Structural Characteristics of Capital Market

THE STRUCTURAL CHARACTERISTICS OF CAPITAL MARKET CYCLE AND ITS RELATIONSHIP WITH ECONOMIC CYCLE
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Part 1
1.1 Problem Statement
The capital market cycle decision is significant in all organizations, institutions, and instruments that offer long-term and medium-term funds. Most finance managers face minimizing the cost of capital and maximizing investors' wealth (Chung & Turnovsky, 2010). Though businesses go through various stages, the unique characteristic at each phase may push an organization to display a different financial structure to suit their needs. In their study, Hodnett and Hsieh (2012) found that the capital market cycle changes along the economic cycle stages of an organization. This is influenced by different financing needs that change at every cycle point (Park, 2013). Researchers have conducted empirical evidence on the capital market cycle and how its relationship with the economic cycle can help firms improve their finances in each cycle phase.
1.2 Motivations
The stability and development of the capital market are core drivers of progressive, sound and well-functioning economic operatiosn from both micro-and macro spheres. The capital market generates substantial opportunities for businesses, investors, and traders. It remains a daunting securities platform amid heightening market disruptions and uncertainty. To widen the mechaniss for lucidity and interpretation of capital market performance, this study seeks to determine the structural relationship between capital market and business cycles. Various reasons motivated this study.
The first reason is lack of adequate empirical study on the economic growth factors and their connections to financial securies despite the strong attention paid to financial securities. Multiple studies have been done to establish the relationship between business cycle and economic growth, but no study has been conducted on the link between capital market cycle and business cycle. Experts have found that both cycles contribute significantly to the eonomy because they control the investors’ decisions. Rather than observing the capital market as one measurement, this sudy examines the sub-compomnents of the capital market independently. The second motivation is the need to evaluate the economic growth of the capital market. Studies show that this growth occurs in the short-rum and long-run. Investigating both the short-run and long-run growth based on the cycles is a good move.
The third motive is Malaysia’s remarkable growth in the financial market. Instead of focusing on multiple capital issuing countries, this study concentrated on Malaysia. Malaysia has experienced a remarkable growth in the financial market over the last three decades, and it has been a reference point for the financial market, particularly from legal framework and tax regime’s perspective. One of the most-though provoking aspects of capital market and economic analysis is the connection between the actual financial and economic dynamics (Ardalan, 2017). Malaysia’s financial economy, together with the global financial environment continue to be faced with uncertainty and proliferating market complexity amid dynamic forces for economic, geopolitical and social factors. As such, the need for the broad knowledge of stock or equity market performance is critical especially afte the wake of the 2008 global financial crisisand its impacts on domestic and international markets.
Another motive is the volatility of the capital market and business cycle. Volatility is the rate at which the stock price increases or decreases over a specific period. The fluctuations in the stock prices control the investment activities. They inform the investors whether or not to invest in particular asset. Since this study investigates the relationship between structural characteristics of capital market and business cycles, it is important to look into the effects of volatility in the investment activities. Therefore, this study was informed by the increasing volatility in stock market and financial securities, which seem to have a significant impact on the economy.
Lastly, the study was attracted by the stock market movements. Various scholars opine that variations in real economic activities are caused by stock market movements, making capital market a primary signal for economic projection. A significant argument raised by Dzikevičius and Vetrov (2012) is that some business cycle indicators seem lead to capital market cysles over an extended period and this potentially qualifies them as early stockprice signals. Therefore, the ablity of business cyle to potentially lead stock price movements is worth investigating. For the longest time, experts have used business cycle indicators to determine the peaks and troughs of the reference points of the business cycle, which are aggregated to create single indexes, indicating ether the lagging, leading or coinciding features of the economic cycle.
1.3 Research Questions
* What is the relationship between the structural characteristics of the capital market cycle and the economic cycle?
* How do volatilities and stages of the capital market cycle compare to volatilities and stages of the business cycle?
