out of the stock positions based on the overall economic cycle. While this may not be a timing method that one can use often, it can reap big rewards if done correctly as the economy eventually goes through a recession and then recovery from time to time. The thing that makes this market timing method relatively simple is that you just have to follow the overall economic conditions for cues as to when to get out and get back into the stock market. But, it is not quite that simple. Based on historical stock market performance going into and during recessions, there are key points in the economic cycle that are the best time to sell stocks and the best time to buy back stocks.


Stock Market Timing Using The Economic Cycle

The performance of the stock market is remarkably predictable during the economic gyrations known as the economic cycle. The economy does not expand forever. Economic expansions eventually come to an end and turn into economic contractions, which is commonly called a recession. Let’s take a look at the four stages of the economic cycle as it relates to stock market performance and how to maximize gains by getting into and out of stocks at the right times.

Stage 1 (Sell Stage) - The economy is well into an economic recovery and you have been holding your stocks for years watching them appreciate in price along with the overall stock market. The Federal Reserve is worried about inflation pressures overheating and causing too much inflation, and therefore raises short-term interest rates and reduces money supply to slow the economy. The yield curve inverts (meaning short-term rates are higher than long-term rates) and the stock market eventually makes a top within eighteen months of the yield curve inversion. It is during this eighteen months that you want to sell stocks and move money into cash or safe interest-bearing investments. The Federal Reserve’s high-interest rate policy eventually causes a recession to begin as Stage 1 comes to a close, and the stock market selloff commences.

Stage 2 (Buy Stage) - The economy is in a full-blown recession and the stock market is selling off in response to bad economic news and poor corporate earnings reports. During most recessions, the stock market sells off at least twenty percent, but sometimes it sells off much more than that (up to eighty percent). The Federal Reserve increases the money supply and lowers interest rates to help the economy dig out of the recession. There is a critical point during Stage 2 when the stock market bottoms and it is a very good time to buy stocks. The time to buy stocks is when the economic indicators have reached a bottom, about midway through a recession. This means that economic indicators such as unemployment stop getting worse. The stock market usually rallies strongly once a recession has reached a bottom, in anticipation of an eventual economic recovery.

Stage 3 (Hold Stage) - The economy is in the recovery mode recession, as it climbs out of the recession trough and economic growth resumes. The Federal Reserve continues its low-interest rate and generous money supply policies to help the economy recover. The stock market makes large gains during Stage 3. Money from the sidelines comes back in and new money is put to work to help the stock market rise, as the economic indicators show growth has resumed. It is important to be holding stocks during Stage 3 to reap the benefits of the rising stock market.

Stage 4 (Hold Stage) - The economic expansion continues with variable but positive growth. The Federal Reserve starts to raises short-term interest rates to counter rising inflation pressures that go along with an economic recovery. The stock market continues to generally rise during Stage 4 as economic numbers and company earnings reports are good, with the typical corrections along the way. This is a time to hold onto stocks to reap the gains in the stock market and look for indications that the economy is entering Stage 1 to prepare to time the stock market during the next recession.

Remember, timing the stock market using the economic cycle does not work unless you keep track of the condition of the economy and whether the Federal Reserve has inverted the interest rate yield curve by raising short-term rates to a point that it signals a looming recession and a stock market selloff. It is also important to be patient and act when the indicators tell you to act, no sooner and no later. Most of the long-term gains made in the stock market are made during a few big rally days that occur from the middle of Stage 2 through Stage 4, as the recovery economy drives stock prices higher. If you are sitting on the sidelines when those big stock market rally days happen, then you will miss out on the gains.

If stock market timing is not for you, there is nothing wrong with using a diversified buy and hold stock investing strategy. Instead of timing the market by selling and buying back into stocks, just hold stocks and increase your holdings when the stock market is down during the first half of Stage 2.

S&P 500 Index Performance With Recessions Included

A graphical depiction of the S&P 500 Index performance over decades with recessions included as grey bands.

A graphical depiction of the S&P 500 Index performance over decades with recessions included as grey bands.

