Often hitting the news headlines and profusely used in common investing parlance, bull and bear markets are part of the stock market lifecycle. Whereas one exists side-by-side a strong, robust and growing economy with stock prices informed by future expectations of profits and the ability of companies to generate cash flows, the other, takes place when the economy hits a rough patch, such as in the face of recession or spike in unemployment, when it becomes increasingly difficult to sustain rising stock prices.
For better or worse, you must experience the lows of the bear market to reach the highs of the bull. But with a diversified portfolio and knowing what to expect, you will be better positioned to handle your investment decisions through them. And since both have the potential to affect your investments, it pays to understand how they work before you charge or retreat.
What is the difference between a bull and a bear market?
Both bear and bull markets often coincide with the economic cycle which reflects the fluctuations of the economy that undergoes four phases, namely expansion, peak, contraction and trough. The onset of a bull market typically serves as a leading indicator of economic expansion and in contrast, bear markets usually set in before an economic contraction takes hold.
What is a bear market?
A bear market is a period of falling stock prices on major market indexes, such as the S&P 500 or the Dow Jones Industrial Average, typically marking a price fall of 20% or more from recent highs. Having said that, individual stocks or commodities may also be in a bear market if they experience a decline of 20% or more over a persistent and prolonged period. A bear market takes place due to widespread pessimism and negative investor sentiment, as well as declining economic prospects.
The term is often used interchangeably with stock market correction and although both are associated with negative market performance, what differentiates one from the other is the fact that they refer to different magnitudes of negative performance. For instance, a correction occurs when stocks have fallen by 10% or more from recent highs, yet, in order for a downturn like this to be officially considered a bear market, it must be ongoing for a period longer than two months.
Investing during a bear market can be risky, while many investors tend to sell their investments so as to protect their money, move their holdings to more conservative securities or get access to their cash. Doing so may create what is known as a sell-off, which can make prices fall even lower. In addition, some investors may end up selling their stock for less than the price they paid for them, which can have an overall effect on their financial goals.
What is a bull market?
Essentially the opposite of a bear market, a bull market is when a major stock market index rises at least 20% from a recent low and just as is the case with a bear market above, the term can also be used to refer to any individual investment that is experiencing a price rise. During a bull market stock prices increase steadily, while investors are optimistic about the stock market’s future performance and expect that these strong results will continue for an extended period of time. What’s more, a bull market indicates that the economy is strong, while unemployment rates are generally low, affording people with more income to invest.
Bull markets are notoriously difficult to predict since prices rise and fall continuously during trading and as a result, analysts only recognise this phenomenon after it has happened. Often, the start of a bull market is marked at the market bottom of a bear market. For example, the S&P 500 reached the lows of the financial crisis in March 2009. As a result, the date is considered the start of the bull market which lasted until early 2020.
What causes a bull market?
Different market sectors can experience bull markets at different times, however, what causes bull markets is a demand for a security or group of securities that outweighs the usual laws of supply and demand, which in turn push prices higher. This is often accompanied by bullish expectations for the economy and company earnings.
What causes a bear market?
There are several factors that can cause a bear market, however, a common cause is investor fear or uncertainty, as well as a slowing or sluggish economy. When investors sell off shares to avoid losses, this may be a signal of the onset of a bear market. A sluggish economy is usually characterised by low employment and low disposable income, a drop in business profits and other indicators. Other historical causes have been widespread investor speculation, over-leveraged investing, commodity price movements, such as that of oil and irresponsible spending amongst others. On occasions, government intervention in the economy, like a change in the tax rate, can trigger a bear market.
What is a real-world example of a bull market?
A popular example of a bull market was the period between 2003 and 2007, when the S&P 500 increased by a significant margin after a previous decline. Another well-known instance of a bull market in the U.S. began during the end of the so-called stagflation era in 1982 and concluded during the dotcom bust in 2000, during which the Dow Jones averaged 16.8% annual returns, while the Nasdaq increased its value five-fold between 1995 and 2000, starting off from 1,000 point and rising to over 5,000. Moreover, the year 2009 saw the start of a more than a 10-year bull market run, with analysts believing that it was mainly led by an upswing in technology stocks.
What is a real-world example of a bear market?
