Bear and Bull Markets: Understanding Market Cycles

Regardless of an investor’s level of experience managing their finances, bear markets are never pleasant. For those who are newer to investing, market downturns can feel as if they will never end. However, understanding market cycles, and the fact that both bear and bull markets are important, can help investors endure market swings and position for long-term returns.

While day-to-day market movements are largely unpredictable, longer periods are usually related to economic stagnation or growth, known as the business cycle. Business cycles are characterized by periods of expansion and contraction. Periods of expansion generally see economic activity increase alongside business output and household consumption during which jobs are created and wages grow. In contrast, periods of contraction are typically accompanied by slowing consumer spending, job loss, and stagnant wages.

Experienced investors and economists know that these boom-and-bust cycles are natural and unavoidable parts of the economy. These cycles are the process of restoring the balance between economic growth and inflation, especially when there is over-investment in some sectors such as technology, energy, or manufacturing. Since the stagflationary period of the late 1970s and early 1980s, the duration of expansions has increased and contractions have become shorter and more infrequent. 

Economic contractions and expansions are very often correlated with bull and bear markets. Technically, bear markets are defined as a market drawdown of 20% or more from its all-time high. While these periods are challenging, all recessions and bear markets across history eventually stabilized, paving the way for economic expansions and bull markets.

Chart: Bull and bear markets behave very differently. 

Sources: Clearnomics, Standard & Poor’s, National Bureau of Economic Research. Past performance is not a guarantee of future returns. Investing is subject to risk of loss, including loss of principal.

The bull and bear phases of the economic and market cycle are also not created equal. The history of modern market and economic cycles suggests that while downturns may be sudden and deep, the subsequent expansions more than make up the difference. As the chart above shows, bear markets since World War II have lasted anywhere from 6 months to two-and-a-half years. During these periods, the U.S. stock market has fallen anywhere from 22% (1957) to 57% (the 2008 financial crisis) at their worst points. On the other hand, bull markets have lasted from about 2 years to over a decade in length, with the two longest cycles occurring during the past 30 years. These cycles have seen the stock market multiply in value many times over. The eleven-year bull market that ran from 2009 to 2020 experienced a price return of 401% and close to 530% with reinvested dividends. If seasons behaved like the bear and bull markets of recent decades, there would be beautiful weather 11 months out of the year.

Of course, past performance is no guarantee of future results, and the point is not that bear markets are insignificant or inconsequential. Instead, it’s a reminder that some good investment opportunities often occur during bear markets, when investors are more pessimistic. These are times where staying invested and diversified can help investors benefit from all parts of the market cycle.