Regular investors don’t need to have an encyclopedic mastery of every syllable of The Street’s colorful financial wordplay, but knowing the most important basic terms and concepts can add to a more productive investing life.
Some of the words and phrases are accurate, singular and descriptive, like “common stock,” but others require a baseline understanding of the broader concepts the words mean to convey. Some phrases sound frivolous or even antiquated like, “pigs get slaughtered,” “dead cat bounce,” or “straw hats in winter.”
Other words that convey the state of the markets–past, present and future–seem to find their way into headlines and stories on a daily basis. Such is the case with bull, bear, correction and crash.
Everyone’s favorite bovine: The Bull Market.
Generally speaking, a bull market is characterised by rising securities prices with the expectation that prices will continue to rise more. A bull market can last for months or years, and because so many economic indicators are involved in defining a bull market, they are difficult to predict, so it is quite often we don’t know we’re in a bull market until we look in the rearview mirror.
Beyond economic data, emotions become an important factor since investor expectations are high in a bull market, sometimes unreasonably so. Confidence and optimism are the order of the day, and if you listen hard enough you may hear Fred Astaire singing, “We’re in the money,” somewhere in the background.
Even in the late days of a bull, you will hear advertisements making outrageous claims, like “get rich on one stock.” or “call now for our options trading secrets!” If you’re selling them, pal, their not secrets.
No animal lives forever, not even the mighty bull. As the market loses steam, with enthusiasm, confidence and optimism waning, we see share prices drop. Many investors confuse market corrections with market crashes, but they’re not the same thing. This is not surprising, since many normal (and healthy) corrections make good fodder for media hyperbole.
When stock prices drop by 10% we are in a classic market correction. This generally happens after share prices and the market as a whole becomes overbought. In other words, the securities are overpriced because of more buying than selling which pushes prices well above the securities’ intrinsic valuations.
These corrections look scary but are actually quite healthy. The key to understanding a correction is found in the word itself. The market is correcting, reaching for it’s correct valuation level, that is, selling will push prices down until a new low or new entry point is established and heavier buying resumes.
Corrections are not a reason to panic, rather they provide an opportunity to buy shares that have “gone on sale.” Corrections are good news for investors who don’t succumb to emotion, have wisely kept some cash on hand for selective buying opportunities and follow a long-term wealth building plan.
Corrections will often form a bottom, to use some trader jargon, which means things may be turning around, but sometimes share prices keep dropping. If losses extend into the 20% territory, the correction has turned into a real bear.
It may take many months for a bona-fide bull correction to turn into a bona-fide bear, where share prices have fallen 20% or more from bull market highs and stay at these low levels for at least a few months. These tend to be confusing times, as investors search for signs of a market bottom so they can jump back in at the low. When that elusive bottom takes a long time to show itself, things get dark. The skies open. Fear and worry rule the day, and Armageddon is just around the corner!
Emotions run rampant, but history shows that the markets ultimately reward patient investors who anticipated these historically inevitable bad market cycles into their long term investing strategy.
Corrections are not a reason to panic, rather they provide an opportunity to buy shares that have “gone on sale.”
A cyclical bear market can last as little as a few weeks to several years. In other words, shorter cycles.
But a secular bear market is different. Now we are measuring in decades, A secular bear can last from ten to twenty years. Your portfolio can take a real beating due to sustained below average returns. Oh, you’ll see flurries of strength and short-lived rallies here and there, but overall share prices remain low.
In a secular bear, even the most conservative, long-term investors may need to evaluate if strategies like short selling, put buying and inverse ETFs are right for them.
Not all corrections turn into bear markets. Not all bear markets turn into a crash. Some do.
We are talking losses of up to 50%. You remember 2008 and 2009, don’t you? Ok, I apologize for that chill that ran down your spine! The mortgage/derivative/CMO-induced Financial Crisis saw 50% of the S&P 500’s value just melt away from its previous high. Yes, it was scary.
The good news is we’ve experienced one of the longest lasting bull markets since then. Hopefully you didn’t vacate the market on a permanent basis, but if you stayed in, and continued to invest, good for you, but don’t forget that market’s continue to contract and correct, so be patient and take advantage of lower prices where you are able, according to your own long-term strategy.
~Bull markets correct themselves (always, because it’s healthy).
~Corrections often bounce back into a new Bull market phase as prices rise.
~Corrections can also lead to further price erosion, a precursor to a new Bear Market.
~A Bear can lead to a crash (or not).
~Crashes are scary!
~History shows that we have eventually bounced back from every crash.
Bulls, Bears, Corrections and Crashes, Part 2, offers useful strategies to deal with ever-changing markets.
Originally posted October 14, 2019, this perspective is just as relevant today, as we face the economic uncertainty and health fears brought on by the COVID-19 pandemic.