What I’ve learnt accumulating wealth through dividend investing is this: understanding how market cycles work.
Dividend investing isn’t chasing “hot stocks” or timing “perfect market bottoms”. Even the late Charlie Munger said trying to time market bottom is a fool’s errand.
Over the last 16 years of investing in both stock and bond markets, I still see these rules play out in market cycles.
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These rules are what I’ve observed:
- Markets “mean revert” over time
- Earnings are the anchor of stock market performance
- Every high-quality dividend stock has a yield cycle
- Bull markets have four phases – Quiet Phase, Institutional Phase, Public Phase (euphoria), Mania (melt-up), then Crash
- Most people buy at market highs – and least at market lows
- Markets can stay irrational for longer periods of time
- When analysts and gurus all start to make bullish predictions, something is going to happen
- When analysts and gurus all turn bearish, the bottom is usually near
- Never overpay for a stock
- “This time is different” is indeed a dangerous word
- Excessive highs and lows are never permanent
- You can always make money in any part of the stock market cycle
Obviously, the hard part is this: when you’re in a market cycle, it’s hard to say whether these trends could end quickly or last much longer.
In fact, market cycles can go on for longer periods than we logically think about.
But what’s crucial to know is these market cycles will eventually “mean revert” for ANY reason, even as simple as a change in Mr. Market’s mood.
That’s why different stocks, sectors and markets behave differently at certain periods.
Some can outperform the other in one period. And underperform in the next.
I mean, just take a look at these excessive cycles over the last decades.
Value vs Growth Stock Cycles
Value stocks are considered large, established companies with consistent dividends and considered to be trading less than their intrinsic value – meaning they are undervalued by Mr. Market.
Meanwhile, growth stocks are expected to have significantly higher future earnings potential, whose stock prices may appear much higher relative to their current earnings potential.
Below shows the annualized return difference between Value (Russell 1000 Value) and Growth (Russell 1000 Growth) within the US large cap sector.
There will be periods when growth outperforms value and vice versa…
I mean, it’s not just Value vs Growth stocks.
Large Cap (Tech) vs Small Cap Stock Cycles
Even during the dotcom bubble, large cap tech giants outperformed small cap stocks. And eventually that cycle turned…
Interest Rate Cycles
Of course, if we look at interest rate cycles, the same thing…
Commodity Cycle vs Dow Jones Industrial Average
Another is the commodity cycle dated as far back as the 1900s…
What I found interesting is to see how commodity prices have sold off to an extreme it has become severely undervalued over the past 120 years.
The other times it came close to such massive undervaluation was in 1929, 1969 and 1999. Like I’ve said, “This time is different” is indeed a dangerous word.
Market cycles are never different, they repeat in patterns.
We often get carried away by the stock market cycles. And this is driven largely by our emotions….
I know, it’s easy to say all these looking at charts that date back decades ago. But when we’re invested in the stock market, sometimes it’s just hard to tell how we’re moving.
A simple approach is to figure out the sentiments of the crowd.
Warren Buffett built Berkshire Hathaway over the last 60 years, which lasted through stock market cycles.
His core principles still remain: look for high quality businesses with a durable economic moat and pay a reasonable price for them.
Then, we want to diversify our portfolio across countries and sectors. For instance, Diligence members know I aggressively diversified into China and Hong Kong stocks (see chart below) as the bear market unfolded.
This allows me to identify hidden opportunities and widen my focus in undervalued regions.
My final thoughts
Whether you want to accumulate wealth safely and profitably to achieve your financial freedom, our goal is to focus on what truly matters: pick high-quality dividend growers, with a durable economic moat, more important pay a sensible price.
This way, you’ve a predictable way to grow your passive income in retirement year after year.
