In the world of finance, the terms "bear market and bull market" are frequently thrown around, often leaving investors confused. These terms refer to the prevailing sentiment and trends in the financial markets and may influence investment decisions and portfolio management strategies. As a financial advisor, it is crucial to comprehend the differences between bear and bull markets and guide clients through the unique challenges and opportunities presented by each. In this article, we will discuss the characteristics, causes, and strategies for navigating bear and bull markets. To paraphrase Sir Francis Bacon, “Knowledge is power”, and a major goal of PHP Capital is to educate investors, empowering them to make informed decisions in various financial climates.
Understanding the Bull Market: A bull market signifies a period of sustained optimism and rising prices in the financial markets. The Securities and Exchange Commission states, “Generally, a bull market occurs when there is a rise of 20% or more in a broad market index over at least a two-month period.”
Features of a “Bull Market” commonly involve the following:
- Increasing stock prices across various sectors that comprise an index. The three most commonly discussed measures of market performance include the S&P 500, Nasdaq 100, and the Dow Jones Industrial Average (DJIA). Stay tuned for a future article discussing all three in more depth.
- Positive investor sentiment and confidence.
Investors who feel positively about the markets or the likelihood of continued increases in the stock market buy stocks (or stock-oriented funds) and drive prices higher.
- Expanding economic activity and growth. As our economy grows, businesses make more money and are therefore worth more. There are many measures of growth, including Gross Domestic Product (GDP).
- Opportunities for capital appreciation and wealth accumulation.
Causes of a Bull Market: The driving forces behind a bull market can vary, and it is essential to understand the key factors that contribute to its emergence. We explore several factors that can spark and sustain a bull market, such as:
- Favorable economic indicators and low unemployment rates (more growth leads to more jobs and thus lower unemployment rates).
- Corporate earnings growth and positive financial performance.
- Technological advancements and disruptive innovations leading to increases in productivity. Disrupters change industries, keeping competition high and driving other companies to advance and constantly improve.
- Stimulative fiscal and monetary policies. Fiscals are items such as tax rates, government policy, and government spending, while monetary policies are controlled by the Federal Reserve.
Strategies for Thriving in a Bull Market: While a bull market may seem like a boon for investors, it is vital to approach it with caution and adopt strategies to capitalize on the prevailing upward trends while mitigating risks. We discuss several strategies that investors can employ during a bull market, including:
- Proper asset allocation and diversification.
- Regular portfolio rebalancing. Being disciplined with portfolio rebalancing is extremely important because you are taking gains on winners, which may be expensively valued, and deploying the capital elsewhere.
- Selective stock picking based on fundamental analysis and potentially technical analysis. Fundamentals are critical and include details like how the management team is performing, growth of earnings, opportunities for future products or services adding to growth expectations, how financial statements look, for instance, debt loads, etc. Technical analysis is simply looking at charts and making predictions using only charts. It is often a self-fulfilling prophecy because if the chart says, “buy this stock”, people buy the stock, bidding up stock prices. Technical analysis should not be ignored as there is such a large amount of capital being managed on “technicals” that, regardless of “fundamentals," it can and does move stock prices.
- Evaluating risk tolerance and adjusting investment goals as a portfolio grows.
Understanding the Bear Market: A bear market, in contrast to a bull market, is characterized by a sustained period of pessimism, declining prices, and investor uncertainty. The generally accepted definition is a market falling by 20% over at least a 2-month period (Note: you may also hear individuals say there is a “pullback”, which is a 10% decline). Features and key characteristics of a bear market include:
- Negative investor sentiment and increased fear.
- Decreased economic activity and potential recessionary pressures.
- Lower trading volumes and reduced liquidity.
- Challenges in the preservation of capital and continued wealth preservation.
Causes of a Bear Market: A multitude of factors can cause a bear market, ranging from economic indicators to geopolitical events. Understanding the causes behind a bear market is crucial for financial advisors when formulating strategies to navigate challenging times. Several factors can contribute to the emergence of a bear market, such as:
- Economic recession or contraction.
