Bull and bear markets. What's the difference?

You've probably been hearing a lot about bull and bear markets over the past year. And while the terms are a common way to describe a market's upwards and downwards performance, they're very different animals when it comes to the impact on both your portfolio and your investment decisions.

What is a bull market?

Financial markets are hugely affected by consumer confidence. That's why investors get excited about a bull market because it's an environment where investments can gain significant value very quickly.

Economists don't share one absolute definition of when the market has become a bull market. However, one widely accepted approach is when the market's overall value reflects a 20% increase in share prices over the period of at least three months - and ideally longer, so it can be considered a sustainable change. This is what you'll have seen taking place last year and earlier this year. Rising prices have led investors to buy into securities or simply hold onto their investments, which has created the perfect conditions for a buyer's market.

Therefore, bull markets take place when the economy is strong, unemployment is low, and investor sentiment has become increasingly buoyant.

The financial markets have experienced a series of bull markets throughout history, which have lasted for varying periods. The most recent ran from 2009 to 2019 following the Global Financial Crisis and the collapse of the U.S. housing market.

What is a bear market?

Quite simply, a bear market is the exact opposite of a bull market. So, if share prices drop by 20% or more over at least three months (and again, ideally longer), we've entered bear territory.

Bear markets occur when the economy slows down, there's high unemployment, fears of interest rate rises and consumer confidence hits rock bottom.

What's more, bear markets may self-perpetuate into a downward spiral as investors frantically sell off their investments in a desperate attempt to limit their losses.

How long will a bear market last?

Bear markets can last a few months, or they can run on for years. Over the last twenty odd years, the most notable examples include the dot com crash from 2000 to 2002, when the market fell by around 75%. The 2007 to 2009 financial crisis, when it fell by more than 50%. And more recently, the 2020 COVID-19 crash, which resulted in the fastest stock market plunge in history.

The rises and falls of the share market

It's important to put drops in the financial markets into perspective. Take a look at the chart below, which illustrates the performance of the markets from 1915 until April 2021. You'll see that despite the various crashes over time, there are more ups than downs. What's more, the ups last longer and over the long term, the markets move higher.

Dow Jones - DJIA - 100 Year Historical Chart

What is a stock market correction?

You'll often hear the term "stock market correction" when a market starts to move quickly. That's because a steep rise or dip can look like the market's heading in the general direction of the 20% marker. But if the fall doesn't go that far and only moves by, say 10%, it's seen as meeting the definition of a correction. Nonetheless, this rapid movement still creates the expectation of moving into a bull or bear market.

The difference between a bear market and a stock market correction is further marked by the sentiment behind the drop. A market correction is often simply a temporary glitch that will sort itself out. On the other hand, the negative emotion that fuels a bear market only brings it down further.

Investing for the long haul.

Bear market investing is about a long-term approach. Although you're buying at low prices, there is the possibility that your investment will drop even further, so you need to be prepared for this to happen. Therefore, think carefully about which shares you want to invest in for the long haul so that if they do drop, you're not tempted to sell.

Furthermore, younger investors with higher risk tolerance and capacity sometimes see bear markets as excellent investment opportunities. They know they have time to recover from the effects of the bear market, will experience others in the future, and can reap the rewards of the bull markets that take place in between.

Don't second guess the bottom of the market.

Don't try and predict when a market is going to hit rock bottom. Buying into a bear market is about selecting long-term investments. So, take it slowly, build your stock gradually over time. And if prices do drop even further, consider additional investments in companies that have the right qualities.

Where's the market going in 2021?

If you're going to invest in the financial markets, it's vital to understand the general direction they're heading. But it's impossible to know with any certainty when a bull market will move into a bear market.

That said, many economists believe that due to the level of government stimulus and central bank support around the world, at the moment, the economic outlook has rarely looked so positive. However, some have expressed fears that there may be too much support and stimulus. Their concern lies in the high level of support creating inflation. This would lead to interest rates rising earlier than expected, which would not be a good outcome for most investments.

Strategic investments

At Clearwater, we believe that investing your money in a long-term strategic asset allocation will help your investment weather the ebbs and flows of the market. That's why we have a skilled team of fund managers on board to assess the market every day for opportunities and recommend the best place to invest your money.

Our DMGDP is designed to smooth out the significant variances between the bull and bear markets. The CDP takes a longer-term approach, which is designed for investors who are prepared to ride through the ups and downs of financial markets and benefit from the gains that will eventuate from remaining invested.

by Gary Lucas.