The stock market goes through cycles of ups and downs, otherwise known as bull and bear markets.
Whether you’re new to investing or want to understand current market motions, 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 – in essence, a characterization of the market at large – that means prices generally have declined for some time.
Generally, a bear market is any condition where securities prices fall 20% or more compared to recent highs while accompanied by negative investor sentiments and widespread investor pessimism.
Put another way; a bear market is one where the stock market, in general, is in decline. People buy fewer securities, which helps to drive prices down.
In many cases, this creates a self-reinforcing, negative feedback loop where investors see declining prices, so they buy less, further driving prices downward.
Most bear markets are associated with declines in market indexes, such as the S&P 500. However, individual securities or commodities can be in their bear markets if they experience 20% or more declines over two months or more.
Brokerages know that bear market territory leads to an economic downturn relative to past performance. Such a market impacts stocks, ETFs, mutual funds and other market assets.
This is one reason they recommend strategies such as smart asset allocation, diversification and dollar-cost averaging, which help investors avoid the effects of economic recessions and markets like the dot-com bubble.
Bear markets are contrasted with bull markets, characterized by opposite market conditions: high and increasing prices, rising market sentiment and overall market optimism.
A bull market is where investors with a high-risk tolerance can see explosive returns for sustained periods.
Bear markets, on the other hand, are periods of market downturn where diversified portfolios, financial planning and different more risk-averse wealth management strategies can best help keep you afloat.
Differing definitions of bear markets
Different investment firms and companies have different definitions of a bear market. For example, most investors follow the 20% rule, counting any market with prices that drop below 20% as a bear market.
That said, bear markets can go much deeper than 20% over long-term periods, such as the periods following the Crash of 1929 and the Crash of 2008.
Your financial advisor may have a different investment strategy if the financial markets appear to trend toward a bear market. If your Wall Street analyst says the S&P 500 index or other key NASDAQ stock indexes are showing ominous signs, listen to them.
Is a bear market the same as a market correction?
Not exactly. Bear markets are not the same things as corrections; corrections are short-term trends that last for two months and help with price discovery (the process of determining how much a security or market commodity is “really” worth).
Market corrections are natural and occur when stocks are overvalued due to positive press, investor delusion and misleading or hidden fundamentals.
Corrections are often valuable for investors, as they allow new investors to enter new markets or purchase securities for lower prices.
In contrast, bear markets don’t usually offer investment opportunities for new investors, as it’s difficult to determine when a bear market will turn around and rise back into a bull market with any certainty.
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Bear market phases
Four distinct phases characterize most bear markets:
- In the first phase, there are high prices and positive investor sentiment across the market (or within the specific security about to experience an individual bear market). At the end of the first phase, investors stop to drop out of particular markets and take their profits.
- In the second phase, stock prices fall sharply. Corporate profits and trading activity may drop correspondingly. Various economic indicators become below-average rather than positive. At this stage, many investors may panic, and investor sentiment begins to slip. This phase is sometimes called “capitulation.”
- In the third phase, 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, stock prices drop, but they do so more slowly. Low prices attract investors to the securities that lost them previously. 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.
What causes a bear market?
A wide variety of things can cause bear markets. For example, broad economic factors, like inflation, high-interest rates and low wage growth, may also signal a decline in overall economic activity, which could be accompanied by a bear market or stock market crash.
Generally, a shrinking economy leads to a bear market as investors predict corporate profits to decline in the near to midterm futures. They sell their stocks, pushing the market lower and may drive other stockholders into a selling panic.
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 potential war, the market may turn into a bear market even if the economy is healthy.
It’s impossible to predict with 100% certainty when a bear market will arrive. But savvy investors can learn the signs and signals to protect their portfolios from long-term degradation.
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How long do bear markets last?
While bear markets aren’t usually suitable for investors, they do not tend to last very long. The average bear market duration is about 363 days or approximately one year. In contrast, bull markets last 1742 days on average or several years.
Because of this, it’s important to remember that while bear markets can cause damage to your portfolio, you can always recover and take advantage of long bull markets afterward in the majority of cases.
Bear market examples
There have been many real-world examples of bear markets that new and experienced investors alike can learn from.
For example, the big housing mortgage default crisis finally affected the stock market in October 2007, leading to the 2008 Recession. The S&P 500 reached a high of 1565.15 in October 2007, then crashed to 682.55 by March 5, 2009.
As 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 next day.
Interestingly, this was followed by a significant bull market, partially driven by stock prices declining due to the COVID-19 pandemic. In this way, it’s clear how bear and bull markets are integrally tied together.
What does a bear market mean for you?
A bear market is a standard type of stock market cycle characterized by downward trending stock prices and reduced buying activity.
While a bear market can be scary, it doesn’t mean the end of your investment profits. You can often wait out a bear market and make it to the next bull market with your portfolio intact so long as you use the right long-term strategy.
Check out Entrepreneur’s other guides and articles for more information on this topic.