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What is a bear market?
They don’t happen often but when they do it can be painful - a bear market! This is an explainer on how they happen and what you can do to prepare for them.
Big ideas
- A bear market is a market where prices are falling and investors are expecting prices to continue to fall.
- One way to understand how bear markets happen is via the so-called ‘Phases of a bubble.’ Confident investors eventually drive prices too high in a bull market, insiders sell and gradually then all of a sudden, so does everybody else.
- Looking at past bear markets and how long they lasted can help alleviate uncertainty about periods of falling prices.
What is a bear market?
A bear market is a period of time in which the stock market is in decline. What bear market means is investors need to act carefully. There will be some stocks that rise during a bear market and there will be days and weeks when the stock market rises - these are known as bear market rallies but on average, in a bear market, stocks decline.
Stocks go up and down, so what?
Investing always means uncertainty. You can’t be certain that a stock will rise in price after buying it. You can just do your best job investing in a good company that is doing good things at what seems like a reasonable value. In a bear market, there is even less certainty than usual.
Think about it statistically.
Stocks go up and down, so what?
Investing always means uncertainty. You can’t be certain that a stock will rise in price after buying it. You can just do your best job investing in a good company that is doing good things at what seems like a reasonable value. In a bear market, there is even less certainty than usual.
Think about it statistically.
Example
Let’s pretend the whole stock market consists of 10 stocks.
It’s a bull market so 7 of them are rising and 3 of them are falling.
You have enough capital to buy 5 of them.
You will still feel a bit uncertain but you can reasonably expect that most of your 5 stocks will rise in price because most of the 10 stocks are rising. So overall you feel comfortable enough to overcome your uncertainty and stay the course.
It’s a bull market so 7 of them are rising and 3 of them are falling.
You have enough capital to buy 5 of them.
You will still feel a bit uncertain but you can reasonably expect that most of your 5 stocks will rise in price because most of the 10 stocks are rising. So overall you feel comfortable enough to overcome your uncertainty and stay the course.
But what about when that’s all flipped on its head?
Example
Now it's a bear market and 7 of the 10 stocks are falling.
Now it’s impossible that all of our 5 stocks can be rising - and there’s a good chance that we will own more stocks that are falling than stocks that are rising.
When this is happening we are going to be feeling uncertain about what we own, and even more uncertain about making any new investments.
Now it’s impossible that all of our 5 stocks can be rising - and there’s a good chance that we will own more stocks that are falling than stocks that are rising.
When this is happening we are going to be feeling uncertain about what we own, and even more uncertain about making any new investments.
Bummer right? Not necessarily.
Bear market vs bull market
A bull market is where the overall market is rising over time. It doesn’t mean every stock rises every day, there will be some stocks that rise and some that fall. On some days market indices like the S&P 500 or the FTSE 100 will rise and some days they will fall. It’s about the average movement. On average, stocks rise in a bull market.
A bull market is the usual state of play in the stock market. That’s why it’s beneficial to be a long-term investor in stocks. Long term investors must invest in a bear market and bull market.
A bull market is the usual state of play in the stock market. That’s why it’s beneficial to be a long-term investor in stocks. Long term investors must invest in a bear market and bull market.
Bear market vs correction
Not every period of falling prices in the stock market meets the definition of a bear market. This makes sense because markets are constantly spending short periods of time going up, down and sideways.
A correction is a shorter-term decline, usually lasting for weeks or months. While both can be painful for investors, a bear market is typically much more severe, with prices falling 20% or more from their peak. Corrections are more common and tend to happen after a prolonged period of rising stock prices.
A correction is a shorter-term decline, usually lasting for weeks or months. While both can be painful for investors, a bear market is typically much more severe, with prices falling 20% or more from their peak. Corrections are more common and tend to happen after a prolonged period of rising stock prices.
Bear market vs recession
Although both stem from falling confidence and can happen at the same time, a bear market and a recession are two different things. What we have discussed so far is the state of the stock market, while a recession is something happening to the economy. A recession is when economic activity is in decline. The textbook definition of a recession is two consecutive quarters of declining Gross Domestic Product (GDP).
