How to Invest in a Bull Market

Posted on Monday, October 22nd, 2018 MarketBeat Staff

One of the most commonly heard phrases when it comes to investing is “the bulls and the bears”. The bulls in that phrase refer to bull markets, and these are seen as a good thing for investors.

In this article, we'll define a bull market and review the economic, psychological and consumer characteristics of a bull market. We’ll also review how to invest in a bull market and tell you why a bull market can be present even when an economy is in a recession.  

What is a bull market?

A bull market occurs when a particular asset class is rising in value. This encourages buying, which then causes the asset class to continue to rise. Although it tends to be used as a generic reference, the classic definition of a bull market is an asset class or market that has risen 20%. This gain typically, but not always, occurs after a decline of over 20%, and the bull market will usually precede another decline of 20%. For this reason, bull markets tend to only be spotted once they’ve ended or, in the case of a long bull market, when it already exists.

Although commonly referenced in relation to the stock market, bull markets can be about any asset class. For example, during a period when the stock market was considered to be in a bear market, gold and some other precious metals were enjoying a massive bull market. Although this was partially due to investor hysteria, there is truth to the idea that asset classes tend to move in opposite directions. When stocks are up, bonds tend to be down and vice versa. In some very strong bull markets, stocks become the rising tide that lifts all asset classes.

What are the economic characteristics of a bull market?

When you’re talking about the broader market, a bull market is generally a sign of a strong and expanding economy. During a bull market, unemployment is generally low or declining and gross domestic product (GDP) is strong. By themselves, those characteristics don’t signify a bull market, but when those economic metrics are strong, corporations generally start to report higher revenues and profits. This incites investor optimism which and are more likely to be buying shares. Corporations also feed on this optimism as bull markets are generally a time when initial public offering (IPO) activity is also on the rise.

An underlying economic reality of all bull markets can be found in the principle of supply and demand. As consumers, we know that whenever there becomes strong demand (i.e. a large number of buyers) for a particular product or service, but a limited amount of that same product or service (i.e. sellers) the price generally goes up. Think of the secondary market for tickets. If you’re a season ticket holder for a particular team and that team is having a great season, the value of your tickets on the secondary market will go up. There will be high demand for the tickets, but fewer sellers looking to part with their tickets. This means that the price of an available ticket will increase and continue to do so until they reach a point where demand is saturated or the price becomes prohibitive.

It’s the same with securities during a bull market. As investors gain confidence and start to invest in stocks, demand increases. However, companies only have a finite amount of outstanding shares available to buy. Sellers (usually institutional investors) will want to hold on to these shares as they increase in value. This drives the price per share up. This will continue until a particular stock or group of stocks reaches a “tipping point” where investors demand is met. In these cases, investors may look to sell in order to capture the profits that they have made. Just because selling activity occurs does not mean that the bull market has run its course. In fact, there are frequent "pauses" or even corrections in a bull market that preceded the next leg up.

The psychology behind a bull market

Although there are many measurable characteristics of a bull market, it is a psychological event. Once the market notices that conditions are right for a bull market, a bull market can become a self-fulfilling prophecy as investors rush in to buy stocks. Once this upward momentum has started, it can be amplified by the fear of missing out. It plays on our natural inclination to want the best possible return. What is true about a bear market is that once assets begin to rise at a certain pace or beyond a certain level, other investors are likely to jump on board which then creates momentum for that asset to continue to rise.

Another part of the psychology of a bull market is that, because it is a statistical event, it often ends because investors feel that it’s time for it to end. Take our current bull market for example. There are some experts who insist that it has been ongoing since 2009. Others point out, correctly that the market declined by more than 20% both in 2011 and again in 2016. However, this leads to questions about what defines the 20% rule. Does it have to be a closing price threshold? Is it only defined by the Dow Jones Industrial Average or S&P 500 Average or do other indices count?  The question impacts the psychology of the market.

