Bull and bear are two of the most commonly used terms in the world of investing. The fearsome duo have long been symbols of opposing market sentiment. In this article, we’ll explain the meaning of bull and bear markets, how they are commonly defined and investing strategies suited to each one.
What is a Bull Market?
A bull market takes place during a sustained period of rising prices. Some think of a bull thrusting its horns upwards as a representation of the ascending movement of the market. The term is most commonly used in the context of the stock market but can describe other markets, or financial instruments. For example, there could be a bull market in an asset class such as bonds. An individual asset such as gold could also be in a bull market. A broadly accepted definition is that a bull market begins when prices have risen by 20% from a recent low.
An investor is described as bullish when they anticipate that prices will rise and bearish when they expect prices to fall. The underlying idea is that bulls (bullish investors) outnumber and dominate the bears (bearish investors) during bull markets, giving bulls the upper hand.
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What Causes a Bull Market?
Bull markets in stocks typically take place against the backdrop of a strong economy and prosperity. During bull markets the Gross Domestic Product (GDP) growth rate is positive, corporate profits rise and unemployment falls. Bull markets are characterised by a rising demand for stocks fueled by positive economic data and investor optimism. During a bull market, demand is greater than supply, driving prices higher.
Bull Market Investing Strategies
Investments to consider during a bull market include growth stocks, cyclical stocks, small-cap stocks, call options and index funds.
- Growth stocks typically perform well during bull markets. They often have high price-to-earnings (P/E) ratios reflecting the high growth expectations of investors. Growth stocks usually do not pay dividends. If these companies meet or exceed growth expectations during a bull market, their stock prices can rise substantially.
- Cyclical stocks (also called offensive stocks) tend to surge during bull markets, when the economy is thriving. Cyclical stocks rise and fall along with the economy as a whole. They belong to industries tied to discretionary spending such as travel, restaurants and entertainment.
- Small-cap stocks often perform better during bull markets. The definition of small cap can change over time, but generally in the UK, the companies in the bottom 10% of the market in terms of their market capitalisation are those considered to be small-cap stocks. While small-cap stocks can be volatile and high risk, during bull markets they may be lifted as a result of the positive economic backdrop and climate of optimism among investors.
- Call options are a powerful way of profiting from a rising market with a relatively low outlay of capital. Call options give an investor the right, but not the obligation, to purchase a specified amount of shares of a stock within a specified time. The fee to purchase a call option is called the premium. The most that an investor can lose by buying calls is the amount of the premium. Call options allow bullish investors to speculate that stock prices will rise within a set timeframe for a relatively small upfront cost. They allow the call buyer to buy at a low price if the market rises.
- Index funds: During a bull market, indices such as the FTSE 100 are likely to rise in value. Investors can benefit from this by buying index funds. An index fund is a type of mutual fund or exchange-traded fund (ETF) which tracks a financial market index. For example, the iShares Core FTSE 100 UCITS (ISF) is an ETF that tracks the FTSE 100 stock market index. Index funds also have the benefit of helping investors reduce risk since they are highly diversified.
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What is a Bear Market?
Bear markets are the opposite of bull markets. Some see the way that a bear swipes its claws downwards as a representation of the downward movement in price seen in a bear market. When prices fall by 10% from a recent peak, it is considered to be a market correction. A bear market is commonly defined as beginning when a market has fallen about 20% from a recent high. When market analysts say that stocks have entered a bear market they are usually referring to a major index such as the FTSE 100 having shed 20% from a recent high. During bear markets, bearish investors dominate bullish investors and have the upper hand.
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What Causes a Bear Market?
Bear markets in stocks take place when prices are falling and there is a slowing economy with a decrease in Gross Domestic Product (GDP), falling corporate profits and rising unemployment. Other factors that can lead to a bear market are bubbles, such as the dot-com bubble which burst in 2001. The Coronavirus pandemic was what caused the most recent bull market to end in 2020, with the market dipping into bear market territory after a historic run.
During bear markets, there is negative economic data and a lack of confidence prevails among investors. Pessimistic investors may decide to sell their assets in an effort to avoid losing money or to stem existing losses. This creates a situation where supply is greater than demand, driving prices lower.
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Bear Market Investing Strategies
Investments to consider during a bear market include value stocks, defensive stocks, inverse ETFs, put options and bonds.
- Value stocks are typically sound investments during bear markets. Value stocks have low P/E ratios, reflecting that investors are not expecting a high level of growth. Most value stocks pay dividends, which allows investors to make money even during a bear market.
- Defensive stocks can be good investments during bear markets. These are shares of companies that tend to perform well even during periods of economic downturn. Defensive stocks have stable earnings and dividend payments and often come from sectors such as utilities, consumer staples and healthcare. Investing in an ETF tracking an industry sector can help provide diversification and is less risky than investing in an individual stock.
- Investors can benefit from taking short positions during a bear market by short selling stocks or buying inverse ETFs. For example, an investor buying Xtrackers FTSE 100 Short Daily Swap UCITS ETF (LON: XUKS) would make money as FTSE 100 shares fall in value.
- Investors can also profit from a declining stock market by buying put options. Put options give an investor the right, but not the obligation, to sell a specified amount of shares of a stock within a specified time. The fee to purchase a put option is called the premium. The most that an investor can lose by buying puts is the amount of the premium. Put options allow bearish investors to speculate that stock prices will fall within a set time for a relatively small upfront cost. In the event that the market falls, the put buyer has the right to sell at a high price and thereby make a profit.
- Bonds prices generally move in the opposite direction of stock prices, making them an appealing investment during a bear market. Adding bonds to your portfolio can also provide income, diversification and tax advantages.
- Applying pound-cost averaging can help investors manage their risk during a bear market. This investment strategy involves investing in the same asset at periodic intervals over time, rather than making one single purchase. This allows investors to benefit from buying dips in the market and also prevents them from making their entire purchase at the high of a market.
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How Long Do Bull and Bear Markets Last?
Historically, bear markets are typically shorter than bull markets. According to Invesco, using data from 1968 to 2020, the average length of a bear market was 349 days, while the average length of a bull market was 1,764 days. The average loss in a bear market was 36.34% and the average gain during a bull market was 180.04%.
The longest bull market in history took place between 2009 and 2020. The bull market began as stocks recovered from the Global Financial Crisis of 2007-2008 and finally ended as stocks sold off by more than 20% in March of 2020 as a result of the Coronavirus pandemic. The second longest bull market took place between 1990 to 2000, lasting 113 months.
The longest bear market in history took place between 1937 and 1942 as the Great Depression continued throughout the 1930s and the threat of war loomed in Europe. The bull market of 1942 to 1946 began shortly after America joined World War II, due to the attack on Pearl Harbor in December 1941.
While investors may be deterred by the existence and inevitability of bear markets, such market conditions occur relatively seldom. Research from Hartford Funds indicates that during the last 92 years, markets have been rising 78% of the time, with only about 20 years of bear markets.
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