How Stock Market Cycles Work


Among all of Wall Street’s iconic figures, real and mythical, nothing symbolizes the dual essence of the markets better than the bull and the bear. Many financial professionals use the terms “bull market” and “bear market” to describe the two primary phases of the stock market cycle.

Here we take a closer look at bull and bear markets. We hope this article strengthens your understanding of their defining characteristics and how they integrate within the larger context of a stock market cycle. In this article, we hope to help you define bull markets and bear markets, illustrate factors we believe drive the stock market cycle and help you distinguish a bear market from a bull market correction.

Bulls and Bear Markets

Generally speaking, bull markets are lengthy periods over which stock market prices generally rise—often multiple years. Bear markets, on the other hand, are generally shorter time periods in which fundamental factors drive stock prices downward approximately 20% or more from a previous peak or market high.

Since 1946, US stocks have endured 11 bear markets lasting an average of 16 months and dropping an average of 34% in price returns.[i] During the same period, bull markets have averaged nearly five years in duration and 149% in the S&P 500 Price Index.[ii]

Bull markets have—on average—lasted much longer and their returns are often much stronger than bear markets.

If your research and forecast leads you to believe a downturn in the stock market cycle is forming or is currently underway, you may be able make a tactical decision to switch to more defensive assets. However, this can be dangerous if done too frequently or at the wrong time. Investing can be fraught with emotions like fear, and understandably so—after all, for many investors, their portfolio represents a lifetime of savings and their livelihood in retirement. But we urge you to use extreme caution and refrain from going defensive for emotional reasons, such as reacting to political news or newspaper headlines. One of the trickiest endeavors for investors is distinguishing a bear market from a bull market correction—a sharp, sentiment-driven stock market decline of roughly 10 to 20%.

Distinguishing Bears from Scares

It may seem easy to identify bear markets in hindsight, but spotting one in its early stages is far more challenging. We believe there are two general ways that bear markets begin: The Wall or The Wallop.

The Wall

The Wall refers to what we call the “wall of worry”— a succession of fears or negative events that occur during the course of a bull market. Often, stocks continue rising despite the initial panic and media hype, and investors realize their fears were overblown.

Though investor fears can potentially trigger bull market corrections in the short term, they don’t often develop into full-blown bear markets. The reason: most of these declines in price are driven by negative investor sentiment—feelings—rather than negative fundamentals.

Hence the saying the markets climb a “wall of worry.” In other words, markets will likely continue to climb until investors become euphoric and stop looking for potential negatives. When investors are all looking for hot stocks and more reasons the bull market should continue, they often set overly positive expectations and miss potential fundamental negatives. At this point, the bear market may have already begun, marking the end of the previous cycle.

The Wallop

The Wallop, on the other hand, is an unforeseen event that is strong enough to knock off trillions of dollars from global GDP. Think of it as a big negative thing nobody is talking about or expecting. The impact of this negative event can “wallop” a strong global economy, derailing a healthy bull market and ushering in a bear market.

But there is a difference between declines related primarily to investor fears and a fundamentally driven bear market. Though stocks may waiver some on investor fears and negative sentiment in the short term, if the negative event isn’t capable of causing global GDP to contract for two or more quarters, then it likely isn’t a Wallop, and markets will likely recover soon.

What Drives Stock Market Cycles?

We forecast global market conditions primarily based on three broad drivers for stocks: economics, politics and sentiment. Each driver comprises a set of smaller contributing factors which play a significant role in the progression of every individual market cycle. Different developments can also help investors identify roughly what stage of a stock market cycle we may be in.

For instance, with regard to economics, we pay close attention to various factors such as leading indicators of economic growth, interest rates, the yield curve, credit index and equity supply. Politics can also play a leading role in the stock market cycle. When evaluating different countries to invest in, we pay close attention to factors such as government stability, trade practices and capital barriers that might affect the local economy.

Last but not least, investor sentiment is another critical stock market driver. It helps us gauge how investors and financial media feel about the stock market looking forward. While emotions are subjective and difficult to assess, we look at a wide variety of potential indicators—such as margin debt levels and mutual fund flows—to indicate the collective sentiment of investors at large. In addition, professional forecasts and media coverage help clarify the picture of where overall market sentiment stands.

How Fisher Investments Can Help

Timing the market can be nearly impossible if you don’t have sufficient research or insight to guide you. If stock market history has shown us anything, it is that the market cycle is rarely transparent and often causes investors to react poorly to ongoing market developments.

Fisher Investments can help you stay disciplined as you navigate the various conditions of stock market cycles. Our dedicated Investment Counselors are here to answer client questions and help quell fears they might have regarding the market. To learn more, download our one of our educational guides or ask to speak with one of our qualified professionals today!

 

[i] Source: Global Financial Data, as of 2/5/2018; S&P 500 Index Price Level from 5/29/1946 – 12/30/2013. FactSet, as of 2/5/2018; S&P 500 Index Price Level from 1/1/2014 – 2/2/2018. For “Duration,” a month equals 30.5 days.

[ii] Source: Global Financial Data, as of 2/5/2018; S&P 500 Index Price Level from 5/29/1946 – 12/30/2013. FactSet, as of 2/5/2018; S&P 500 Index Price Level from 1/1/2014 – 2/2/2018. For “Duration,” a month equals 30.5 days.

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Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations.