I’ve got four investing strategies to take advantage of any stock market. Whether the bull market keeps charging or a bear market mauls investors, you'll be ready to make money.
In this video, we’ll look at the history of bull and bear markets as well as what has caused stocks to crash over the last 50 years. I’ll then reveal two investing strategies you can use for each type of market.
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Does a Bull vs Bear Market Strategy Matter?
Every time the stock market starts wobbling like it has lately, the news fills up with talk about bull markets and bear markets. Now it’s important to know the difference between a bull vs bear market and I’ve got some great strategies for investing in each but the truth is sometimes all the news just leads to people making the worst investing decisions.
Investors see those headlines about a bear market right around the corner and they rush out to panic sell or some hack on TV screams bull market and investors rush out to buy a certain stock.
It’s why the average investor earned an average of just 2.6% annually in the decade through 2013 according to researcher Dalbar and that’s versus an average return of over 7% on stocks. It’s those knee-jerk investing decisions and that’s what I want to save you from with this video.
We’ll cover a quick definition of bull market and bear and look at the history of each in the stock market. We’ll look at the average returns and losses in each market, how long they last and what’s caused bear markets in the past.
I’m then going to show you four investing strategies you can use to maximize your returns in each market. You’ll be able to use these strategies to not only protect your money in a bear market but boost your returns in either.
What is a Bull Market and Bear Market?
So the technical definitions of these two types of markets aren’t great. A bull market is just when stock prices are increasing over more than a few months. A bear market is any drop of 20% or more from the most recent high in a stock or the market as a whole.
So you can have a bull or a bear market in the overall stock market or an individual stock. But what’s more important here is the investor sentiment in each, investor’s sense of excitement in a bull market and the sense of panic in a bear.
That’s really what drives prices in the market and what’s going to signal those investing strategies we’ll talk about.
Bull Market vs Bear Market History
So let’s look first at this data by Mackenzie Investments on a composite S&P and TSX index, so this is data on US and Canadian stock markets. We’ll look at some bear markets going back to the 1930s but I like to use the broader data back only to 1956 for a more modern perspective on the markets.
There have been 12 bull markets since ’56 though there’s some argument whether the 2001 gain was a real bull market or just a quick bounce in the 2000 crash. On average, stocks have jumped 129% from the low of the previous bear market and have rallied for 54 months.
Now on that last point, it does seem like bull markets are lasting longer than they have in the past. Five of the last seven bull markets have all been over that 54-month average so the number could be skewed a little low by older data.
There have also been 12 bear markets of a 20% drop or more since 1956 with stocks falling an average of 28% and for that plunge in prices lasting an average of nine months from the previous highs.
Now it’s said that history doesn’t repeat itself but it does tend to rhyme. That means while no two bear market causes will be the same, there are some common themes that cause stocks to plunge.
What Causes Bear Markets?
So looking at some of the causes of bear markets in the past, we can get a sense for warning signs of a future stock market crash.
We don’t need to go too far back, just looking at the causes of stock crashes over the last 60 years gives us a good idea of those common causes. So starting with the crash of ’56 we saw the economy booming in the post-war years and this is where the saying that the Federal Reserve stops the party by taking away the punch bowl. Fed Chair Martin previewed higher rates in a 1955 speech and fears over a recession were aggravated by the Suez Canal crisis and the Soviet’s invasion of Hungary.
So this one was the Federal Reserve increasing the cost of borrowing and geopolitical risks threatening to push the world into war.
The stock crashes in ’61 and ’66 don’t even register on some bear market charts because they were so quick. The 1961 crash was the original flash crash with stocks falling 6% on a single day and for no reason. Interest rates were rising for most of the decade but nothing really set off these two mini-crashes.
It wasn’t until 1969 that the U.S. saw another major crash and this is probably one of the most under-studied bear markets. The late ‘60s were the most chaotic in U.S. history with an escalation in Vietnam, racial tensions and the assassinations of Robert Kennedy and Martin Luther King Jr.
The recession here wasn’t so bad but it followed a huge runup in stock prices so all the political uncertainty, rising inflation and interest rates, it all came together for a 36% drop in the S&P 500 from late ’68 through May 1970.
Runaway inflation started the bear market of ’73 when Nixon announced relaxing price controls. Consumer prices jumped 21% in just two years so not only did real consumer spending fall off a cliff but you had twin fears of recession and interest rates.
Now a lot of pundits want to blame the ’81 crash on the Federal Reserve, and it’s true that Chair Volcker raised rates as high as 20% to offset double-digit inflation that year. But this is also one of the first stock market crashes in modern history that was really about high stock prices. Shares surged 288% in just the seven years and just got way ahead of valuations.
The stock market crash in October 1987 is maybe the most famous with a one-day loss of 23% on the Dow Jones. It was actually pretty brief, with the bear market only lasting three months, and blamed on the surge in computerized trading that went haywire when stock prices started to plunge.
Iraq’s invasion of Kuwait is considered the match that lit the 1990 recession though this was really a borderline crash. Oil prices more than doubled during the war so people were worried about inflation and consumer spending.
