The stock market goes through cycles of ups and downs, known as bull and bear markets.
Whether you are new to investing or want to understand current market movements, you need to understand what a bear market is and what it means. Read on for the answers to each of these questions and more.
What is a bear market?
A bear market is a stock market condition – essentially a characterization of the market as a whole – meaning that prices have generally been falling for some time.
In general, a bear market is any situation in which security prices are down 20% or more from recent highs, accompanied by negative investor sentiment and widespread investor pessimism.
In other words; a bear market is one where the stock market in general is in decline. People buy fewer securities, which helps drive prices down.
In many cases, this creates a self-reinforcing, negative feedback loop where investors see falling prices, so they buy less, driving prices down further.
Most bear markets are associated with declines in market indices, such as the S&P 500. However, individual securities or commodities can be in their bear market if they experience a decline of 20% or more for two months or more.
Estate agents know that bear market territory leads to an economic downturn from past performance. Such a market affects stocks, ETFs, mutual funds and other market assets.
This is one of the reasons why they recommend strategies such as smart asset allocation, diversification and dollar-cost averaging, which help investors avoid the effects of economic recessions and markets such as the dot-com bubble.
Bear markets contrast with bull markets, characterized by opposing market conditions: high and rising prices, rising market sentiment, and overall market optimism.
A bull market is where investors with a high-risk tolerance can see explosive returns over extended periods of time.
Bear markets, on the other hand, are periods of market decline when diversified portfolios, financial planning, and various more risk-averse asset management strategies can best help you stay afloat.
Different definitions of bear markets
Different investment firms and companies have different definitions of a bear market. For example, most investors follow the 20% rule and count any market with prices falling below 20% as a bear market.
That said, long-term bear markets can go much deeper than 20%, such as the periods after the 1929 crash and the 2008 crash.
Your financial advisor may have a different investment strategy if the financial markets appear to be moving into a bear market. If your Wall Street analyst says the S&P 500 index or other major NASDAQ stock indices are showing ominous signals, listen to that.
Is a bear market the same as a market correction?
Not exactly. Bear markets are not the same as corrections; corrections are short-term trends that last two months and aid in price discovery (the process of determining how much a security or market product is “really” worth).
Market corrections are natural and occur when stocks are overvalued due to positive press, investor deception, and misleading or hidden fundamentals.
Corrections are often valuable to investors because they allow new investors to enter new markets or buy securities at lower prices.
In contrast, bear markets usually do not provide investment opportunities for new investors because it is difficult to determine with any certainty when a bear market will turn and rise back into a bull market.
Related: Bear Market – Hub for entrepreneurial topics
Phases in the bear market
Four distinct phases characterize most bear markets:
- In the first phase, there are high prices and positive investor sentiment throughout the market (or within the specific securities about to experience an individual bear market). At the end of the first stage, investors stop leaving certain markets and taking their profits.
- In the second phase, share prices fall sharply. Corporate profits and trading activity may decline accordingly. Several economic indicators are turning below average rather than positive. At this stage, many investors may panic and investor sentiment begins to decline. This phase is also known as ‘capitulation’.
- In the third stage, speculators begin to enter the market. This may raise the prices of some securities and increase trading volume, albeit temporarily.
- In the fourth and final phase, share prices fall, but at a slower pace. Low prices attract investors to the securities they previously lost. As new investors report good news, other investors return to the market and the bear market begins to stabilize back into a regular or bull market.
Related: Here are the multiple stages of a bear market
What Causes a Bear Market?
A wide variety of things can trigger bear markets. For example, broad economic factors, such as inflation, high interest rates, and low wage growth, may also indicate a decline in overall economic activity, which may be accompanied by a bear market or stock market crash.
In general, a contracting economy leads to a bear market, as investors predict corporate earnings to fall in the short to medium term. They sell their shares, depressing the market and can panic other shareholders.
However, bear markets can also be caused by things like shared investors. For example, if a large number of investors get it into their heads that the market is about to crash due to a possible war, the market can turn into a bear market, even if the economy is healthy.
It is impossible to predict with 100% certainty when a bear market will start. But savvy investors can learn the signs and signals to protect their portfolios from long-term decline.
Related: Bear Market Game Plan Revealed!
How Long Do Bear Markets Last?
While bear markets are usually not a good fit for investors, they usually don’t last very long. The average duration of the bear market is about 363 days or about a year. In contrast, bull markets last an average of 1742 days or several years.
That’s why it’s important to remember that while bear markets can wreak havoc on your portfolio, in most cases you can always recover and benefit from long bull markets.
Bear market examples
There are many real life examples of bear markets that both new and experienced investors can learn from.
For example, the Great Residential Mortgage Default Crisis finally hit the stock market in October 2007, triggering the 2008 recession. The S&P 500 peaked at 1565.15 in October 2007, then crashed to 682.55 on March 5, 2009.
A more recent example, the Dow Jones Industrial Average experienced a bear market on March 11, 2020, while the S&P entered a bear market the following day.
Interestingly, this was followed by a significant bull market, driven in part by falling stock prices due to the COVID-19 pandemic. In this way it becomes clear how bear and bull markets are integrally connected.
Related: Don’t make these 3 critical mistakes when investing in stocks in a bear market
What does a bear market mean to you?
A bear market is a standard type of stock market cycle characterized by falling stock prices and reduced buying activity.
While a bear market can be frightening, it doesn’t mean the end of your investment gains. You can often wait out a bear market and make it to the next bull market with your portfolio intact, as long as you use the right long-term strategy.
Checking out Other guides and articles for entrepreneurs for more information on this topic.