Bull and bear markets can reflect the optimism and pessimism of the economy but markets can also run counter to the economic data and sentiment.
They can rise – be bullish – when pessimism dictates they should fall and fall – be bearish – when optimism says they should rise.
As an investor you’ll be sensitive to signs of both bull and bear markets to have a better idea of your investment strategy and to structure your portfolio.
Knowing when to time the market is an impossible science.
However, it is essential to understand both market and economic cycles and how market sentiment can affect your securities. It will better inform what to do to either maximise profit or mitigate losses.
Defining the bull and the bear
There are a number of theories about the origin of bear and bull in relation to stock markets among the most common are references to the way both animals attack and the use of bear- and bull-baiting in arenas during Elizabethan times as entertainment.
DeFreitas and Minsky considers a visual reason for the terminology through the actions of the bull and bear as they attack. A bull drives its horn up into the air reflective of the upward movement from low of the stock market while the bear makes a downward swipe with its paw reflecting a down market from high.
According to Merriam Webster, in terms of etymology, the use of bear in a commercial context appeared first.
In the seventeenth century it appeared in a proverb that warned not “to sell the bear’s skin before one has caught the bear”.
By the eighteenth century, the term bearskin was used to describe a commercial transaction,through the use of the phrase “to sell (or buy) the bearskin”.
It was also found in its reference to the middle man called a “bearskin jobber” who sold bearskins at some determined price before he received the actual bearskin. He hoped to make a profit on the difference between the price he paid for the skins and the price he sold it.
Soon the word bear came to mean a stock sold by a speculator as well as the speculator selling the stock (this is now called short selling).
Bears were said to sell a borrowed stock with a delivery date specified in the future. This was done with the expectation that the stock price would fall and it could be bought at a lower price allowing profit from the difference of the selling price.
The famous South Sea Bubble in 1720 saw more widespread use of the term as many people took to speculating.
The use of bull came into existence around the same time as a rival and equally powerful image to the bear. DeFreitas and Minsky point to when the London Stock Exchange was established in the 17th century there was a bulletin board where traders posted offers to buy different stocks.
A high demand for stocks meant a board full of bulletins, commonly called bulls and when there was little demand the board was ‘bare’.
The bull was associated with a person making a speculative purchase in expectation of a rising stock price.
Soon bull came to denote a market with a rising price and bear represented a market with falling prices. There is a bull and bond market for different securities such as bond, equities and commodities.
Today the bull is a visible symbol around the financial markets. In 1974 Merrill Lynch, a financial company, adopted a charging bull as its logo.
There is a sculpture of a charging bull created by the artist Arturo Di Modica that he displayed briefly in front of the New York Stock Exchange in Wall Street in all its symbolic glory following the Black Monday stock market crash of 1987.
An exuberant bull…
Part of the economic cycle is periods of time when there are fluctuations between rapid expansion (boom) and severe contraction (bust).
The length of one cycle is a single boom and contraction (measurable only after the fact when growth and national output figures are available).
There are four stages of an economic cycle: boom, slowdown, recession and a recovery.
Economically, a boom can be said to be occurring when there are more jobs, higher wages, increased demand for imports and fast growth in consumption among other things.
Consumers feel good and they feed this optimism and confidence through to markets like housing and shares.
But, when investors pour into these assets sending the market higher for any extended period that’s exuberance with a psychological problem – irrationality.
Investors spurn or, more to the point ignore, any news that isn’t reinforcing the feeling.
Alan Greenspan, a former US Federal Reserve Chairman, made a speech in December 1996 where he coined the term ‘irrational exuberance’ used in a different context but has since been used to describe the euphoria in a bullish market.
A bull market characterised by on-going volatility and exuberance could be a sign of an overheated economy or what is called a ‘bubble’ (see South Sea Company).
The FT defines a bubble as when prices of securities or assets rise so sharply and at a sustained rate that they exceed valuations justified by the fundamentals making a sudden collapse (burst bubble) likely.
Bubbles can be formed as a result of economic and monetary policies, interest rate levels, inflation, liquidity as well as social psychology factors based on optimism.
But, the real drivers of bubbles are mania and easy access to money. During bubbles, sentiment is at work as people feel wealthier and act on illusory beliefs about quick profits and that the bubble will never end.
Psychosocial theories abound about the why’s:
- Greater fool effect: one overly optimistic fool buying an overvalued asset in the hope of selling it on to a greater fool
- Herd behaviour: Investors’ tendency to buy or sell in either direction