A bear market is a finance jargon used to describe a steep drop of 20% or greater in an asset from its most recent high, which may happen over the course of weeks or months and may be attributable to many reasons. The term is most commonly used to describe a sustained fall in the level of a stock market index, such as the S&P 500, the FTSE 100, or the Nikkei 225.
The term can also be used to describe a single security or commodity whose price has dropped more than 20% from its recent high. For example, Bitcoin entered a bear market in November 2021 after dropping more than 20% from its recent all-time high.
A bear market is a financial term used to describe a drop of over 20% in any asset, although it is most commonly used for stock market indexes.
Bear markets happen fairly often and are part of the economic cycle, but it does strongly signal a potential economic downturn.
There are many causes of a bear market, such as geopolitical risks and market bubbles bursting, and each bear market is unique in how far the market may drop and how long it may last.
During a bear market, there are certain things that investors can do to benefit, such as investing in inverse ETFs or short-selling stocks.
What is the Significance of a Bear Market?
Firstly, bear markets occur fairly often and are part of the economic cycle. There isn’t anything special about the figure of 20%. However, it is a psychological and symbolic hurdle for investors of the growing risk of an economic downturn or recession. However, a bear market doesn’t always lead to a recession.
The origin of the term bear market is not certain, but one popular theory is that since bears are known to hibernate in the winter, a bear market is one where the market is retreating. The opposite of a bear market is a bull market, where assets, like a bull, are charging.
Bear Market vs Market Correction
A market correction is often incorrectly used as a synonym for a bear market. The key difference between a bear market versus a market correction is the level of price decline and the duration.
A market correction is a decline of at least 10%, but less than 20%, from a recent high, and often lasts for weeks. On the contrary, a bear market is a decline greater than 20% and tends to last for months or years.
Public health crises(such as the SARS and COVID-19)
Geopolitical crises(such as the Persian Gulf War and the War in Ukraine)
Slowing economic growth/poor economic data
Overly contractionary monetary or fiscal policies
Depending on the duration of the bear market, bear markets can be defined as secular or cyclical. A secular bear market is driven by forces/influences that cause the price of securities to fall over an extended period, generally years.
On the other hand, a cyclical bear market is generally caused by normal market volatility and generally lasts for months.
Some Historical Perspective of Bear Markets
The most recent example of a bear market for the S&P 500 is May 2022, but as we mentioned, it happens fairly often, the last one being March 2020. If we look at the S&P 500 stock market index in the U.S. specifically, we’ve seen 15 bear markets in the last century. Of those, nine of those drops were milder; between 20% to 40%. We’ve also seen five more severe bear markets with declines in the S&P 500 of greater than 40%, as we can see in the table below:
On average, it took eight months to fall into a bear market and 13 months to go from peak to trough. In other words, the market continues to fall on average for another five months after entering bear market territory before we see a bottom.
It is also worth noting that the faster an index falls into bear market territory, the shallower they tend to be.
Historically, when a bear market does coincide with an economic recession, however, the fall in stock market indexes tends to be greater than when it doesn’t.
While it is impossible to tell how long a bear market will last, it should be no surprise that larger overall drops take longer to recover. On average, for falls between 20%-40%, it took 14 months to recover, but an average of almost five years to recover from drops of 40% or more. The longest bear market for the S&P 500 this century ended in March 1942 and took 62 months to recover.
Stages of a Bear Market
There are typically four stages in a bear market:
Stage 1: Recognition, which is characterized by high (positive) investor sentiment and high prices. In this phase, investors tend to initially ignore the initial onset of a bear market and mistake it for ordinary day-to-day fluctuations. At the end of this phase, some investors will recognize that a bear market is impending and start selling their securities.
Stage 2: Panic, where prices tend to fall sharply, and investors capitulate. Trading volume tends to drop, economic indicators may start pointing to a worsening economy, and investor sentiment will drop significantly.
Stage 3: Stabilization, where panic selling begins to taper off and investors start digesting the reason for the price decline. The stabilization stage is volatile, turbulent, and usually lasts the longest out of the other stages. There may be rallies that tend to reverse as market speculators enter.
Stage 4: Anticipation, where prices begin leveling off and finding a bottom. Low valuations and/or good news start attracting more investors into purchasing securities.
What to Do in a Bear Market
In a bear market, one normally expects to see the following:
Diminished investor confidence in the financial markets
High/Unstable interest rates and/or inflation – leading to high volatility
A decline in initial public offerings (IPOs) – companies tend to avoid going public in a bear market to avoid depressed company valuations
A comparative rise in short-selling
However, there are a few strategies to consider in a bear market, including:
Short selling securities, which involves selling borrowed securities, purchasing them back at a later date at a lower price, and returning the securities back to the lender.
Purchasing put options, which gives the holder the right, but not the obligation, to sell a specified amount of the underlying security at a specific price. Put options are used to speculate on falling prices.
Inverse ETFs, which are structured to change values in the opposite direction of the ETF it tracks. An example of an inverse ETF of the SPDR S&P 500 ETF (which tracks the S&P 500 Index) is the ProShares Short S&P 500 ETF. Inverse ETFs are used in trading accounts that are restricted from short selling.
Leveraged Inverse ETFs, which is an inverse ETF that incorporates financial derivatives and debt to amplify returns. An example of a leveraged inverse ETF of the SPDR S&P 500 ETF is the ProShares UltraPro Short S&P500 ETF, which offers 3x the inverse daily performance of the S&P 500 Index.
One thing to be cautious about is whether to sell everything to avoid more losses. Experts advise only doing that if you need the money now or if you want to lock in the losses for tax purposes.
Ups and downs are natural in the markets, and by dumping your stocks in a bear market, you might miss out on the market recovery. For example, when the S&P 500 entered a bear market in March 2020 from its high on February 14, 2020, the market took less than three weeks for stocks to recover and gain 20%.
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