Two of the most well-known bear markets in history are the Great Depression, which began with the stock market collapse of October 1929 and the aftermath of the bursting of the dotcom bubble in March 2000, which wiped out approximately 49% of the S&P 500’s value. The ballooning housing mortage default crisis also caused the S&P 500 to come crashing down to 682.55 on March 4, 2009 when it had previously touched a high of 1,565.15 on October 9, 2007.
And of course, the most recent example of all, was the bear market of 2020, when fears about the spread of the COVID-19 virus drove the global economy into a downward spiral, sending markets into bear territory in the beginning to the mid-part of 2020. On March 23, 2020, the S&P500 dropped 34%, marking one of the worst drops in the history of the index, according to Forbes. It wasn’t until May 27, 2020 that it broke the 3,000-mark, after which it began to climb higher.
Why are they called bear and bull markets?
A bear market is thought to have taken its name from the way in which a bear attacks its prey, in other words, by swiping its paws downwards, a move that is reminiscent of falling stock prices. In contrast, the bull market got its name from the way in which a bull attacks – thrusting its horns into the air.
What are the bull and bear market cycles?
It is usually difficult to consistently predict when the trends in the market might change and this is usually mainly due to the fact that psychological effects and speculation often play a large role in the markets. Having said that, bull and bear markets do have distinct cycles as outlined below:
Bear market cycle
Historically, bear markets tend to be shorter than bull markets, with the average length being approximately 289 days, however, some bear markets have lasted for years, such as that of the Great Depression, which is considered the longest bear market, which lasted from March of 1937 up to April 1942. In contrast, the most recent bear market, began in March 2020 and ended in August of the same year when stocks closed at record highs.
The four phases of a bear market are:
- Phase 1: characterised by high prices and high investor sentiment, however, towards the end of this phase, investors drop out of the markets and take in profits.
- Phase 2: stock prices fall sharply, economic indicators shift to below average, trading activity and corporate profits drop.
- Phase 3: speculators enter the market, raising some prices and trading volume.
- Phase 4: in this last phase, stock prices continue to drop, albeit slowly. Low prices and the start of good news begin to attract investors once again and this is how a bear market leads to a bull market.
Bull market cycle
Bull markets typically last for a few months to several years and as a general rule of thumb, they tend to be longer than bear markets, with an average bull market lasting 973 days. The bull market that took place between 2009 and 2020 is considered one of the longest bull markets during which stock growth reached 400%. What’s more, bull markets tend to be more frequent. And just like bear markets, bull markets occur in four distinct phases:
- Phase 1: this phase is characterised by low prices and low investor sentiment who have a pessimistic outlook of future prices.
- Phase 2: economic indicators are eventually brought above average thanks to an increase in trading activity, positive corporate earnings and stock prices.
- Phase 3: as trading activity continues to increase, market indexes and securities reach trading highs, while dividend yields reach new lows.
- Phase 4: this final phase is usually marked by excessive IPO and trading activity, as well as speculation. Investors then either take profits or react to negative indicators, bringing the bull market to an end.
How to invest during bear and bull markets?
Investing in a bear market
There can be opportunities to put your money to work when investing in a bear market. Here are some ideas:
- You may be able to benefit from falling prices if you take a short position. To achieve this, you may short sell, buy inverse ETFs (exchange-traded funds) or buy put options.
- If you still want to invest during a bear market, opt for safer investments, such as fixed-income securities.
- Alternatively, consider defensive stocks, whose performance is not impacted much by changing trends in the market. Such stocks remain stable no matter the market cycle. Such stocks tend to outperform at times of market volatility as their business models are considered less sensitive to economic performance, such as consumer staples and utility companies.
- Avoid knee-jerk reactions to market movements and moving in and out of stock positions too quickly.
Investing in a bull market
During bull markets investors can usually invest actively and confidently into stocks, with a higher probability of making a return, while any losses may be minor and temporary. Here is how you can make the most of a bull market:
- Take advantage of rising prices by buying stocks early in the trend, ideally during phase one and then sell them when they have reached their peak.
- Bargain shop for stocks at the bottom of a bear market.
- Opt for companies with strong growth fundamentals, such as solid earnings growth, experience high demand for their products or services and other such strongpoints.
- Be mindful of the industry the company operates since, some industries tend to bounce back much better than others. This depends on the economic backdrop at the time of investing.
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