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Bear Market

A decline of 20% or greater in a stock index

What is a Bear Market?

A bear market refers to a 20% drop or greater in a stock index, such as the Dow Jones Industrial Average, the S&P 500, or the Nasdaq Composite Index. For example, the S&P 500 entered a bear market in March 2020, when it fell more than 20% from its recent high made on February 14, 2020.

A bear market can also be used to describe securities or commodities whose prices have dropped more than 20% from their recent high. For example, Bitcoin entered a bear market in November 2021 after dropping more than 20% from its recent all-time high.

 

Summary

  • A bear market describes a 20% drop or greater in a stock index.
  • There may be numerous causes of a bear market, such as market bubbles bursting, geopolitical crises, slowing economic growth, recessions, and overly contractionary monetary or fiscal policies.
  • Bear markets can be secular or cyclical.

 

Understanding a Bear Market

The general causes of a bear market include:

  • Market bubbles bursting (for example, excessive risk-taking by market participants, such as entering into highly leveraged positions),
  • Pandemics or health crises (such as the COVID-19 pandemic)
  • Geopolitical crises (such as the Global Financial Crisis)
  • Slowing economic growth/Poor economic data (for example, high unemployment rates, a rapid rise in the inflation rate, weakening productivity, low disposable income, etc.)
  • Overly contractionary monetary or fiscal policies (for example, drastic changes to the federal tax rate or the federal funds rate)
  • 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 of time, generally years.
  • On the other hand, a cyclical bear market is generally caused by normal market volatility and generally lasts for months (for example, the COVID-19 pandemic, which resulted in a months-long bear market). 

 

Characteristics of a bear market, in addition to a 20% drop from recent highs, include:

  • Diminished investor confidence in the financial markets
  • High/Unstable interest rates and/or inflation
  • 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

 

Bear Markets in U.S. History

The following chart shows a list of bear markets in the United States:

 

Bear Markets - Examples in US History
Source: S&P Global, CNBC

 

As shown above, the shortest bear market occurred in February 2020 during the onset of the COVID-19 pandemic. The longest bear market occurred in March 1937, which was caused by contractionary monetary and fiscal policies that reduced aggregate demand.

 

Stages of a Bear Market

A bear market typically comprises four stages:

 

Stage 1: Recognition

The recognition stage is characterized by high (positive) investor sentiment and high prices. Investors tend to initially ignore the initial onset of a bear market and mistake it as ordinary day-to-day fluctuations.

At the end of the recognition phase, some investors will recognize that a bear market is impending and start selling their securities.

 

Stage 2: Panic

In the panic stage, prices tend to fall sharply, and investors capitulate. Trading volume tends to decline, economic indicators may start pointing to a worsening economy, and investor sentiment will drop significantly.

 

Stage 3: Stabilization

Stabilization takes place when panic selling begins to taper off and investors start digesting the reason for the price decline. The 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

In the anticipation stage, prices begin leveling off and finding a bottom. Low valuations and/or good news start attracting more investors into purchasing securities.

 

The following diagram charts the four stages during the Global Financial Crisis:

 

Bear Market - Stages
Source: Morningstar (from Steel Peak Wealth)

 

Trading in a Bear Market

Gains can be made in a bear market through a number of methods, including:

 

1. Short selling securities

Short selling involves selling borrowed securities, purchasing them back at a later date at a lower price, and returning the securities back to the lender.

 

2. Purchasing put options

Put options give the holder the right, but not the obligation, to sell a specified amount of the underlying security at a specific price. They are used to speculate on falling prices.

 

3. Inverse ETFs

Inverse ETFs 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.

 

4. Leveraged Inverse ETFs

A leveraged Inverse ETF 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.

 

Bear Market vs. Market Correction

A market correction is often incorrectly used as a synonym for a bear market. The key differences between the two concepts are (1) the level of price decline and (2) 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 other hand, a bear market is a decline greater than 20% and tends to last for months or years.

 

Additional Resources

Thank you for reading CFI’s guide to Bear Market. To help you advance your career, check out the additional resources below:

  • Contractionary Monetary Policy
  • Dow Jones Industrial Average (DJIA)
  • Market Sentiment
  • Nasdaq Composite Index
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