The upward movement by over 20% in major stock indices characterizes a bull market, while a downward movement by the same amount is referred to as a bear market.
The global economy has taken quite the worrying turn as a result of strong measures across the world to combat the COVID-19 crisis. While many areas have done well to curb the crisis, such mitigation tactics have put a strain on numerous aspects of the economy, including the stock markets. At the beginning of the year, the stock market enjoyed a tremendous rally, with investors enjoying some incredible returns. However, things turned sour pretty fast as the seriousness of COVID-19 became more clear. The market took a steep fall through March and has continued its downward spiral in April.
2020 started as a bull market, but nosedived into bear territory within the first quarter. While this transition from bull to bear has been analyzed extensively, many average people may be curious about the metrics of a bull or bear market. Also, why the animal references?
Definition of Bear and Bull Markets
According to Sperandeo, one of the few sources for an official definition, a bull market is characterized by a long-term upward movement in stock indices, while a downward trend in index values is referred to as a bear market. Investors have further fine-tuned this definition to include a threshold of 20% in upward or downward movement in major stock indices for a market to be classified as a bull market or a bear market, respectively.
While this is generally a consensus, the figure of 20% is completely arbitrary, as is the timeline over which the growth or decline may be measured. Essentially, when we observe stock indices like the S&P 500, the FTSE 100, or the Dow Jones Industrial Average go up in value by more than 20% or decline by that amount over a specific period of time, anything from a few weeks to several years, we call it a bull or bear market, respectively.
Phases of a Bear Market
The development of a bear market can be classified into four main phases. In the first phase, investor sentiment is solid and confident, as stocks are reaching significant highs. Investors may be quick to exit the market and enjoy their tremendous profits. In the second phase, stock prices begin to drop sharply. Investors panic and the feeling quickly becomes more pessimistic. This phase is also known as capitulation. In the third phase, speculators enter the market and improve stock trading volumes. By the start of the fourth phase, stock prices continue to drop, but the decline is slower. Lower stock prices entice investors to start buying once again. Eventually, investor sentiment stabilizes, and stock prices begin to rise.
Phases of a Bull Market
A bull market begins with a steady rise in stock prices, along with strong growth in gross domestic product (GDP) and a fall in unemployment. Investor confidence begins to rise as corporations report healthy profits. In the second phase, the demand for stocks is positive and several major stock indices continue their upward climb. By the third phase, there is significant increase in IPO activity, as more start-ups are encouraged to go public due to positive investor sentiment. In the fourth phase, stocks tend to reach all-time highs and some investors begin to exit the market, realizing their gains.
Origin of Bears and Bulls
Merriam-Webster states that the use of “bear” in stock market jargon came first. Etymologists identified an old proverb that cautioned people not to “sell the bear’s skin before one has caught the bear.” It is believed to have originated from stories of merchants who would take money from buyers for bear-skin before actually having caught a bear. The term gained popularity in finance during the South Sea Bubble of 1720, in reference to speculators who bet on the fall of the stock market.
South Sea Bubble of 1720
The South Sea Company, founded in 1711, was a publicly listed enterprise that traded with the Spanish South American colonies. Between January and June of 1720, the shares of the company surged in value from £128 up to the sum of £1050 per share. This was primarily due to numerous claims made by the company’s directors about its success and profitability. However, as September arrived, these claims were found to be false, and the shares fell back down to £175. It was the first stock market “bubble” in which several investors, including Sir Isaac Newton, lost a lot of their wealth. This could be considered the world’s first recorded bear market!\
The bull found its place in stock market jargon as the alter ego of the bear. The imagery of a bear and bull being opposites caught on based on something written by Alexander Pope in 1720.
“Come fill the South Sea goblet full;
The gods shall of our stock take care:
Europa pleased accepts the Bull,
And Jove with joy puts off the Bear.”
However, there is an alternative explanation about the origin of the term.
Alternative Origin of Bulls and Bears
Some say that bears and bulls were chosen to represent the trends of the stock market based on the way each animal attacks their prey. The bear launches a strong downward swipe with its claw, analogous to a downward trend of the stock market. On the other hand, the bull thrusts its horns upward to attack its prey, akin to a rising trend of the stock market.
Yet another theory states that the terms came from the early days of the London Stock Exchange when traders would post “bulls” (bulletins) when trading volumes and frequency were high. Alternatively, on days when trading activity was slow, the bulletin board would remain “bare”.
A Positive Tip
According to research from Asger Lunde and Allan Timmermann, the longer that a bear market extends, the higher the probability that it will end. In contrast, the longer that a bull market extends, the lower the probability of its termination. Essentially, the longer your stocks decline, the chances that the decline will stop increase. The longer your stocks surge, the greater the chance that the surge will continue!
No matter how dark things seem amidst this COVID-19 crisis, remember that it’s always darkest before the dawn.