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Spiral Staircase

5. Cycles


“Markets move in 10 year cycles, people have 5 year memories.”

The Simplest Fact
The recent house price rises have occurred during a period of economic expansion and prosperous growth. But what lies ahead? In order to determine this we need to accept one of the simplest facts of life:

Markets move in cycles, all markets, anywhere, always!

To be clear from the start, most people consider the property market of their country to operate in a vacuum. They talk of supply and demand pushing house prices higher or lower. They have a micro focus on the house prices in their city, post code or street. They do not realise the important relationship between the property market and the economic cycle as a whole. For example, if a country goes into recession, if millions of jobs are lost and the banks become averse to the risk of lending money, where is the demand for property going to come from? In these circumstances a formerly healthy property market cannot survive.

In addition, and again to be clear, I am not aware of any market, anywhere, at any time in history, that has successfully managed to plateau following a prolonged period of exponential growth, especially when that growth was driven by a flood of credit.

Whether the market is property, equities, commodities, bonds, it doesn’t matter. The fact is, if it is a market, it moves in cycles.
The Pattern of a Cycle
As we have seen, the economic cycle begins with a period of growth or “expansion”. We are all familiar with the expansion period as these are the good times we have experienced over the last 10 years or so. The economy cannot expand indefinitely however and eventually the conditions of prosperity can no longer be maintained.

This might occur, for example, when companies and individuals reach the limits of their financial means.

At this point companies begin to scale back their spending, cutting jobs. In turn, consumers become more conservative and reduce their spending, hurting corporate profits further. Simultaneously, banks reduce the amount they are willing to lend as corporations and consumers alike begin to suffer under the burden of their financial commitments. Soon the social mood changes from optimism to pessimism.

A downturn in the market results and continues until any economic excesses from the previous expansion are unwound. This is a period of “contraction” in economic activity, which can turn into a recession if conditions are serious enough. Eventually a bottom is reached at which the economic outlook becomes more positive than negative and conditions improve. From this point onwards contraction gives way to a new phase of expansion, leading into a new economic cycle of the same pattern.
Conclusion
So at some point the economy will start to turn. This is utterly inevitable.

Since the recent house price rises have occurred during a period of economic expansion and prosperous growth, what can we expect when the economy reaches the limits of its growth and starts to contract?

What will happen to house prices when banks become more pessimistic and conservative, reducing the amounts they are willing to lend?

In order to determine what is likely to happen to house prices in the future we must first examine our current position.

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