The market's direction has a significant effect on the value of your investments and therefore requires different investment strategies. Because bull and bear markets can significantly change the value and price of assets and securities in the market, it is essential to understand how they can impact your portfolio.
What is a bull market?
When we use bull market to describe market conditions, it indicates that stock prices are increasing or are expected to increase, usually by 20% or more. These increases refer to stock market prices but can also apply to any type of security or financial instrument that is traded, such as bonds, real estate, currencies, and commodities.
Since the prices of securities rise and fall throughout the day, the term bullish is typically reserved to describe market behavior over a much longer time frame. A bull market occurs when the prices of traded securities are rising continuously following an extended period of significant decline. Bull markets can 'run' or last from several months to many years.
Some of the typical characteristics of a bull market are:
- Increased optimism and investor confidence: Investors believe that they will be able to ùgenerate positive returns in an upwardly trending market.
- Higher trading volumes: In the hope of realizing capital gains, more investors participate in the market and more money is invested in the stock market.
- Tendency towards higher valuations of securities: Along with higher trading volumes, investors are also willing to pay more for securities because there is an expectation that their value will appreciate, i.e., the price will go up. Many individuals may invest for the long term.
- Increase in the number of companies going public through initial public offerings (IPOs): With increased investor optimism and confidence, it is easier for companies to raise capital using IPOs. IPOs give investors the opportunity to participate in the company's current and potential future growth.
What is a bear market?
A bear market occurs when prolonged price decreases hit the market. The exact opposite of a bull market, a bear market describes conditions when the price of securities drops by 20% or more from recent highs. This is often accompanied by widespread pessimism and negative investor sentiment. A bear market may also be associated with a general economic downturn such as a recession, and like a bull market can last months or years.
Some of the typical characteristics of a bear market are:
- Pessimism and fear of ongoing market downturn: Investors become nervous about their portfolios. Their fears can cause them to sell stocks, hold cash, and seek out alternative investments like bonds, precious metals, real estate, or money market funds rather than stocks.
- A weak or slowing economy: Typical signals of an economic slowdown include high rates of unemployment, low disposable income, weak productivity, and a drop in business profits.
- Bursting market bubbles: Prolonged periods of continuing growth can become unsustainable. This can trigger a market bubble burst, creating a domino effect that spreads from sector to sector and generates an extended market downturn or bear market.
How long can a bear or bull market last?
While it’s impossible to predict the future, we can learn a lot from looking at previous bear and bull markets. Since 1975, North American markets have risen steadily. Significantly, in nearly every bear market, losses have not exceeded the gains made in the preceding bull market.
What investment strategies can be considered during a bull market?
Typically, an investor should take a different approach to managing their portfolio during a bull market.
Here are some strategies to consider in a bull market:
- Diversify your portfolio: 'Not putting your eggs in one basket' is a key principle of good portfolio management. With a diverse portfolio, you won’t be caught up in trending stocks. And by spreading your risk, you limit the effects of market volatility. An option to consider are exchange traded funds (ETFs) that focus on a variety of asset classes and/or sectors.
- Dollar cost averaging: Timing the market to your advantage is difficult, even for experts. Using a dollar cost averaging (DCA) strategy takes out the emotion and guesswork of trying to time the market. Instead, you invest a fixed amount of money, rather than a fixed number of shares, into a security or securities at set intervals. Over time, it can result in lowering the total average cost per share.
- Take a long-term approach: Bull markets tend to last longer than bear markets based on historical evidence. However, making rash decisions during a bull market can be difficult to recover from because positive market trends often translate to more expensive stock valuations over time. It’s always easier to feel confident about your investments during a bull market but when that bull market becomes bearish, the best approach is usually staying the course.
Source: CIO Office, National Bank Investments (data via Refinitiv)
What can investors do during a bear market?
A market downturn is when you want to limit losses and, if possible, take advantage of lower asset prices.
- Again, diversify your portfolio: The importance of diversification applies to both bull markets and bear markets!
- Consider defensive industries: Investing in sectors such as utilities, consumer staples, and other necessities that people buy regardless of economic conditions can be an effective strategy for keeping your portfolio healthy when there is a contraction in the market. Assets like these are often less subject to extreme volatility during periods of economic busts and booms.
- Tax-loss harvesting: This is a tax strategy that is designed to minimize or cancel out capital gains tax by selling securities held in a non-registered account that have decreased in value. These losses can be used to offset the capital gains tax that will be applied to securities that have appreciated over the course of the calendar year.
- Take a hands-off approach: Whether through an advisor or robo-advisor, a managed solution can reduce the emotions and guesswork around investing.
While the stock market has experienced sustained periods of growth with bull markets and periods of decline during bear markets, historically, it has performed well and has grown overall. For example, $100 on an index like the S&P 500 in the year 2000 would be worth over $448 in 2023¹, while the value of the TSX Composite Index has more than doubled in the same period².
Investors, big or small, have to keep in mind that past performance is no guarantee of future results. Understanding the direction, the market is taking and having a carefully constructed long-term plan, as well as a diversified portfolio, are important to managing the ups and downs of market conditions.