* What impact (s) do volatilities and stages of capital market cycle versus volatilities, and stages of the economic cycle have on the country's business operation?
1.4 Research Objectives
* Ti investigate the relationship between the structural characteristics of the capital market cycle and the economic cycle.
* To compare volatilities and stages of the capital market cycle with volatilities and stages of the business cycle?
* To examine the impact (s) do volatilities and stages of capital market cycle versus volatilities, and stages of the economic cycle have on the country's business operation.
Part 2
2.1 Literature Review
The casual link between the capital market and the economic cycles has been the topic for researchers and practitioners. The hypothesis that stock prices mimic the increases and declines in the business cycle is firmly supported in a related way (Anna et al., 2015). With few exceptions, studies indicate that stock prices result in the level of economic activity. This phenomenon is based on the notion that current stock prices in the capital market accurately impound future expectations of economic activity (Beaudry et al., 2020). Begenau (2020) pointed out that stock exchanges can serve as a conduit for acquiring quick capital due to the ease with which investors trade securities. Therefore, stock exchange activity plays a crucial role in determining a country's macroeconomic status.
2.1.1 Capital Market Cycle
The capital market cycle is a proposed pattern in the capital market. According to Tan and Shafi (2021), a capital market is where investors trade financial securities like stocks, bonds, and exchange-traded funds (ETFs). This market cycle has five stages: recovery, the mid-cycle breather, the boom phase, the late-cycle, and the bear market (Hille & Müller, 2018). The recovery is the first phase of the cycle. It occurs when risk assets recover after the bear market period.
During this period, bold investors are rewarded provided that they return to the market (Hille & Müller, 2018). Although Sovereign bonds turn into a positive performance in this stage, they perform below corporate bonds. Similarly, high-yield bonds underperform investment-grade bonds, but conservative strategies outperform growth strategies due to the increased inequities with double-digit returns (Hodnett & Hsieh, 2012). However, classical-low risk investments like gold do not perform well in this stage. This period is also accompanied by an increase in the dollar value.
The second phase is the mid-cycle breather. This stage has substantial price gains accompanied by the lateral move. The viewpoint is that the markets take a hiatus to reclaim their potency (Hille & Müller, 2018). Sometimes when prices stagnate, carry strategies focus on high-coupon and dividend-bearing securities to maximize current income. Hille and Müller (2018) defined carry as a strategy that involves the investor's sale of a particular currency with a relatively low-interest rate to buy another higher-yielding currency. This is the phase where the performance of high-yield bonds increases.
The third phase: - the boom phase, starts after the beginning of the tightening cycle (Hille & Müller, 2018). After the pause, the markets and the economy begin to develop. Growth stocks lead in this phase. Treasuries experience high pressure due to the rate hikes, leading to the yield curve flattening (Tan & Shafi, 2021). Corporate bonds and high yield bonds in this stage do better than treasuries. The dollar gradually weakens against other currencies.
In the fourth stage, the later phase, the yield curve flattens or inverses. The transition from the third stage to the fourth stage is accompanied by increased volatility(Rusmita et al., 2020). The market shift from a low-volatility to a mild-volatility makes the corporate bonds to become more demanding. These bonds are pressured by the steady attrition of the bond agreement created to protect creditors(Park, 2013). However, equity performance continues to grow. The prevailing view is that commodities have an outstanding performance in the latecycle. Unfortunately, consistency declines with the maturity of the late-cycle. An increasing commodity cost and a weaker dollar indicate that bonds and equities in the emerging markets perform well in this phase(Hille & Müller, 2018).
The last phase: - the bear market, is the stage in the capital market cycle that leaves a specific bitter taste in many investors' mouths for an extended period(M'ng et al., 2017). This phase is characterized by an average of about 20% price declines across-the-board (Hille & Müller, 2018). Therefore, to ensure profitable long-term investments, it is imperative to mitigate the impact of bear markets as the principal dictate of capital and asset allocation.
