Bear Markets and Bull Markets: What's The Difference?

Bull markets and bear markets are contrasting phases of financial markets. Together, they form the economic cycle. Despite being diametrically opposed, the start of the transition from one state to the other can only be determined retrospectively.

What Is A Bear Market?

A bear market describes a prolonged decline in stock prices by 20% or more from their most recent highs. They are often triggered by an economic recession. Bear markets are typified by falling GDP, higher unemployment, and negative investor sentiment. Stock prices will continue on a broad downward path until share prices more accurately reflect fair value for current economic conditions.

Many investors will sell their stock and move to the sidelines as a bear market gathers momentum, sitting on cash while waiting on a turnaround. This added selling pressure intensifies the selloff, sending prices even lower.

What Is A Bull Market?

A bull market is a broad upward trend in stock prices that rises more than 20% from their most recent low. They are characterized by rising GDP, economic expansion, lower unemployment, and positive investor sentiment. Rising prices entice more investors into the market, increasing demand for stocks in an environment where fewer investors are willing to share.

Share prices in a bull market will often rise above intrinsic value as more people enter the stock market or expand their exposure to equities to capture profits from rising prices.

The Economic Cycle

The Economic Cycle explains the interplay between bull and bear markets. Technically, a bear market begins once a bull market has hit its high point, and a bull market begins when a bear market puts in a bottom.

The Economic Cycle has four phases:

• Expansion
• Peak
• Contraction, and
• Trough

A bear market begins at the peak of the cycle, or early in the contraction phase.

The economy slows down, often falling into a recession. Corporate earnings falter or fall, while investors turn pessimistic. Investors can get burned by buying into false rallies, which reaffirms a negative outlook even as share prices fall. Finally, valuations bottom out, encouraging investors to start moving back into the market to purchase oversold stocks. Fiscal and/or monetary stimulus gives the economy a foundation to stage a recovery.

A bull market usually starts as prices begin recovering from the trough. Economic stimulus can accelerate the turnaround, helping the market put in a higher trough than it otherwise would have experienced. Low interest rates and stimulus allow the companies that survived the bear market to grow earnings. Investors begin moving back into the market as share prices climb.

Increased demand for stocks combined with an unwillingness of shareholders to sell drives stock prices higher. This excess demand propels many stocks into overbought conditions and pushes prices past sustainable levels. In the worst cases, a stock bubble forms that only pops when enough investors start selling to book profits or central banks raise interest rates to constrict the money supply.

Investor Sentiment

Market sentiment can become a self-fulfilling prophecy. Investor sentiment that a downturn in the stock market will continue can extend the duration of a bear market. Conversely, bullish sentiment can override, at least temporarily, moderating conditions that would otherwise cause price appreciation to slow or falter.

The belief that stock prices will continue to rise for the indefinite future can be a more destructive form of crowd mentality than bearish sentiment, since it breeds a fear of missing out on profits. This fear can lead investors to push a stock’s price far above fundamentals, setting them up for sudden, sharp losses.

Bull and Bear Market Duration

Generally speaking, there are two types of markets: cyclical and secular. Secular bull and bear markets last far longer than their cyclical counterparts. Bull markets generally last longer than bear markets, in part because stock prices can climb to indefinite heights with no clear cap while stock prices in bear markets typically will bottom out after falling below what the business’s assets could be sold for.

The average length of a cyclical bull market is two to four years. The average secular bull market lasts from 10 to 20 years. The average cyclical bear market lasts from 1 to 2 years, while a secular bear market can last 10 to 20 years.

Secular bull or bear markets can experience cyclical counter-markets without invalidating the overall trend. The most extreme example may be the secular bear market in Japan that was sparked by the collapse of the world’s largest real estate bubble in 1989. Initially described as the Lost Decade, the Japanese economy has still not completely recovered more than 30 years later.

There have been five cyclical bull markets in the Japanese economy since 1989. They have ranged in duration from the 1995-1996 recovery that ended in a banking crisis to the 2003-2007 recovery that was brought down by the global financial crisis. None has been strong enough to overcome the economic malaise that fuels the secular bear market.

Investing In A Bear Market

Investing during a bear market is trickier than investing in a bull market, but its no time to panic. A defensively-minded investor will focus on established non-cyclical stocks such as utilities, healthcare, and consumer staples. Companies with a long history of paying dividends are usually more resilient than non-dividend stocks.

This is when dollar-cost averaging can shine, provided you’re investing in solid companies. Rebalancing your portfolio into bonds and fixed-income assets may be a sensible option, depending on your risk profile and time horizon. Another option is selling underperforming assets at a loss for a tax write-off.

Investing In A Bull Market

It’s tempting to go all-in on the hot growth stocks during a bull market, but keeping a diversified portfolio is important in any market. Small-cap stocks can many times overperform in a bull market. Don’t limit yourself to only mega-cap stocks, or over-invest in one particular sector. That said, you may want to adjust your asset allocation more toward equities.

Don’t fall into the trap of getting caught up in the hype surrounding the newest hot thing. FOMO is difficult to avoid if you aren’t disciplined, but remember that nothing keeps going higher forever, and no one can call the exact top of the market.