If you're investing in the stock market, it's good to have a general understanding of bear and bull markets. Not only do these two terms describe the overall mood and trend of the stock market, but they also present unique opportunities for long-term investors.
Changes in the stock market are inevitable but educating yourself will help you invest wisely. Read on for an in-depth look at bear and bull markets, their distinct features and how to respond wisely during periods of market volatility.
A widespread decrease in stock prices is a clear sign of a bear market. The term comes from the downward swipe of a bear's attack, which resembles the downward trend of stock prices in this market phase.
During a bear market, investors tend to have a negative outlook. Anticipating further price drops due to a variety of factors, like an economic recession, natural disasters or a global crisis, they often "panic sell" stocks to limit their losses during a bear market.
The characteristics of a bear market can vary but, typically, stock prices fall by at least 20%1 from their previous peak and the decline can last several months to years. During this prolonged period, your investment portfolio is likely to experience negative returns — which might not feel good — but it also means that stocks are “on sale."
This period could present a potential opportunity for savvy investors. During a bear market, investors can purchase more shares for less money and stockpile assets at a much lower cost. In many cases, portfolio managers find opportunities to buy blue-chip companies at a discount. For example, companies that are fundamentally strong may be oversold during a bear market due to widespread pessimism and can therefore be purchased at a lower price during a bear market compared to their typical value.
When the market eventually recovers, the value of these stocks can surge. For instance, after the stock market plummeted 20% from December 2019 to March 2020, the U.S. equity market rebounded in just four months — going back to precrash levels by July 2020 and then pushing the prices even higher2.
The term "bull market" comes from the upward movement of a bull's horns. In a bull market, there's a widespread increase in stock prices, and investors tend to be positive.
During a bull market, you can expect prices to rise because of investors' optimism, driven by factors like a robust economy, strong corporate profits, declining unemployment, innovative technology and/or industry breakthroughs. People tend to invest in stocks to benefit from the upward trend.
Like with a bear market, the characteristics of a bull market can also vary. However, it's generally defined as a period when stock prices rise by at least 20% from their previous low and lasts at least two months and can last for several months or even years.
During a bull market, investors commonly experience positive returns, and many stocks are priced at a premium. However, bull markets also have risks — companies may be overvalued, and investors may pay more for a stock than it's worth.
One thing to keep in mind is that bear and bull markets aren't always clearly defined, and the transition between them can be gradual. Another thing to consider, is that different sectors of the market can also be in different stages of a bear or bull market all at the same time.
For example, the overall market might be in a bear market (the stock market is in decline), but a certain sector, such as technology, may be in a bull market (the stock market sector is rising). This is why it's important to stay focused on building a globally diversified portfolio that's aligned with your financial goals and risk tolerance, rather than trying to time the market and buy “winning" stocks or sectors.
When the market experiences sudden increases in volatility, it can be unsettling and make you consider abandoning your long-term plan in favour of short-term relief by investing in cash or other liquid assets. However, when it comes to investing, think long-term instead of getting caught up in short-term ups and downs.
Aside from thinking long-term, there are a few other things to keep in mind, such as:
- Diversifying your portfolio, so that if one area doesn't do well, the others can balance it out.
- Staying informed about the market.
- Seeking professional advice from experts who can give you helpful insights and help guide you through the process.
- And sticking to your financial plan.
Understanding the basics of bear and bull markets can help you feel more well informed and confident in your investment decisions, especially during times of market volatility. And don’t forget that if you need guidance and reassurance in your strategy, you can always lean on a knowledgeable portfolio manager to help you reach your long-term investment goals despite what the market is doing today. After all, as the saying goes, the most important factor isn't timing the market — it's time in the market.
This article is provided for information purposes only. It is not to be relied upon as financial, tax or investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules, and other investment factors are subject to change without notice and The Bank of Nova Scotia is not responsible to update this information. All third party sources are believed to be accurate and reliable as of the date of publication and The Bank of Nova Scotia does not guarantee its accuracy or reliability. Readers should consult their own professional advisor for specific financial, investment and/or tax advice tailored to their needs to ensure that individual circumstances are considered properly and action is taken based on the latest available information.