The four stages of bear markets
You might have heard it said that markets move in cycles. The most basic cycle of all is the cycle between bull and bear markets. Bull markets move in phases and there are phases of a bear market. You’ve probably seen the below diagram before. It was created by Dr. Jean-Paul Rodrigue, who called it the Phases of a Bubble.
Bear market chart
Source: Dr. Jean-Paul RodrigueThis diagram works for the entire market, for ETFs and an individual stock level to describe the stages of a bear market.
Let’s talk about the first stage in the cycle first, the bull market to give us some context for the last stage, the bear market.
Let’s talk about the first stage in the cycle first, the bull market to give us some context for the last stage, the bear market.
Why do bull markets happen?
The so-called ‘smart money’ which consists of company insiders and investors with close access to the company start to buy close to the bottom when prices are low. This isn’t any kind of conspiracy, it’s just life.
Say you work at ABC (A Bananas Company) - which sells bananas. It’s been a slow few months then suddenly you begin to notice orders for bananas are starting to rise. You ask around a bit and the banana split is making a major comeback as a dessert of choice. Naturally, you go buy yourself some ABC shares because all these orders should translate to higher earnings.
A quarter later, earnings at ABC start to rise so a few savvy outside shareholders buy in response to the better results. So the shares go up even more after they buy. Now the stock has been shooting up a bit and garners some attention from the media. ABC gets mentioned on some blogs and on TV and retail investors who read this media start buying in. Now the stock has made some really good gains and the general public catches wind of it and the stock really starts taking off to the moon.
Say you work at ABC (A Bananas Company) - which sells bananas. It’s been a slow few months then suddenly you begin to notice orders for bananas are starting to rise. You ask around a bit and the banana split is making a major comeback as a dessert of choice. Naturally, you go buy yourself some ABC shares because all these orders should translate to higher earnings.
A quarter later, earnings at ABC start to rise so a few savvy outside shareholders buy in response to the better results. So the shares go up even more after they buy. Now the stock has been shooting up a bit and garners some attention from the media. ABC gets mentioned on some blogs and on TV and retail investors who read this media start buying in. Now the stock has made some really good gains and the general public catches wind of it and the stock really starts taking off to the moon.
Why do bear markets happen?
After a while, you and your colleagues at ABC (the smart money) notice all is not as it was. The stock price is now pricing in some gigantic earnings growth. You can see that orders for bananas are still good but they are not rising at the pace indicated by the share price. You think to yourself, I’ll sell the shares and pocket the profits. Your selling alongside other insiders with similar thoughts causes the price to fall.
You can see where this is going…
Earnings are released and they miss expectations so savvy investors start to sell. Then retail investors see their shares fall in value and start selling them, causing another leg lower in the share price. By this stage, the shares have dropped a lot and are in a bear stock market. The general public is in a state of panic and capitulates, selling their shares. At this stage, there is almost nobody left to sell and the share price stabilises - until someday - insiders see an opportunity to buy again. Rinse and repeat.
This is a simplified bear market example but just imagine this process happening thousands of times over and you’ve got the bare bones of what causes a bull and a bear market. The pessimism of a bear market can only follow the optimism of a bull market. The reasons for the pessimism that cause a bear market change every time. Bear markets can be caused by fear of economic recession, inflation, political unrest etc.
You can see where this is going…
Earnings are released and they miss expectations so savvy investors start to sell. Then retail investors see their shares fall in value and start selling them, causing another leg lower in the share price. By this stage, the shares have dropped a lot and are in a bear stock market. The general public is in a state of panic and capitulates, selling their shares. At this stage, there is almost nobody left to sell and the share price stabilises - until someday - insiders see an opportunity to buy again. Rinse and repeat.
This is a simplified bear market example but just imagine this process happening thousands of times over and you’ve got the bare bones of what causes a bull and a bear market. The pessimism of a bear market can only follow the optimism of a bull market. The reasons for the pessimism that cause a bear market change every time. Bear markets can be caused by fear of economic recession, inflation, political unrest etc.
Watch our video
Characteristics of a bear market learned from history
Every bear market is unique but they are all sort of similar.
Quote
“History doesn’t repeat itself, but it often rhymes."
