Market Cycles vs. Macro Regimes
It’s surprising how often everyday terms don’t have precise definitions. This seems to especially be true of economic and market phrases which emerged historically to describe conditions. Often “rules of thumb” become accepted popular definitions. It seems that this is an attempt to apply precision to fuzzy concepts. A common rule-of-thumb defines a “bull market” as a gain of 20% or more. Where did this 20% number come from? No one really knows. The 20% definition showed up in the 1990s though the term without a number dates back to the 19th century.
Economic concepts like cycles and regimes also have loose definitions and the terms are often used interchangeably. There have been attempts over time to add some rigor to the definitions but there is no general agreed upon definition. I’m not going to come up with THE definitions of these terms but I am going to describe how I use them so the information I am giving here will be coherent.
Climate as Metaphor
One way to think of cycles vs. regimes is to look at climatology. The seasons, as we know, are defined by the tilt of the Earth towards and away from the sun. We have vernal and autumnal equinox dates to define when the seasons change. Characteristics change as the seasons change including temperature and precipitation. The full seasonal cycle covers the time that the Earth circles the Sun which defines one year of time. But around this are longer periods generally termed as “ages” which last for centuries when the overall average temperature of the earth changes. This affects the seasons but during these ages the seasons persist as the Earth continues to tilt on its axis towards and away from the Sun. The nature of each seasonal cycle changes appreciably within the age but they continue. The cause of the longer age can vary over time. Sometimes they’re due to the exogenous events such as meteor strikes, or massive volcanic eruptions. At other times they’re due to a build-up from the change of seasons. A common element is the amount of CO2 in the atmosphere. But the seasons continue regardless, though their nature can change. [Footnote – I know I’m simplifying these concepts.]
Macro Regimes
Regimes are equivalent to the ages of the climate model. They are long periods of time which set the conditions for the economy as a whole. Research has found that the two most prevalent regimes are those tied to the level of inflation, and those tied to the stability of the banking system. While the change in regimes occurs because of a build-up in shorter term events, the regimes themselves change the way the markets and economies function and generally last for up to 20 years. We will further define these regimes in another page on this site.
But regimes can be variable or permanent. They don’t necessarily return to where they started. And at extremes they can permanently change or even destroy a system. In economics permanent regime change could be a change in the system of government such as Italy and Germany turning from capitalism to fascism in the early 20th century. Or it could be something influential like the international currency system moving from the gold standard to fiat currency in the early 1970s. In the context of our discussions here we won’t be evaluating permanent regimes changes unless they occur in real time. And our analysis will be about free market systems.
Market Cycles
We can think of the expansion and contraction of the economy and the rise and fall of markets as similar to the changing of the seasons. But dates equivalent to equinoxes do not exist to define economic turning points. The business and market cycles are none-the-less tied to expansions, peaks, falls, and troughs and continue to follow that pattern in what chaos theory calls “non-periodic cycles.” Periodic cycles are like sine waves or pendulums in that they last for a specific time. Non-periodic cycles have an average cycle length, but any particular cycle can be above or below that average. While we think of weather seasons as being regular, they’re not really. How many cold vernal equinoxes have we experienced and laughed at how such a cold day could be the “first day of summer?” If we used temperature rather than the Earth’s tilt to proxy the seasons we would find a similar non-periodic pattern averaging around the equinoxes. Numbers like Gross Domestic Product (GDP) or the S&P 500 as proxies for the business and market cycles also give us non-periodic cycles.
To illustrate the difference between a periodic and non-periodic cycle I’m showing a graph that has a sine wave with a period of 50 and the Mackey-Glass equation which has a non-periodic cycle of average length 50. The Mackey-Glass equation is a chaotic system used to model red blood cell production. This simulation has the same average period length as the sine wave but you can see that each individual cycle can be different than 50, sometimes significantly different. The market cycle works in much the same way. The stock market has an average length of four years (A result I published in my book “Chaos and Order in the Capital Markets”), but can vary significantly from cycle to cycle.
Market Cycles within Macro Regimes
But the character of each market and business cycle is set by their concurrent regime just as the annual seasons are different in each climate age. Economic and market behavior is quite different when inflation is 2% vs. 10%. But the market and economic cycles continue. In the period of rising inflation in the US from 1968 – 1983 there were still economic expansions and recessions as well as bull and bear markets. Likewise, during the declining inflation period from 1983 – 2021 we still had the same economic and market cycles. But in the two periods the behavior of markets and what investors considered important information varied as well.
So in this way we will define cycles as happening within regimes. The nature of the cycle is determined by the regime, but they still influence each other. It is this interdependence which makes free market systems so fascinating.