The currency crisis in the late 90s was also more of a hiccup in the dot-com bubble and even with a 27% drop mid-year, stocks still finished ’98 with almost a 30% gain.
It wasn’t until the Fed started raising rates in ’99 that the market took its cue and prices plunged 49% starting in March 2000. Besides the fear that higher interest rates would cause a recession, this one was really about valuations. Tech stocks were trading on pure adrenaline and had jumped almost 900% during the decade.
Finally before we get to those bull and bear market investing strategies, most investors remember the big crash of 2008. After cutting rates to just 1% in 2003, the housing market exploded and the loan market started creating signs of a bubble. The Federal Reserve raised rates 17 times through June 2006 to cool down the pace.
The problem here was that not only did higher rates slow down the economy, they also uncovered a huge problem in the mortgage market. People were getting loans on no docs and no jobs and with rates that reset after a few years. When these loan rates jumped and it became clear that borrowers could in no way make payments, the bubble burst and led to the worst crash since the depression.
So looking at these past bear markets, we see some common causes that we can use to signal a stock market crash or a recession. One of the most frequent causes or at least parallel changes is the Fed raising interest rates.
Now I don’t want to put the blame solely on the Fed here. They’re public servants trying to manage full employment, so a strong economy, but at the same time stable prices, so low inflation. That means raising rates when the economy overheats and decreasing rates to jumpstart it.
But the fact is that increasing interest rates do slowdown the economy and can lead to a recession. If it’s on the back of booming stock prices then a lot of times, investors will use that as an excuse to take profits and stocks start falling in the sell-off.
These other two causes, high inflation and a recession, are related. The Fed is more likely to raise rates when consumer prices jump and all of this means lower consumer spending and an economic slowdown.
These last two bear market signals, booming stock prices and external shocks, aren’t usually causes in themselves but just the straw that breaks the camel’s back. When you’ve already got fears of a slowdown or really expensive stock prices, any headline risk or the potential for war can send the market lower fast.
Investing Strategies for a Bull Market
Now let’s look at those two investing strategies for each type of stock market, two strategies for a bull market and two for the bear.
The first strategy here for investing in a bull market is going to be focusing on the sectors of the economy that do best when the economy is growing. Here we see research by Fidelity on the 11 stock sectors and the average annual return at the first hint of a bull market, so in that early stage of a rebound.
Financials and consumer discretionary stocks both do well because these are two of the hardest hit during a bear market. Lending rebounds and people start spending again on all those beautiful things we love but don’t really need.
The black diamonds here, and these are really important, these show how often the sectors have produced that positive return during this early-stage of a bull market. For example, you see that consumer discretionary has jumped in every single instance and shares of industrial companies aren’t far behind with a 90% hit rate.
This doesn’t mean you’re jumping in and out of stocks or timing the market. It just means maybe you focus a little more money on these cyclical sectors during a bull market. You don’t want to rush out to sell your shares of those non-cyclical sectors like utilities but maybe you just put any new money in these sectors that benefit from a bull market.
The next strategy for investing in a bull market is called growth investing. This means looking for stocks of companies growing sales and earnings at a faster rate than the market as a whole.
Growth stocks are those of companies with profits that are growing faster than competitors in their sector or industry and that last part is important. If you’re just screening for stocks with fast sales or earnings growth, you’re going to get a list of stocks exclusively in a few sectors like technology and biotech. Growth is just naturally going to be faster in these innovative sectors versus what you’ll find in consumer staples or industrials.
So when you’re looking for growth stocks to buy in a bull market, you want to do a separate screen for each sector. You want to find a couple of growth picks in each sector to give yourself a diversified portfolio that doesn’t depend on any one part of the economy.
Investing Strategies for a Bear Market
Now investing in a bear market is going to be the opposite of this in many ways. Here we see that same analysis by Fidelity of sector performance during a recession. The sectors that do the best here are consumer staples, utilities and health care, all with hit rates of above 70% during a recession.
So again when you see some of those recession and bear market signals like rising interest rates or inflation, maybe you start shifting your new investments into these non-cyclical sectors. That’s sectors of the economy that benefit from stable sales even during a recession, things that people need to buy no matter what.
The other bear market strategy you can use is kind of the opposite of growth investing, or value investing.
Now value investing is focusing on the fundamental value of a stock and its share price. Here you’re prioritizing stocks that trade below their fair value on an earnings or sales basis. Now those of you in the bowtie nation know I’m not a big fan of the price-to-earnings ratio because it’s so easy for management to manipulate reported earnings. Instead, focus on other price multiples like the price-to-sales measure when you’re picking cheap stocks.
Just like the growth investing strategy, here you want to use that idea of investing in each sector as well. If you were to filter for stocks with the lowest PE ratios, you’d get a list mostly of companies in the utilities and telecom sectors. Instead, filter your search by each sector individually to find the best value stocks in each group.
You CAN make money in any type of market, bull market or bear market. The difference is understanding what affects these markets, how to spot the signals of a bear market and knowing how to invest your money.