5 signs to tell if the market is in bull or bear cycle - Kalkine Media

Financial markets globally move in cycles. When the markets are going up, it is called bull cycle, and when it is going down, with a significant decline, it is said to be a bear market.

Knowing where we are in the cycle is important as an investor, to know if you should take more risk or avoid risk.  

Understanding the signs of a bull or bear market is crucial to make informed decisions. Historical events such as the dotcom bubble burst in the early 2000s, resulted in major bear market that lasted for almost 3 years.

It is also important to keep a diversified portfolio irrespective of the market cycle to reduce your risk.

We will examine these signs in more detail and explore other methods for identifying whether the market is in a bull or bear cycle.

Sign #1 - Market Sentiment

In a bull market, investors tend to be optimistic and confident, driving stock prices higher. However, in a bear market, they tend to be more cautious and risk-averse, leading to a decrease in prices of securities.

Paying attention to market sentiment can provide valuable insight into the current market conditions and help you make informed decisions. Often when you are at the extremes of a sentiment, these are the warning signs that a cycle may be ending.

Another key indicator that synchronizes with market sentiment is the moving average (MA) indicator.

Firstly, one of the most popular moving average indicators is the 200 day MA. A Simple Moving average is based on an average of past closing prices of an asset taken over 200 days.

Its use was popularized by world renowned trader Paul Tudor Jones. According to his 200 MA rule: when the market price is trending below the 200-day MA line, it may be entering a bear market, and it’s a signal to sell or be cautious when buying.  

Some traders combine a 50 day MA and 200 day MA indicators on their trading chart for confirmation of trends.

Secondly, the Volatility Index or ‘VIX’ is another widely used sentiment indicator. It is a measure of how much fear is in the market. When the VIX figure is below 20, volatility is low, and above 20 means high volatility.

It's important to note that there are several sentiment indicators but no indicator is perfect. A combination of different indicators gives a better confirmation.

Sign #2 - Significant Changes in Major Market Indices

A bear market is characterized by a prolonged period of declining stock prices, and a general lack of investor confidence. Once a major market index like the S&P500 falls by more than 20%, it signifies a bear market has started.

In contrast, a bull market is characterized by a prolonged period of rising stock prices and increased investor confidence. The rise and fall of major market indexes can also be used to identify the stage of the market cycle, whether it's in expansion, peak, or contraction.

The significance of the index movement also suggests the level of investors’ sentiment, which is the driving force behind the market trend.

One example of a bear market was the period from 2000-2002, where the S&P 500 index fell by 51.9%. This bear market was caused by the dot-com bubble bursting.

Another example of a bear market was the Global Financial Crisis (GFC) of 2008-2009, where S&P 500 index fell by 57%. This bear market was caused by the housing market bubble burst and lasted about one year.

On the other hand, an example of a bull market was the period from 2009-2020, where the S&P 500 index rose by over 300%.

However, it's important to note that these are general indicators, and stock prices can be affected by various other factors such as company performance, economic conditions, liquidity, and global events.

For example, a company's individual performance can drive its stock prices up or down in short term regardless of the market trend.

In short, the performance of major market indexes can provide valuable insight into the current state of the economy, and can help investors make informed decisions.

Sign #3 - An Increase in Short Selling Using Leverage

When you engage in shorting using leverage, you are borrowing money to increase your short position, which is a sign that you believe the stock price will decrease.

According to the ASIC Short Selling Regulatory Guide, to short sell, you first approach your ASIC accredited stockbroker and use stock that you already own as collateral, or borrow stock from the broker. If your collateral stock is worth say AU$5,000, your broker can allow you borrow stock worth more than that amount and this gives you more leverage.

You then sell the borrowed stock at the current market price, re-buy it at a lower price in the future, and return to lender. The sell/re-buy price difference is your profit. This is often associated with a bear market, as short sellers look to profit from falling asset prices.

However, shorting can also be done via Contract for Difference (CFD) without borrowing the asset, instead you bet on the price movement. These are only suited for experienced traders. There are multiple ASIC regulated CFD brokers in Australia who provide you mobile platform to trade CFDs on various markets, be it equity, currency, indices, or commodities.

It's important to note that short selling is a speculative strategy, and it carries an unlimited upside risk of losing money, if the underlying asset price increases instead of decreasing.

Succinctly, an increase in short selling using leverage may be a sign of a bear market, as investors are betting on falling asset prices.

Sign #4 - Central Banks Adjust Interest Rates

In Australia, the Reserve Bank of Australia (RBA) is the central bank that sets the benchmark interest rate, known as the cash rate currently at 3.1%.

When interest rates are excessively high, it becomes more expensive to borrow money, which can lead to decreased investment and spending, and an increase in the equity risk premium, and this could be a sign a bear market is coming.

When interest rates are low, spending power is increased as companies can access affordable loans for expansion, hence increasing their output and profitability. Individuals can also borrow more to invest and this is a sign of a bull market.

Sign #5 - Inverted Bond Yield Curve

The bond yield curve is a graph that shows the relationship between bond yields and time until maturity.

Typically, the yields on long-term bonds should be higher than that on short-term bonds, giving the curve an upward looking slope.

An inverted yield curve occurs when the yield on short-term bonds like 2-Year, is higher than the yield on long-term bonds like 10-Year. This is considered an unusual occurrence, as investors typically demand a higher yield for taking on the added risk of longer-term bonds.

An inverted yield curve can be a sign of a bear market, as it is often a signal that investors are becoming more cautious and are shifting their investments to short-term bonds, as they are expecting a recession or an economic downturn in the near future.

This shift in investor sentiment can lead to a decrease in stock prices, as investors become more risk-averse and pull their money out of the stock market. An inverted yield curve can also be orchestrated by the government like yield curve control is implemented in Japan.

However, an inverted yield curve has been a reliable indicator of an impending recession in the past. It's important to note that an inverted yield curve is not exclusively a bear market indicator, but it's a strong signal that the economy may be headed for a downturn, and you should be cautious and consider adjusting their investment strategies accordingly.