- Inflation leads to higher interest rates where the Federal Reserve must raise interest rates to combat inflation.
- Increases in commodity prices such as oil and gas prices.
For instance, higher food or gas prices lead to a reduction in consumer confidence.
- Negative earnings revisions and weak corporate performance.
- Geopolitical tensions and uncertainty.
- Excessive speculation and overvaluation. One example of this would be the “dot-com bubble”.
- Investor panic and market contagion.
- Poor fiscal policies. One example would be drastically increasing tax rates, limiting consumers' ability to spend (Consumer spending makes up roughly 2/3 of the US economy).
Strategies for Navigating a Bear Market
In a bear market, it becomes imperative for financial advisors to guide their clients through the storm and work to preserve their wealth while identifying opportunities for long-term growth. Here are several strategies that can help investors navigate a bear market:
- Review and reassess your portfolio. Conduct a thorough review of the portfolio, analyze the holdings (what you own and why you own the position to ensure the thesis that led to the purchase is still intact), make changes in asset allocation, and review your risk tolerance to ensure the portfolio is suitable for your tolerance. Make necessary adjustments as needed.
- Diversify and allocate assets appropriately.
Diversification may include exposure to various industries, asset classes, sectors, and geographical regions.
- Do not panic. Oftentimes, investors panic when the market declines, make investment decisions based on emotions and make wrong decisions. Remain objective and ask yourself if you would buy each position in the portfolio now. If the answer is no or the thesis was wrong, it may be best to sell a stock and cut your losses. If you are down on a position and the thesis remains strong, it may be best to add to the position and lower your cost basis (average price paid per share). An advisor’s role is to help in difficult times to keep clients viewing the situation objectively. Keep in mind that you should speak with your tax advisor regarding potentially capturing capital losses as a tax strategy if the position is not in a qualified account.
- Expand your knowledge, and potentially look at bonds, defensive stocks, and sectors that may perform better in the current environment. Many defensive positions pay dividends, and good examples include utilities, consumer staples, and healthcare. Defensive positions are often considered defensive due to more stable demand for their products and services, reasonably reliable earnings expectations, and resilient business models.
- Dollar-Cost Averaging may be a strategy to consider. This strategy involves regularly investing a fixed amount regardless of market conditions. Investing a fixed amount regularly (monthly or bi-weekly for example) at regular intervals allows you to buy more shares when prices are low and fewer shares when prices are higher. This strategy may help smooth out the impact of market volatility and can lead to lower average purchase prices over time.
- Maintain a long-term perspective and focus on fundamentals. Markets move up and they move down – this is specifically why we’re discussing bull markets and bear markets. Hartford Mutual Funds has a publication that states, “The average length of a bear market is 292 days or about 9.7 months. That's significantly shorter than the average length of a bull market, which is 992 days or 2.7 years. Every 3.5 years: That's the long-term average frequency between bear markets.” Maintain a focus on your long-term goals, and expect bear markets to occur as they are a normal part of the market cycle. This does not mean that you cannot prep your portfolio for an expected bear market or you must stay fully invested all the time. Focus on companies with strong financials and quality management, buy quality bonds, and review your portfolio regularly with your advisor.
- Look for Opportunities During Volatile Times: While a bear market may be challenging, it also presents unique opportunities – most companies get punished during bear markets. Keep an eye out for undervalued stocks or investment opportunities that may arise during the downturn.
Understanding the differences between bear and bull markets is crucial for investors and advisors alike. By comprehending the characteristics, causes, and strategies associated with each market environment, investors can make more informed decisions. Remember to diversify, know what you own and why you own it, manage risks, and seize opportunities. Whether it's navigating the optimism of a bull market or weathering the storm of a bear market, a knowledgeable and proactive financial advisor can provide invaluable guidance and support to aid in the long-term financial success of their clients.
William (Bill) Parrish is a financial advisor that owns PHP Capital in Littleton, Colorado. He can be reached at (720) 284-2372 or via email at parrish@phpcapital.com.
Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer member FINRA/SIPC. Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Cambridge and PHP Capital are not affiliated.