Investing in a bull market

The term bull market is mostly used when stock prices rise by 20% or more from their previous low, though it can also refer to a single asset class (e.g., bonds, real estate,  etc.) that’s experienced a large price increase. Bull markets often last several years and take place between the end of one recession and the beginning of the next. Over the course of a bull market, stock market indices may double or even triple in value as company profits grow and rising confidence causes valuation multiples — the ratio of stock prices to earnings and book value — to expand.

Why is it called a bull market? It’s unclear how the terms originated, but optimistic investors are known as bulls while pessimistic investors are known as bears in financial parlance. In fact, over the course of a market or economic cycle, investor emotions may change, going from a “bullish” state of mind to “bearish” and back again. Some theorize the symbolism relates to the way bulls’ horns point upward while bears’ claws slash down. Regardless, bull markets are characterized by widespread optimism and rising stock prices whereas bear markets are characterized by pessimism and declining stock prices.

What happens in a bull market? 

Because bull markets tend to follow bear markets, stock prices are usually depressed at the start of a bull market. The dearth of investment capital creates an abundance of potentially profitable investment opportunities for public companies, increasing the chances their investments will pay off. Stock prices tend to rise as improving economic conditions, such as rising consumer spending, cause corporate profits to grow. As well, the unemployment rate gradually declines and utilization rates across various industries inch up toward capacity, increasing returns on investment.

The bull will continue to run as long as these fundamental factors support revenue and profit growth, and valuation multiples stay strong. Sometimes, the run will continue even as fundamentals start to weaken. This happens when investors buy for other reasons, such as a fear of missing out (FOMO), when they see other investors posting impressive returns. 

Asset bubbles can form if a bull market goes on for too long and stocks rise beyond what the fundamentals support. When asset bubbles pop, which they often do, investors can lose a varying amount of money. This happened during the dot-com tech bubble in the late 1990s. Between 1995 and 2000, investors grew overly excited about technology stocks, pushing the tech-heavy NASDAQ index up by 400%. In 2000, the bubble burst, which caused the NASDAQ to fall by nearly 80% over the next two years.  

In this case, and in all other bull-to-bear market transitions, the gap between actual corporate performance and market confidence becomes so wide that capital gets misallocated toward potentially money-losing investments. That’s when conditions arise for a correction or bear market. This turn is also often triggered by other factors such as spiking inflation or rising interest rates. If confidence collapses to the point where a market index declines by more than 20%, the bull market is over. 

The longest bull run in stock market history took place between March 2009 and January 2020, ending with the outbreak of the COVID-19 pandemic. Over that time, the S&P 500 climbed by 378%, while the S&P/TSX Composite Index rose by 125%. More commonly, bull markets last the length of the broader economic cycle, typically seven or eight years.

Just because stock indices rise during a bull market, that does not mean everyone gets richer. Climbing markets can still be volatile and experience corrections of between 10% and 20%, after which it may take the market a year or more to regain its previous highs. This happened in 2011 and 2018, during the U.S. markets’ decade-long bull run.

Individual stocks and even entire sectors may also see sales, earnings and their competitive positions decline during a bull market. In some cases, and especially more recently with popular technology stocks the vast majority of a market’s capital gains may be generated by just a few stocks. Many other stocks barely move at all. It takes skill and experience over time as an investor to ensure your portfolio contains more winners than losers.

Bull markets can also lead to a phenomenon described by technical analysts as a bull trap. This is when investors buy on the expectation of continued growth only to find the market, sector or security subsequently loses value. The trap happens when a very rapid rise in the price of a stock is followed by a sharp price consolidation, usually after a stock trades within a tight range.

It’s called a trap because those who recently bought in tend to hold onto those stocks as they’re falling — and many often add to their position during the decline. They eventually sell after a significant price drop, usually at a loss. If you’re saving for long-term retirement goals, you may not be too bothered by bull traps. Why? Because your investing time horizon may be long enough that you’re not playing market ups and downs. Instead, many long-term investors can remain invested until they need the money later in life.