Financial markets work through cycles that are upward and are downward, just as the economy goes through such cycles varying from strong to weak. When a financial market as a whole, or as a group of securities has been rising, this is known as a bull market. When the opposite is true, that a financial market as a whole, or a group of securities has been falling, this is known as a bear market. Bull and bear markets can last for months, or even for years. Bull markets tend to last longer than bear markets, just as bull markets tend to rise slower than bear markets fall. We will discuss here our views on the key differences between bull and bear markets and what are the changes to our trading strategies for a bull vs bear market.
Let’s start by looking at the characteristics of a bull market. When the correction for the stock market ended in March 2009, that started a bull market that has continued for almost a decade.
Figure 1. S&P 500 Total Return during a bull market.
Since the general direction of the market is up for an extended period of time, one approach that can be successful is to buy more stocks whenever the stock market has a small move downward. This is known as “buy on the dip”. It is also possible to buy broadly diversified investments and hold them for extended periods of time. Since the overall direction of the stock market is up, these investments may continue to grow for long periods during the bull market. One trading style during a bull market is to “let winners run” when possible, meaning to hold investments that are going up with the market for as long as possible, sometimes as long as many years.
When the economy is generally improving during a bull market, corporate profits are also generally increasing. Let’s use the S&P 500 as our broad measure of the US stock market. There is a strong correlation in the graph below between the orange line, which is the trailing twelve month earnings per share, versus the value of the S&P 500, in blue. We can see that when the earnings are dropping on the S&P 500, so is the stock price for the S&P 500.
Figure 2. The S&P 500 index compared with its trailing twelve month earnings per share (EPS)
During bull markets, investors may look for investments that will go up more than the overall market. This could potentially include investments such as small company stocks or technology stocks. Conversely, it may mean avoiding investments that could go up less than the overall market. This could potentially include avoiding investments such as utility stocks.
The characteristics of a bear market are somewhat opposite that of a bull market. In the late 1990s, there was a large run up in the stock market over excitement about new technology and internet companies. When many of these startups went backrupt, this was known as the “Dot Com Bust”. In the next few years, there was an extended downward market or bear market. Note that while the overall direction of the market was downward, there were periods of weeks where the S&P 500 was going up.
Figure 3. S&P 500 during a bear market
Since the general direction of the market is down for an extended period of time, one approach is to sell stocks each time the stock market has a short term rally or an upward movement. This is known as “sell on the rip”. Holding an investment for an extend period of time can result in watching the value drop month after month. But within a bear market that is lasting several years, there can be shorter bull market rallys that can last for weeks or several months. These shorter term upward rallys during the middle of a bear market are often called “Bear Market Rallys”. Making money buying stocks in a bear market may require holding them only during the shorter bear market rallys. Since investments are held for a shorter time during a bear market, there may be the need to do more trading during a bear market. We believe an important goal in a bear market is be to avoid losing money as the overall stock market is moving down. A 1-2% return could look good, if the overall stock market is down -10% or more.
Bear markets often occur when the overall economy is declining, and possibly going through a recession. Corporate profits may be declining. Note in Figure 2 above, the S&P 500 tends to be going down during the periods when the earnings are declining and during the gray areas, which are recessions.
During bear markets, investors may look for investments that will go down less than the overall market. This could potentially include investments such as utility stocks or bonds. Conversely, it may mean avoiding investments that could go down more than the overal market. This could potentially include avoiding investments such such as small company and technology stocks.
To summarize, bull markets can extend for years and are generally uptrending markets. This is when it can be time to “buy on the dip” to get a lower price on an investment and then continue to own the investment as the stock market moves up. This may be a period where investments can be held for a number of years and they can continue to go up in value along with the overall stock market. A bull market is a time when the goal is growing your investment values.
A bear market is the opposite of a bull market. The overall stock market may move downward for many months, or even several years. While the overall direction is down, there can still be periods of weeks or several months where the market is moving up. These are known as bear market rallys. During a bear market, investors may choose to “sell on the rip”, meaning each time the market has a short term movement up, then it is time to sell some investments. Bear markets may be a time when the number of trades goes up, since investments may be held for weeks or months, rather than for years, as is done during a bull market. A bear market is a time when preserving the value of your investments is important.
We believe in active money management, not buy and hold. This means that we are studying the economy and the markets to look for the the trends of bull and bear markets to help guide our clients through these various cycles. Sometimes it means we are more offensive and other times more defensive. We like to look for opportunities in any market. Even at the end of a bear market, when the stock market has gone down significantly, this can present a new opportunity to buy investments at much lower prices at the start of the next bull market. Therefore, we think active management makes sense in today’s world.
Your Financial Journey Partners Team
Index returns shown are not reflective of actual performance nor reflect fees and expenses applicable to investing. One cannot invest directly in an index.
Past performance is no guarantee of future results, and all investing involves risk. Index returns shown are not reflective of actual performance nor reflect fees and expenses applicable to investing. One cannot invest directly in an index.
Investment advisor services offered through Mutual Advisors, LLC DBA Financial Journey Partherns, a SEC registered investment adviser. Securites offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc., and Mutual Advisors, LLC are affiliated companies.