Understanding Stock Market Timing

The concept of stock market timing is not well understood. It is important to understand what it is if you wish to use a timing method successfully. Market timing methods like the one outlined in this article are not designed to and will not get you out of and into the stock market at exact tops and bottoms. Rather, they provide guidance regarding when conditions are favorable and not favorable to hold stocks. With historical performance as a guide. the conditions should eventually cause the stock market to move in a particular direction, either up or down. But, it may take some time for these moves to materialize. Some serious traders and investors use many market timing methods and indicators to verify when to hold stocks and when to wait on the sidelines in cash.


Stock Market Timing By Economic Stage Poll

How Do the Stock Market and the Economy Interact?

© 2018 John Coviello

Scroll to Continue


John Coviello (author) from New Jersey on September 12, 2018:

Warren Buffet times the market himself. He was buying stocks and investing in companies like crazy during the Great Recession of 08/09. He knew that an economic downturn was the time to buy because the economic cycle and the stock market always turn up over time. Since then, not so much because valuations have reached high levels. The Buffet Indicator that divides the value of the stock market by the GPD of the U.S. is at extremely high levels now.

John Coviello (author) from New Jersey on September 12, 2018:

Actually, you can know. Recessions don't last forever. Historically, they are much shorter than economic expansions. Typically lasting 18 months. You can see the bottom of a recession being reached in job losses, the unemployment rate, unemployment claims, etc. If you're off by a few months, who cares? Just average in. The economy always reaches bottom and recovers, and the stock market recovers with it. The point is that the time to buy is before a recession ends because the stock market is forward-looking, and will have rallied a considerable amount off of its lows by the time the recession is declared over.

The Logician from then to now on on September 12, 2018:

“The time to buy stocks is when the economic indicators have reached a bottom, about midway through a recession.”

And you know when the indicators have reached a bottom? Nobody knows that except in hindsight, and the same with when to get out. Unless you can be right everytime without fail you can’t know if any time you are right it was just coincidence or your methodology was the reason.

The Logician from then to now on on September 12, 2018:

Jack is right. Turns in the market typically come at a time of their own choosing and don't hold a news conference.

Buffet says that if we aren't willing to buy and hold shares of a company for 10 years or more, we shouldn't buy it," says Ted Snow, founding principal of the Snow Financial Group in Addison, Texas. "This is so because over time, the market takes care of us. If we buy good companies and hold them, we should be compensated."

He adds: "Market timing only makes the brokerage house rich and deflates what 'success' the day trader had. It is a fool's game."

I think your title for this article is a bit misleading. Entering the market based on the economic cycle is a sound way to invest but when you say timing the market it conjures up the notion of trading in and out which may work for a while then fail, because no one can predict the future. We can only learn from the past and the past proves the best way to invest is to buy diversified investment grade stocks (not to exclude growth stocks) and hold for the long term. History shows us that over any 20 year period the stock market has outperformed all other investments. The best strategy is to have a long term goal and whenever the market corrects add more money and keep buying while it is down because bear markets don’t last that long compared to bull markets. Getting out before a correction and getting back in sounds great but the economic cycle is not always in sync with the market and especially today with all the advanced hedge fund electronic trading methods and international finance even the top professionals will tell you trading the market can be a crap shoot and it is a full time job. If your strategy is long term, buy more when the market is down, you don’t have to be analyzing anything much all the time.

Jack Lee from Yorktown NY on September 09, 2018:

There is no market timing strategy that works. If there were, we would all be millionaires. The reason the market is the way it is, is its unpredictability. When a correct occurs, it is usually very abrupt and there is little advanced notice. The better strategy is to invest in SPY and over the long term, your money will grow and don’t panic sell.

Larry Rankin from Oklahoma on May 26, 2018:

Very educational.

Mary Norton from Ontario, Canada on May 25, 2018:

The individual stocks have also its own cycle. Sometimes, when a growth stock reaches a plateau, it makes no sense holding on. As one experiences more trading in the stock market, one becomes more able to manage one's fear and greed so the selling and buying becomes more rational.

Related Articles