What is a bull market and what a bear market?  There are many definitions out there. One could argue that a 3 months raise in share prices is a bull market. We consider longer-term moves over many years as major bull or bear markets. In the chart, you can see the Dow Jones Index since 1900. It is plotted on a logarithmic scale such that we can better follow it over such a long period in time. We have highlighted major bull markets according to our definition with green background and major bear markets with red.  As you can see, we ignore all moves that only take 1 or 2 years and rather look for longer term developments.

Please be aware that the article continues below the chart

Bull market represent periods in time when the stock market gains significantly in value. In major bear markets, stocks not necessary lose value but could also stay more or less flat over many years (as in the 1901-1920 and 1964-1981 periods). We call those flat developments bear markets as stock investors lose value based on inflation. According to this interpretation, we are in a bear market since 2000. Stock markets have lost value since more than 8 years.

What drives the stock markets? What is the reason that over some longer periods, stocks grow in value substantially and sometimes, they stay flat over even lose value. It turns out that this is a highly interesting question.

The first assumption usually is that it should be economic growth.  A good measure for economic growth is the growth in GDP (Gross Domestic Product). The table below shows the annualized GDP growth for the last major cycles since 1936. It is a big surprise that GDP growth in the bear markets starting in 1936 and 1965 was actually higher than the GDP growth in the following bull markets. Also, the overall weighted average of GDP growth was higher in bear markets than in bull markets as you can see at the bottom of the table. So the conclusion is that we cannot use economic growth as an explanation for bull or bear markets.

The next assumption would probably be that corporate earnings might grow faster in bull markets. Again, some further analysis shows that corporate earnings will not explain the stock market movements.

It turns out that the key driver behind bull and bear markets are valuations.  The chart below shows the PE multiple (price / earnings ratio). It can clearly be seen that bull markets are periods where the PE ratio increases over time whereas in bear markets, the multiples get compressed.

This is a highly important outcome of our analysis on bull and bear markets. We can conclude that in bull markets, investors are simply willing to pay higher and higher prices whereas in bear markets, investors reduce the multiples over time. This shows that bull and bear markets have a lot to do with perception and the willingness to take risks.

It is key for investors to understand whether valuations are in a trend to increase or decrease. Note in the chart below that historically, PE multiples reached a level of 10 or below before a bear market turned into a bull market. Current PE ratios are far from that level. This is a clear indicator that it is still a long way before the current bear market will end.