The economy has been on everyone’s mind this year. With higher prices everywhere you look and interest rates continuing to climb, it’s no wonder people are invested in where the economy is going. And on June 13th, the stock market took a hit — the S&P 500 entered a bear market after recording a 21% decline.
If you’re a novice investor, you’ve likely heard the terms “bull market” and “bear market” tossed around. The problem is, the terms are so ubiquitous that they are rarely explained, even by those using them. They clearly refer to different types of markets and economic conditions, but what do those terms really mean, and how did they originate?
Here’s a look at what a bull market and bear market really are, and more importantly, how they can affect your investment portfolio. Once you learn the difference between the two, you’ll be on your way to learning how to invest like a master.
What Is a Bull Market?
If you’re an investor, a bull market is a very good thing. In bullish times, stock market prices are in a well-defined uptrend. Although different investors and commentators have different definitions of what exactly a bull market is, the U.S. Securities & Exchange Commission defines a bull market as a rise of 20% or more in a broad market index over at least two months. In a general sense, however, a bull market is one in which a large percentage of stocks are moving upwards over a sustained period of time.
While this sweeping definition may refer to the market as a whole, investors can also refer to different segments of the market as being bullish, even if the broad market is in decline. For example, the Standard & Poor’s 500 index is divided into 11 sectors. It’s entirely possible that the technology sector could be in a bull market while the utility sector is trending lower, for example.
In addition to its strict stock market definition, a bull market is also generally accompanied by a booming economy and general optimism among consumers and investors. Known as the wealth effect, this theory posits that when asset values like home prices and the stock market rise, consumers feel more confident and spend more money. This in turn creates additional economic expansion, which can help fuel the bull market even further.
What Is a Bear Market?
A bear market is the opposite of a bull market, in every way.
Generally defined as a drop of 20% or more in stock prices, bear markets also bring about economic pessimism and reduced consumer spending, factors that can contribute to extending a bear market. During a bear market, investors want to protect their savings. This can lead to more money being pulled out of the stock market, driving prices down even further.
Bear markets are more extreme versions of corrections, which are defined as a drop of 10% to 20% in the general market. However, bear markets can be much more severe. During the Great Recession at the end of the 2000s, for example, market prices dropped by more than 50%. Things were even worse during the Great Depression, with prices falling by an astonishing 83%.
The Etymology of the Terms
There is not an agreed-upon understanding as to how the terms “bull” and “bear” came into existence. One theory is that the terms refer to the method in which these respective animals attack: A bull thrusts its horns up into the air, in an upwards motion, whereas a bear swipes its paws in a downward motion.
Whatever the origin, the terms are now a permanent fixture of the investment landscape. There’s even a giant sculpture of a bull in the streets of New York, near the New York Stock Exchange, symbolizing the prosperity and optimism that is typically associated with a thriving stock market.
Bull Market vs. Bear Market
Historically, the bull versus bear battle has been decisively won by the bulls. Since 1928, the S&P 500 has seen 26 bear markets and 27 bull markets. However, bull markets run for much longer than bear markets, and their gains far outweigh the losses endured during bear markets. The average bull market lasts nearly three years. Bear markets, on the other hand, average a run of about 10 months.
The regular occurrences of both bull and bear markets — and the unpredictability of when either will occur — make the case for investors to contribute to their accounts regularly. It’s all too common for investors to get scared out of bear markets at the absolute low and miss out on the typically huge gains that follow a bear market.
Similarly, investors encouraged by large gains in a bull market tend to pile in at the very end, just in time to get clipped by the oncoming bear market. By contributing monthly or even weekly to the market, investors can even out their returns and ensure that they are buying additional shares when the market reaches its bear-market low.
The Bull and Bear Markets of 2020
In 2020, investors had the rare experience of undergoing both a bear market and a bull market in rapid succession. In February and March, the S&P 500 index plummeted precipitously, dropping over 30% in a matter of days. In fact, that bear market was the fastest 30% drop in stock market history. What occurred next was perhaps even more startling. Within just 33 trading days, the market did a complete 180 and surged to all-time highs, marking the shortest bear market in S&P 500 history.
Good To Know
These types of wild swings are uncommon. The typical bear market lasts just about 10 months on average, making the rapid turnaround in 2020 even more unbelievable. However, that market selloff was also a classic demonstration for investors of a so-called “black swan” event, in which an unforeseen external disaster — in this case, the rapid outbreak of the coronavirus pandemic — tanks the stock market.
How Do Bull and Bear Markets Impact Investors?
If you’re a true long-term investor, you shouldn’t really be too concerned with whether you are in a bull market or a bear market. The bottom line is that in the history of the stock markets, the long-term trend is up. If you’re a long-term investor, the ups and downs of bull and bear markets iron themselves out, and the volatile moments — although they can be scary at the time — don’t have a big impact on your portfolio.
It’s only when you give in to emotion that bull and bear markets can cause financial damage. If you get caught up in the euphoria of a roaring bull market and put all your money in at the top, the ensuing selloff could set your investment plan back years. Similarly, if you get scared out when there’s “blood in the streets” and panic in the markets, you won’t enjoy the gains of the subsequent bull market. The best way to combat the ups and downs of the stock market — which are inevitable — is to stay the course with your long-term investment strategy.
Of course, this doesn’t apply if you’re close to retirement or plan on drawing from your portfolio for any reason in the next few years. Investing in stocks is a long-term process. If you need money for a down payment for a house in the next year, for example, keeping your money in the stock market is risky at best.
All it takes is one bear market to hit and you may find yourself losing 20% to 50% or even more of your capital right when you intend to use it. If you intend to invest in stocks, keep a long-term investment horizon, match your purchases to your risk tolerance and consult with a financial advisor.
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