The same can be said for the stock market.
Whether you’re living through a bear market or you suspect one might be coming up - it’s useful to look at some historical bear markets to see what ‘rhymes’ with the present. You will see from the below examples that bear market duration can vary wildly.
Whether you’re living through a bear market or you suspect one might be coming up - it’s useful to look at some historical bear markets to see what ‘rhymes’ with the present. You will see from the below examples that bear market duration can vary wildly.
Historic bear market examples
Experts generally agree that there have been 26 bear markets since the Great Depression in 1929. The following is a quick summary of what happened at the index level of the US benchmark the Dow Jones.
1929
The bear market of 1929 followed the stock market crash on October 24, 1929, known as Black Thursday, the largest daily percentage decline in the Dow Jones Industrial Average in history. The Dow eventually lost 90% of its value in four years before bottoming on July 8, 1932.
2008
The second biggest bear market, most of us lived through - was the 2008 financial crisis. The Dow Jones peaked in October 2007 and bottomed in March 2009 after falling 53%. But crucially it took the index until March 2013 to recover the 2007 peak. So anyone unlucky enough to have bought the top in 2007 wasn’t made whole again until five-and-a-half years later.
1973
The 1973 bear market is of particular interest when dealing with a bear market accompanied by high inflation. It is the third worst on record with a 43% decline from January 1973 through December 1974.
2000
Then there was the bear market of 2000 when the dot-com bubble popped. The Dow fell 38% from January 2000 through to October 2002.
2020
The 2020 bear market was one of the quickest - with the Dow tumbling 37% over about a month before re-taking its previous high within a year.
To summarise these five bear markets:
1929
The bear market of 1929 followed the stock market crash on October 24, 1929, known as Black Thursday, the largest daily percentage decline in the Dow Jones Industrial Average in history. The Dow eventually lost 90% of its value in four years before bottoming on July 8, 1932.
2008
The second biggest bear market, most of us lived through - was the 2008 financial crisis. The Dow Jones peaked in October 2007 and bottomed in March 2009 after falling 53%. But crucially it took the index until March 2013 to recover the 2007 peak. So anyone unlucky enough to have bought the top in 2007 wasn’t made whole again until five-and-a-half years later.
1973
The 1973 bear market is of particular interest when dealing with a bear market accompanied by high inflation. It is the third worst on record with a 43% decline from January 1973 through December 1974.
2000
Then there was the bear market of 2000 when the dot-com bubble popped. The Dow fell 38% from January 2000 through to October 2002.
2020
The 2020 bear market was one of the quickest - with the Dow tumbling 37% over about a month before re-taking its previous high within a year.
To summarise these five bear markets:
Facts
1929: 4 years (90%)
2008: 17 months (53%)
1973: 23 months (43%)
2000: 2 years & 9 months (38%)
2020: 6 weeks (37%)
2008: 17 months (53%)
1973: 23 months (43%)
2000: 2 years & 9 months (38%)
2020: 6 weeks (37%)
Hopefully, having this knowledge in hand greatly reduces some of the uncertainty you might have had about there being a bear market. If you’re asking yourself How long will the bear market last, history provides a good guide. A bear market is nothing new, they have happened many times and will happen again.
Tips for what to do in a bear market
Here are three quick tips about what to do when it’s a bear market:
1. Stay invested
Many academic studies show that ‘market timing’ is very difficult i.e. selling the top and buying the low. If it’s already a bear market, chances are you already missed the first 20% of the decline. If you suspect a bear market then prices might still be at their highs but quite often bull markets last longer than many expect and you miss the upside if you sell too early. Then some of the best daily returns happen near the bottom so if you were waiting to get in, you’ll quite easily miss them.
2. Dollar-cost average
This means if you are financially able to do so, keep adding to your investments. If you are investing for the long term, what you ideally want is to have a low average buying price to give you the best average return when you sell years later. A bear market is the best time to improve your average buying price because markets are down.
3. Rebalance
When there is a bear market in stocks, stock prices are falling. This means stocks now make up a smaller part of your investment portfolio because their value has dropped. To maintain your planned asset mix, you should buy more of what has fallen in value and sell some of which has gotten overvalued, perhaps the bonds in your portfolio.
