Bull Markets and Bear Markets

When asked to predict where the market was headed, the famous investor JP Morgan responded, "the market will fluctuate."  That's one thing you can be fairly certain about.  The market just doesn't go sideways in a narrow band for very long.

People define bull markets and bear markets in different ways, but if the market has gained twenty per cent or more since a recent low, you are in a bull market. And if the market has lost twenty percent of its value recently, calling it anything but a bear market sounds like denial.

The terms bull and bear market apparently come from the days of the old west when brutal fighting contests were held between a bull an a bear in a pit.  It's reported that the bear usually won.  A look at a long-term chart of the stock market however shows that for the last 75 years or so the bull has been the winner in the stock market.  Even after the disastrous crash of 1929, the market recovered and eventually made new highs.  However it was a very long wait in that case.

The direction of the market generally reflects economic vitality, with bull markets occurring during times of economic expansion and bear markets occurring during economic slowdowns.  However the market usually changes direction long before the economy changes course.  This is because investors are always looking at the future.  They invest in the stock of companies that appear to have a good chance of increasing their earnings over the next year or so. 

When there are hints that business is going to be more difficult for individual companies, either because of tighter bank lending policy, shortage of raw materials, increased labor prices, or many other factors, investors will start to sell their holdings.  The price of the company's stock will fall accordingly.  If enough companies in aggregate change their direction the market averages will reflect this.  In fact the performance of the Standard & Poors 500 index is included as one of the components in the government's calculation of the Index of Leading Economic Indicators.

Market indexes, however, don't have a prefect record of predicting changes in the economy.  And random fluctuations in the market, which overlay the broader trend, make it difficult to quickly identify a change in the overall trend in the stock market.  Economists follow stock market movements to help forecast changes in the economy, so using current economic conditions to forecast the direction of the stock market doesn't make much sense.

Bull and Bear markets are generally tied to the business cycle.  Periods of good earnings and business expansion are followed by periods of weaker earnings and business contraction.  The periods of expansion are usually longer than the periods of contraction but there is no standard amount of time for either expansion or contraction.  Measuring the length of time in expansion or contraction is not that helpful. 

The business cycle is influenced by interest rates, wage levels, prices of raw materials, manufacturing capacity, productivity, and just about everything else you can think of.  The government tries to smooth out the cycle by adjusting short-term interest rates, but has been only partially successful in the last ten years or so.

A bull market makes it easier to trade stocks.  Most traders favor long positions and any dips in a bull market are often erased rather quickly.  The biggest moves in a bull market are usually made right at the beginning of the bull market so getting in early is key.

Bear markets tend to go down faster than bull markets go up, so trading the long side is very difficult, even if you think you have found a stock that has been oversold.  Shorting a bear market is difficult because bear markets don't last as long as bull markets and they often end with a quick reversal to the upside.

Although there are no sure fire ways to gauge the market, a 45-day moving average of the Standard and Poors 500 index is a good yardstick.  If prices are above the 45-day moving average, you are generally in a bull market.