The terms bull market and bear market are thrown around fairly often in mainstream media, although the terms are very rarely explained.
There have been 26 bear markets and 27 bull markets in the S&P 500 index since 1928.
A bear market is an investment environment in which stocks have dropped over 20% from recent highs. Since the stock market is generally considered a leading indicator for the economy, a bear market does sometimes foreshadow an economic recession.
A bull market is an environment in which stocks are rising. It occurs after the end of a bear market.
A bear market does not necessarily mean that an economic recession will follow. Although there have been 26 bear markets since 1929, there have only been 15 recessions during this time.
We’ll outline bull market vs bear market below, as well as the key differences between the two.
Bull vs Bear Market: What’s the Difference?
Bull and bear markets are both realities faced by long-term investors as they grow their wealth.
Everyone’s Favourite: the Bull Market
Unless you are running a short-focused fund, bull markets tend to be very pleasant for investors.
Most asset classes are rising in value and the economy tends to be in very good shape. A bull market starts when markets rise more than 20% from a recent low.
Although bull markets follow bear markets and there has been almost an equal amount of both since 1928, stocks gain an incredible 114% during the average bull market.
For investors, it is critical to stay invested during a bull market, as these markets are likely when you will be generating the bulk of your return over time.
Since bull markets tend to begin immediately after a bear market, emotional investors who sold when stocks fell tend to miss the early recovery.
Investing in a Bull Market
When assets are quickly rising in price, investors are happy to look at their accounts and calculate their gains. Fewer investors realize that large investment gains come with a hefty tax bill.
As a tax-paying investor, you should almost always focus on your after-tax rate of return, as opposed to your before-tax rate of return. It is almost always a good idea to prioritize investing in tax-deferred accounts or tax-exempt accounts if you have room.
In Canada, an example of a tax-exempt account is the Tax-Free Savings Account (TFSA). The TFSA is funded with your after-tax dollars and is limited in terms of contribution amount. Investments held within grow tax-free, which can save you a lot of tax dollars during a bull market.
An example of a tax-deferred account in Canada is the Registered Retirement Savings Plan (RRSP). An RRSP is funded with pre-tax dollars and shelters your investments until retirement.
Your investments within can grow tax-free, although the money that you withdraw from your RRSP (or RRIF) is taxed as income.
Everyone’s Most Hated: the Bear Market
Unless you are running a short-focused fund, bear markets tend to be very unpleasant for investors. Asset classes are tanking in value and the economy is probably not doing too well.
Stocks tend to drop an average of 36% during bear markets. Bear markets last under 300 days on average while bull markets last just under 1,000 days.
If you are one of the few rare individuals that can spot a bear market approaching before it actually arrives, your returns will theoretically be greater if you sell your assets ahead of time and re-purchase during the bear market.
In reality, this is virtually impossible. A more realistic approach, similar to bull markets, is to continue to stay invested even throughout a bear market.
While it would be great to time markets for the extra rate of return, staying invested until your goals are achieved is the most sensible solution.
Investing in a Bear Market
Investing in a bear market is slightly more advantageous if done within a non-registered account. A capital loss, the opposite of a capital gain, is realized when you sell an investment for less than you purchased it for (or its cost base).
In Canada, the CRA allows for capital losses to be carried forward indefinitely. This can help to reduce your tax liability in the future if you have to sell winning positions (again in a non-registered account).
Your tax liability for capital gains is calculated on a net basis, which means that your realized capital losses are subtracted from your capital gains.
Capital losses do not count for tax purposes within tax-exempt accounts like a TFSA or tax-deferred accounts like an RRSP.
Investments that Tend to Perform Well in a Bear Market
Not all investment assets may be in a free-fall within a bear market. There are some assets that may actually be appreciating in value. This is always dependent on the type of bear market and the root cause behind it.
Some investments that can do well in a bear market environment include:
- Long-term government bonds
- Gold or gold funds
- Inverse funds
- The US dollar as a currency relative to other currencies
- Market-neutral funds or strategies
If you are looking to target strong performers during a bear market, make sure to consider what type of bear market you are in.
As an example, a bear market that coincides with rising interest rates will likely cause long-term government bonds to fall sharply.
Just because markets are falling, it does not mean that you can’t make money.
Conclusion
Bull and bear markets always follow each other and you can expect to experience quite a few over the course of your life as an investor.
Bull markets tend to be much longer than bear markets. The returns experienced during a bull market also typically overshadow the losses that investors face during a bear market.
The S&P 500 index returned an annualized figure of 10.67% between 1957 and 2021, experiencing both numerous bull and bear markets.
The solution for tackling both bull and bear markets is to stay invested in accordance with your financial plan and goals.
Putting together a plan and establishing your objectives and constraints is a crucial step to take before beginning to invest.
