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For all the advanced technology and complicated algorithms you see these days, there’s something undeniably primal about financial markets. Logic and research are vital tools but base instincts – fear, optimism, greed – play a significant role in market movements.
Perhaps that’s how two of the animal kingdom’s most fearsome creatures came to represents the extremes of market movements. Here’s what you need to know about bulls and bears.
In their commonly accepted definitions, a bear market occurs when prices drop by 20% or more from recent highs, while a bull market occurs when prices rise by 20% or more from recent lows. However, these terms are now often used to describe the current market direction.
Where did these terms come from? It’s thought to have something to do with the ways bulls and bears attack their opponents – bears swipe downwards while bulls thrust their horns upwards.
While there are many factors at play, bull and bear markets are both driven by a combination of economic conditions and investor sentiment. Rising unemployment, falling incomes, weak productivity growth and sluggish profits are all potential signs that a bear market may be imminent, while the conditions you’d expect to find during a bull market include a strong or improving jobs market, rising productivity and profits and greater household disposable income.
However, because markets tend to be forward-looking, bear and bull markets may begin ahead of real-world economic slowdowns. For instance, the post-GFC bull market in the US started in March 2009, while the US economy would remain in recession until the middle of that year and remained weak for several years after.
A market correction is another term associated with falling security prices, though it has a different technical meaning to a bear market.
A correction occurs when an index or the price of a security drops more than 10% from its highs but less than 20%, which, of course, is the point at which the fall enters bear market territory. Corrections are much more common than bear markets and tend to be shorter lived. According to a CNBC report, the average bear market in the S&P500 has lasted around 13 months, compared to four months for the average correction.
Market downturns do not follow a set script and there is no sure-fire way to know exactly when one will begin. However, there are some tell-tale signs to look out for:
The market is over-valued: One way to get an idea of what’s in store for a market index or individual stock is to look at its price earnings (PE) ratio. This measure compares the price of a stock (or index) with its earnings – for instance, a PE ratio of 25 indicates that it will take 25 years for a company’s earnings to match the value of its price at their current levels.
PE ratios tend to rise during the later stages of a bull market as investors become overly optimistic, which can lead to an over-valued market and increases the risk of a downturn.
To use this measure, look at how the PE ratios of indexes or stocks compare to their long-run averages (15 for the ASX). It’s important to note that stock prices can remain inflated for a long time in some cases so a higher-than-average PE ratio doesn’t automatically mean there will be a downturn. As John Maynard Keynes said, “the market can remain irrational for longer than you can remain solvent”.
Falling bond yields: Bond markets and stock markets traditionally tend to move in opposite directions. That’s because stocks are classified as higher-risk investments while bonds are regarded as “safe haven” assets, at least in countries like the US and Australia.
When things are going well, investors move money from bonds and put it into stocks and when things are going bad, they pile back into bonds. Therefore, higher bond prices (which means lower yields) are a sign that investors are pessimistic about the economy or the outlook for markets. However, this dynamic has been complicated over the past decade by central bank stimulus efforts across the globe, which have pushed bond yields to record lows even as stocks have marched higher.
Bad news: Negative trends like rising unemployment may be a sign of an impending downturn, as can disappointing company earnings results (think of the dot com bubble). But markets can also be driven by external events like disasters and geopolitical conflict, for example the 1973 oil strike, when lead to a stock market crash in the US.
The bottom of a bear market is usually only identifiable in hindsight – there’s no official proclamation from the ASX or Standard and Poor’s declaring that it’ll all be plain sailing from here.
However, there will be similar signals to those in place at the onset of bear markets, although they will be inverted – rising bond yields, low PE ratios and improving economic or political news are all potential signs a bull market may be underway.
On a technical basis, indexes will start to move above their 200-day moving averages while volatility will start to drop. To learn more about moving averages and other analysis tools, check out our Technical Indicators page.
Picking the exact bottom of the market is, of course, close to impossible, but recognising early on that a market has turned can lead to significant gains. To get an idea of what can happen, take a look at Macquarie Group, which dived as low as $15.49 per share in March 2009, only to rise more than threefold to $50 per share in September. By late 2019, the shares were trading for $130 per share.
Of course, getting the timing of a turnaround wrong or investing in the wrong companies can lead to significant losses. As always, it’s important to do your research and be aware of your own financial situation.
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