Consumer behavior in bull markets

The role of the consumer is one of the leading indicators of a bull market. You'll frequently hear the phrase "consumer confidence" associated with a monthly economic forecast. This is a non-scientific survey that gauges consumer sentiment. Usually, consumer confidence turns positive in advance of a bull market. When consumers feel that the economy is turning around, they are willing to buy more goods and services. This, in turn, encourages manufacturers to increase production and it increases a company's revenue and/or profits. When a company's output increases, it also increases shipping traffic by truck, rail or air. This, in turn, can impact other areas of the market, such as oil prices. All of which generally causes investors to become optimistic about a company's fortunes and eager to buy stock in that company.

How to invest in a bull market

The classic advice of buying low and selling high is never truer than during a bull market. As an investor, this is a time to make sure you profit from rising share prices. However, few investors can accurately time the market and many investors hop into a bull market when there are few profits to be gained. Other investors may hold on to stocks far too long. Buying and selling is a natural part of a bull market. Even within a bull market, no stock continues to rise forever. Remembering the mantra "pigs get fat; hogs get slaughtered" is helpful. Investors should look to set price targets perhaps even using stop orders to automatically lock in profits when a stock reaches your particular target. Remember holding on to a stock that's ready to roll over on the gains you've made is not a profitable investing strategy.

One of the challenges for investors is knowing when a bull market is occurring. That’s one argument for staying in the market no matter what direction it’s going, then perhaps increasing your spending during times of economic growth.

How frequently do bull markets occur?

There is really no scientific metric to calculate how frequently bull markets occur. However, based on the performance of the S&P 500 since 1926, there have been eleven bull markets, including our current bull market. These have averaged 9.1 years and the average cumulative return has been 480%. The shortest bull market, in the early 1970s, lasted just 2.5 years. The longest bull market, which spanned from 1990 until March of 2000, lasted 10 years.

An interesting point about bull markets that may be counterintuitive to some investors is that they can sometimes occur even during times when the economy is in recession. One example of this occurred in the early 1980s. This is because a bull market has economic and technical indicators that usually indicate the presence of a bull market before consumer and investor sentiment follow suit. It’s usually these technical “bullish” indicators that begin to lead an economy out of a recession.

The bottom line on bull markets

Bull markets are periods of increasing growth in an asset class. The phrase bull market is most commonly used to refer to stocks. In this case, it refers to a period of time when stock prices, in general, are rising. Investor interest is heightened which causes the gains to continue.

There are three components of a bull market. The economic component is the most measurable. Typically a bull market is noted when the market is up 20% off of a low. This rise is typically after the market has suffered a 20% decline and occurs in advance of another 20% decline. During a bull market, gross national product (GDP) is increasing and unemployment is generally on the decline. As a result, companies are reporting higher profits and investors are looking to profit from these companies. A bull market illustrates the principle of supply and demand with investors looking to buy shares, and shareholders wanting to retain the shares they have, thus making supply scarce and making each share more valuable.

Another component that is necessary for a bull market is investor psychology. This is usually expressed as the fear of missing out. As share prices rise, investors want to buy into the market for fear of missing out on the gains that are available. This builds a momentum that can be a sort of self-fulfilling prophecy for a bull market. Unfortunately, this psychology can also lead investors to stay invested in a particular stock even though a bull market is showing signs of running its course.

A third component that is common to every bull market is consumer confidence. As consumers see the stock market rising and companies hiring, they feel better about spending their disposable income. This then fuels company profits which in turn make their stocks attractive to investors and the cycle continues.

A bull market is as much a technical event as it is a psychological event. In many cases, a bull market starts well before consumers or investors realize it has. This is why it’s possible for bull markets to be present even when the country is in the middle of a recession. Although some analysts may disagree on the precise length of a bull market, it is generally recognized that since 1926 the S&P 500 has recorded between nine and eleven bull markets.

 





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