4. Bear market ETF
To take advantage of the short term fall in prices, you must consider investments that are likely to benefit when most stocks are falling. Bear market ETFs are better known as inverse ETFs. These funds are constructed to short sell stocks in an index instead of buy them. That way, if the index falls, these stocks rise in value.
Recap
A bear market is a difficult time but most investors are best off dealing with them by staying invested, dollar cost averaging (if possible) and rebalancing their portfolio when stocks get underrepresented.
FAQ
Q: How long does a bear market last?
A bear market is a market where prices are falling and investors are selling. Bear markets can last for months or even years, and can be caused by a number of factors including economic recession, inflation, interest rate hikes, and political instability. When a bear market starts, it can be difficult to predict how long it will last. Investors often experience losses as they exit the market too late to avoid the bear market or too soon to benefit from the next bull market.
Q: How often do bear markets occur?
The frequency of bear markets can vary depending on a number of factors. However, some experts suggest that bear markets typically occur every three to five years. This means that investors can expect to see a bear market at least once every three to five years on average. Of course, this is just an average, and there will be years where no bear markets occur, as well as years where multiple bear markets may occur.
Q: What is a bear market in stocks?
Bear markets can happen in any free market from commodities to forex to government bonds. A bear market in stocks is specifically when the prices of stocks fall sharply over a period of time. There can be a bear market in stocks at the same time as a bond bull market, in fact this is often the case. That’s why it is beneficial to have a diversified portfolio of stocks, bonds and cash.
Q: What defines a bear market?
A bear market is when the stock market falls by 20% or more from its peak. Bear markets can happen when the economy is weak, or when there is too much optimism and prices get ahead of themselves.
Q: What signals a bear market?
There are a few key signals that can indicate a bear market may be on the horizon. Firstly, if the stock market starts to experience a sustained period of decline, this is a clear sign that investor confidence is waning and a bear market may be on the horizon. Secondly, if market analysts start to issue more bearish than bullish forecasts, this is another sign that a bear market may be looming. Finally, if economic indicators such as GDP growth start to slow down or even contract, this is a strong signal that a bear market is about to begin.
Q: What should you avoid in a bear market?
A bear market is a time when stock prices are falling and investors are pessimistic about the future. There are a few things you should avoid during a bear market:
1. Don't panic - it's important to stay calm and not make any rash decisions.
2. Don't try to time the market - it's impossible to know when the bottom will be reached.
3. Do have a long-term perspective - bear markets don't last forever, so it's important to have a long-term perspective and not give up on your investment goals.
1. Don't panic - it's important to stay calm and not make any rash decisions.
2. Don't try to time the market - it's impossible to know when the bottom will be reached.
3. Do have a long-term perspective - bear markets don't last forever, so it's important to have a long-term perspective and not give up on your investment goals.
Q: What strategy is best in a bear market?
First, it is important to remember that bear markets are a normal and healthy part of the investment cycle. They provide an opportunity to buy assets at a discount, and they present a chance to rebalance a portfolio if needed. Second, it is essential to have a long-term perspective when investing in a bear market. Short-term losses are to be expected, but over the long run, the market will typically recover and even grow.
Q: What sectors go up in a bear market?
In a bear market, investors typically sell off stocks that are considered to be riskier. This includes sectors like tech, energy, and financials. However, there are some sectors that tend to do well in a bear market. These include healthcare, utilities, and consumer staples. These sectors are considered to be more defensive, and they offer investors a measure of safety during times of market turmoil.
Q: How does a bear market benefit you?
A bear market can benefit you in a number of ways. First, it can provide an opportunity to buy securities at lower prices. Second, it can help you to focus on your investment strategy and make sure that you are investing in the right securities. Third, it can help you to become a better investor by forcing you to focus on your investment decisions and to learn from your mistakes.
- Stock Market Cycle: The recurring pattern of market expansion (bull markets) and contraction (bear markets), influenced by economic conditions and investor sentiment.
- Market Correction: A short-term price decline of at least 10% from a recent peak, distinguishing it from a bear market, which is a more prolonged downturn.
