Understanding the Differences Between Bull vs Bear Markets

At its most basic, a bull is an investor who considers that the market is going to appreciate in value, while a bear thinks it will fall. Therefore, a bull market occurs when shares are rising and are expected to continue to rise, while a bear market occurs when shares are falling, and predicted to continue to decline.

Of course, as with all investing terms, the details are a lot more complex.

In this article, I will explore the main characteristics and factors that differentiate bull and bear markets, and how they impact the economy and investor behaviour.

Bull vs Bear Market explained

In a bull stock market, there is typically an optimal financial environment. Hallmarks of a bull market include:

• market prices are rising with favourable economic conditions
• sustained increase in prices, particularly in equity (share) markets
• investors have faith in the long-term uptrend
• strong economy and corporate earnings, and high employment levels
• strong demand and weak supply for shares
• often low interest rates

In a bear stock market, investors tend to have a pessimistic outlook amid weaker economic conditions, with:

• the economy receding with declining stock prices
• stock markets falling by 20% or more
• share prices continuously dropping with consistent downward movements
• negative market sentiment
• a general slowdown in the economy, with rising unemployment levels and a slowed housing market
• often high interest rates

It’s worth noting that both markets are characterised by long-term financial market movements. Small market swings over the space of a few days are not typical of either.

Accordingly, timing a bullish or bearish market is about analysing wider macro events and long-term growth prospects rather than day-to-day fluctuations.

For example, the dot-com bubble crash was arguably the longest bear market in recent history, lasting for over two years. The Great Depression and World War II bear markets lasted even longer. Meanwhile, the shortest bear market was the Q2 2020 pandemic crash, which lasted only a few weeks.

Many investors in a bull market will usually be rewarded for buying and holding stocks for an extended period, as these investment prices tend to rise over time. Conversely, investors who buy and hold assets in a bear market commonly experience significant losses.

The role of investor psychology

There are strong interlinked feedback loops between investor psychology and market movements, such that the market is to some extent determined by how investors perceive and react to it. In a bull market, strongly positive investor sentiment means more investing for profit, which drives share prices higher, in turn further improving sentiment.

In a bear stock market, pessimistic investors who consider that stock prices will decline remove their money from the financial markets, causing more falls and further dampening confidence.

Of course, specific company fundamentals are usually more important to share price movements, but increased subjective sentiment either way can create buying opportunities, particularly for value investors.

Further, businesses – especially those publicly listed on stock exchanges – also have strong influence on wider market movements. Declining profits and corporate pessimism are hallmarks of a growing bear market, whereas bull markets see consumers spend more money, driving profits and share prices upwards.

For the average retail investor, the crucial point is not to let your own emotions cloud your judgement. Instead, consider wider market movements and how best to adjust your portfolio.

How to react to bull and bear markets

One of the most important factors to consider when gauging the market is that short movements only represent short-term trends or market corrections.

Both types of market can only be determined over long-term stock market performance – this is particularly true of bear markets which need to see a 20% fall to meet the definition. Often, there are long periods of stagnation where few people invest in securities and the market struggles to find a direction, resulting in a flat trend.

While the following is not advice, it’s commonly recommended that investors:

1. Buy major index equities early in bull markets and then sell shares close to the peak.
2. Remember that the market as a whole has always delivered positive returns over long timeframes.
3. Buy defensive shares or fixed income securities in a bear market to minimise losses and maximise profits.
4. Consider short-selling or buying put options or inverse ETFs. These are high risk strategies but can be very rewarding in the right economic environment.

Understanding the differences between bear and bull markets can help investors make informed, diversified portfolio decisions, including considering growth stocks or index funds during bull markets and defensive stocks or bonds during a bear market.

Pros and cons of a bull market

As with all investing strategies, there are several advantages and drawbacks when investing in bull markets.

Pros

• potential to make higher returns on value investments as asset prices rise
• increased confidence and willingness to take risks, fuelling growth
• this economic growth generates increased money, job opportunities, and boosts consumer spending

Cons

• often high volatility, with sudden drops in investments that can cause significant losses
• equity over valuations, recently demonstrated by the pandemic tech bubble
• irrational bullish market over exuberance, where decisions are made on emotions rather than market data

Pros and cons of a bear market

Similarly, there are risks and opportunities in a bear stock market.

Pros

• most stocks tend to be cheaper, offering investors the opportunity to purchase stocks at a ‘discount’ for when the market changes
• higher-yielding returns in the long run, as bear markets do not run forever
• companies tend to increase dividend yields to attract investors, while lower stock prices also increase yield organically

Cons

• bear markets can be volatile, and significant capital losses can easily be incurred
• bear markets are typified by economic recession and rising prices, leading to a rising unemployment rate and sell-offs
• bearish pessimism and risk aversion that can prolong the market downturn

Bull v bear markets summed up

• A bull market experiences an upward trend and is typically accompanied by a strong economy, while a bear market is characterised by a declining trend and a rising unemployment rate
• Most investors tend to be optimistic during a bull market and invest in equities, which have historically resulted in positive long-term returns
• A bearish market can be risky to invest in because of increased market volatility and the complexity of timing the bottom
• Timing the bottom often sees traders withdrawing cash from their portfolio and waiting for the bull market to return, exacerbating the downward trend.
• Bull and bear markets are normal economic cycles and should be seen as part and parcel of long-term investing

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