What is a bear market?
The popular definition is a 20% drop from peak to trough in multiple broad market indexes. I have seen similar round numbers in other definitions — e.g., a correction is a 10% decline, a dip is a 5% drop and a crash is a fall of 30% or more.
Other than the fact that these are all base 10 numerals — a coincidence of primates having 10 fingers and 10 toes — there is no rational basis for these percentile heuristics. There certainly doesn’t seem to be any hard data supporting the significance of these percentages.
Now consider the opposite: The definition of a bull market is a 20% rally from the lows. Why 20? Why not 25% or 30% or perhaps 21.759%? The origins of these numbers have been lost to history, but the bigger question for investors is: Are they useful? Do these definitions assist in managing risk, deploying capital or even in thinking about market cycles?
My answer is a definitive “No.”
Just consider the depth of the 2015 correction peak to trough: The Standard & Poor’s 500 Index fell 15.2%, while the Russell 2000 Index lost 27.2%. Was it helpful to know the S&P 500 wasn’t in a bear market, but the small-cap Russell was? Recall the deepest correction since March 2009, the May-October 2011 slide: It was a 21.58% peak-to-trough decline for the S&P 500, while the Russell 2000 fell 30.7%. What should you have done knowing the S&P 500 was in a bear market and that the Russell 2000 had crashed?
What good did it do investors to know that a bear market had begun based on the traditional definition?
These definitions are pointless, unable to help investors in any meaningful way. They don’t assist in managing risk; they don’t inform as to when or how to deploy capital. At best, they may reveal what some other investors, similarly relying on meaningless numbers, may believe. It seems to be one of those trading myths that get passed along from generation to generation, with no one considering whether it has any actual validity.
These market definitions are deeply unsatisfying.
I have been toying with better ways to define markets for 20 years. In the early 2000s, I began to consider a different set of definitions for bull and bear markets. The idea was to create something useful that I could use as an investor, reflecting what was actually occurring during those longer market trends. I found it practical to start with the market gains or losses, then add equal parts long-term economic trends and investor psychology — specifically regarding valuations — to the equation.
Thus, my definitions of bull and bear markets are as follows: