Bull Vs Bear Market: What Causes Them, How to Identify, and What to do?
Some rivalries never end. Bull vs bear is one such rivalry in the stock market.
The human economic history is replete with excesses in either direction. When going is good, we keep going and try to maximize our gain. Inevitably, we go farther than the economic fundamentals would support. The bull market, as the period of expansion and growth is known, eventually ends when the market sentiment turns towards pessimism. Similar events unfold in reverse when the market sentiment is pessimism, and it turns positive. This cyclical swings create the bull and the bear markets that we have so come to know and love (or loathe, depending on whether you are on the right side of the market or the wrong).
What is a Bull Market?
A bull market is when the stocks are generally rising, economic activity is on the upswing, and the inflation is positive but normally well controlled. A bull market is officially confirmed when the stock index (such as S&P 500) rises 20% above the previous low.
Characteristics of a Bull Market
Generally the health of an economy is positively correlated with the trends in the stock market. A growing economy leads to a bull market. As a result, all the signs of a growing economy are present in a bull market.
For example, we can expect the following to be true:
- Rising corporate earnings
- Declining unemployment rates
- Rising wages
- Increasing dividends
- Rising asset price (such as real estate)
- Increase in discretionary spend, for example, vacations, luxury goods, day care, dry cleaning, etc
Additionally, there have been claims that the skirt lengths are inversely correlated with the stock market direction. That is, if the skirts are getting shorter, it indicates the stock market is rising. When the skirts get longer, the stock market tends to be declining. (Please do not invest based on the fashion trends – fashion trends tend to be fickle)
How to Invest in a Bull Market
Throw a dart! Buy an index fund, no matter what the index!
The phrase “Rising tide lifts all boats” tend to be true in a bull market. Even mediocre company stocks do well. If you are careful to avoid some of the worst ideas (money losing enterprises), you will generally come out okay. The key is to be invested – your investment skills have minor influence on your returns. Stay diversified so you can ride out any bad choices or turn of events.
How does the Bull Market End
It is a curious phenomena. We humans like to do what we see others doing (herding behavior). Therefore, when we see others buying stocks, we are more likely to buy stocks. When the stocks go up, we get excited and buy even more. Eventually, the stocks rise faster than the growth in the economy can support. Corporate earnings start to disappoint, perhaps because the business has turned, or perhaps just because the expectations have been lofty in the first place. Either way, when the stocks become too expensive to hold, investors get nervous and start selling. Selling begets more selling, the demand for stock is quickly outpaced by the supply of the stock, and the prices fall.
Notable Bull Markets in the History
Some of the greatest bull markets in the recent history are as follows:
- The roaring 20s. The Great Gatsby was set in this era
- The Internet Boom
- The Real Estate Boom
- Today (I am writing this in Dec 2019)
On average a bull market lasts for 55.1 months and results in a gain of 153.71%.
What is a Bear Market?
A bear market is when the stock market is on a decline, the economy is suffering and there may be deflationary or disinflationary trends in the market. A bear market is confirmed when the stock indexes (such as S&P 500) declines by 20% below the recent high.
Characteristics of a Bear Market
While a correction (decline less than 20%) may occur when the stock prices go out of line with the economic conditions, and if the economy is still otherwise strong, a bear market (decline more than 20%) is generally correlated with a recession or other economic malaise.
We can expect the following to be true:
- Declining corporate earnings
- Rising unemployment rates
- Declining wages
- Dividend cuts or eliminations
- Declining asset price (such as real estate)
- Decrease in discretionary spend, for example, vacations, luxury goods, day care, dry cleaning, etc
- Individual and corporate bankruptcies and market exits
- Increased acquisitions of distressed assets by strong companies or corporate vultures
As we discuss the bear market, it is worth bearing in mind that certain industries and companies are counter cyclical. for example, cheap fast food does better when consumers stop eating at more expensive restaurants and go for the cheap stuff. Certain other industries, such as tobacco or consumer essentials (soaps, grooming, diapers, etc) may not feel any effects of the bear market or recession, as they have a very inelastic demand curve.
How to Invest in a Bear Market
Investing in a bear market boils down to moving your capital to assets that are one or more of:
- counter cyclical
- recession proof
- less risky (such as bonds and other debt instruments), and/or,
- income generating, such as dividends that cushion the blow, so to speak, and when reinvested can continue to compound your investments
Alternatively, if you know for a fact with a lot of certainity that a bear market is coming, you could go short the market. This way, the declining stock prices will generate profits for you. Unfortunately, market timing tends to backfire at the most inopportune time, so I would not advise this.
How does the Bear Market End
Once there is enough blood in the street, the prices have no way to go but up. This is what is said, and it is true – you can only undervalue any asset for so long before someone or other will want to buy it off your hands for a higher price.
Bear markets end when everyone who is likely to sell has sold. The patient buyers, who spot great opportunities, now no longer have a supply of cheap assets, and must bid up the price to fill their demand.
Economy also starts to get better, businesses start hiring new workers, and tourism picks up. General economic sentiment improves, and this in turn leads to more businesses take additional risk by investing in new projects and hiring more workers.
Once investors become net buyers of stock and the stock prices start to rise, more investors enter the market. The economic cycle thus continues.
Notable Bear Markets in the History
Some of the greatest bear markets in the recent history are as follows:
- The Great Depression
- The Internet Bust
- The Real Estate Crash
- The Great Recession
- The Next Recession
An average bear market lasts for 11.7 months and results in an average of 34.33% loss.
Localized versus Widespread Bull (or Bear) Markets
We talk about the bull vs bear market in the larger economy. However it is also important to note that there may be mini bull or mini bear markets that are localized to a sector, industry or geography. For example, as the bull market roared on in most of 2019, the trucking sector underwent a crippling bear market. Speaking geographically, the 1997 Asian Financial crisis was sparked by the devaluation of the Thai Baht. The contagion spread across Asia quickly, but many economies were spared and the contagion was quickly contained.
Bull vs Bear Market: The Key Takeaways
Bull and bear markets alternate like night and day. The economy and the stock market is cyclical, and understanding the cycles is very important if you wish to be a successful investor in the stock market. There are investment strategies that you can use in various phases of the market. A bear market can also give you many investment opportunities to preserve or even grow your wealth. Knowing these concepts will help you with managing your personal finances.