These cycles ensure profitable long-term investment. Understanding these cycles help in interpreting the performance of a fund. The capital market circle also plays a significant role in macroeconomic factors, including unemployment, economic growth, interests rates, and inflation. Due to these factors, there may be a boom period in which investors scramble to purchase financial securities and when panic invades the market, causing investors to sell in large quantities.
2.1.2 Economic Cycle
An economic cycle or business cycle is a regular cyclical pattern of economic boom and bust. It is characterized by six stages, namely, expansion, peak, recession, depression, trough, and recovery (Beaudry et al., 2020). The first stage in this cycle is expansion. It is associated with increased macroeconomic indicators including income, employment, profits, wages, output, demand, and supply (Born & Pfeifer, 2014). Debtors pay their debts on time in this stage the investment and money supply encounter speedy acceleration. This progression continues provided that the economic conditions are favorable for expansion(Gabisch & Lorenz, 2013).
After expansion, the economy reaches a peak point, the second phase of the business cycle (Eusepi & Preston, 2011). This is the stage where the economy attains the maximum growth limit. The economic forces do not experience further growth, but they are at their peak. This stage represents the U-turn point in the economic growth trend(Kamyabi & Ghayour, 2017). Budget restricting occurs at this point.
Recession is the third stage of the business cycle. In this stage, goods and services start experiencing a rapid and steady decline in demand(Gabisch & Lorenz, 2013). Manufacturers do not detect the sharp drop in demand and continue producing in this phase. This creates suplus supply in the market and price decline. All affirmative economic indicators also begin to fall.
The fourth cycle is depression that is characterized by a commensurate increase in unemployment. The economic growth continues to decline, falling below the steady growth line(Eusepi & Preston, 2011). The economy's growth rate becomes negative in this phase. The next phase is the trough. It is accompanied by a further decline until prices, demand, and supply of products and services shrink from arriving at their lowest point(Decker et al., 2016). Eventually, the economy reaches the trough stage, also known as a negative saturation point. This is where national income and expenditure have extensive depletion.
The last stage is recovery. This phase has an economic spin, recovering from the negative growth rate(Beaudry et al., 2020). Demand starts rising due to low prices and an increase in supply. The population cultivates a positive attitude towards employment and investment accompanied by production increases(Anna et al., 2015). Employment starts rising due to accumulated cash balances. Borrowing also indicates positive signals. In this stage, investors replace depreciated capital, encouragingnew investments in the production sector(Bigio, 2015). Recovery continues until the economy returns to normal growth levels.
Chauvet (2011) noted that the business cycle is crucial for investors interested in knowing the next point. Practically, the length of the cycle, the strength of the upswing, and the depth of the recession vary extensively and are impossible to forecast correctly(Dzikevičius & Vetrov, 2012). However, the investors must understand the pattern. Cycle analysis provides investors with a compass reading of the position of the international markets. Investors need this information to decide the suitable allocation of financial securities within their portfolios(Kotlebova et al., 2020). It also helps them to determine geographic weighting. By creating stock selection within the parameters of cycle analysis, the investors will know it is necessary to chase momentum or pursue a more defensive strategy(Buus, 2015).
Practically, market timings are challenging due to the variation of each cycle based on length and amplitude(Caselli & Negri, 2018). Investors often fear purchasing securities too early or selling too late. When the capital market is declining, fear becomes prevalent, with investors predicting a drastic market decline (Dzikevičius & Vetrov, 2012). In contrast, when the market is growing, greed becomes dominat, with investors constantly thinking that the market will be different. This is one reason analysts see the stock market as the leading economic indicator: investors try to jump in and out before the economy rolls(Chauvet, 2011).
An economic cycle is a valuable tool for assessing the economy. It also helps in making excellent monetary decisions. Tracking the economic cycle helps economists project the direction of the economy. The National Bureau of Economic Research declared...