Bear Markets and How to Recognize Them
How to Tell If We Are in a Bear Market or a Bull Market
A bear market is when the price of an investment falls over time. It begins after prices have fallen 20 percent or more from their 52-week high. For example, the Dow Jones Industrial Average hit its record high of 26,828.39 set on October 3, 2018. If it fell 20 percent to 21,462.71, it would be in a bear market.
One of the causes of a bear market is a stock market crash. That occurs when stock prices plummet 10 percent in a day or two. Crashes are dangerous because prices only have to fall another 10 percent to enter the bear market.
Investors also worry about bear markets after a stock market correction. That's when prices decrease 10 percent. A correction can take place over weeks or months.
Bear markets can occur in any asset class. In stocks, a bear market is measured by the Dow, the S&P 500, and the NASDAQ. In bonds, a bear market could occur in U.S. Treasurys, municipals bonds, or corporate bonds. Bear markets also happen currencies, gold, and commodities such as oil. Price drops in consumer goods, such as computers, automobiles, or TVs, are not bear markets. Instead, that's called deflation.
Bear markets created the saying "It's not how much you make, it's how much you keep." A ferocious bear market can wipe out years of hard-won gains made in a bull market. It's important not to get too greedy, and to take profits on a regular basis.
How to Recognize a Bear Market
A bear market occurs when the major indices continue to go lower over time. They will hit new lows. More important, their highs will be lower than before as well. The average length of a bear market is 367 days. The conventional wisdom says it usually lasts 18 months. Bear markets occurred 32 times between 1900 and 2008, with an average duration of 367 days. They typically happened once every three years.
Bear markets are accompanied by recessions. That's when the economy stops growing and then contracts. That causes layoffs and high unemployment rates.
You can recognize a bear market if you know where the economy is in the business cycle. If it's just entering the expansion phase, then a bear market is unlikely. But if it's in an asset bubble or investors are behaving with irrational exuberance, then it's probably time for the contraction phase and a bear market. In 2018, we are in the expansion phase of the current business cycle.
Bull Market Versus Bear Market
A bull market is the opposite of a bear market. It's when asset prices rise over time. "Bulls" are investors who buy assets because they believe the market will rise. "Bears" sell because they believe the market will drop over time. Whenever sentiment is "bullish," it's because there are more bulls than bears. When they overpower the bears, they create a new bull market. These two opposing forces are always at play in any asset class. In fact, a bull market will tend to peak, and seem like it will never end, right before a bear market is about to begin.
Bear Market Rally
A bear market rally is when the stock market posts gains for days or even weeks. It can easily trick many investors into thinking the stock market trend has reversed, and a new bull market has begun. But nothing in nature or the stock market moves in a straight line. Even with a normal bear market, there will be days or months when the trend is upward. But until it moves up 20 percent or more, it is still in a bear market.
Secular Bear Market
A secular bear market lasts anywhere between five and 25 years. The average length is around 17 years. During that time, typical bull and bear market cycles can occur. But asset prices will return to the original level. There is often a lot of debate as to whether we are in a secular bull or bear market. For example, some investors believe we are currently in a bear market that began in 2000.
How to Invest
You can prepare for a stock bear market by decreasing risk in your portfolio. For example, you can increase the amount of cash and reduce the number of growth stocks. You can also select mutual funds that perform better in a bear market. These include gold funds, and sector funds focusing on health care and consumer staples.
During a bond bear market, individual bonds are safer than bond funds. Their interest rates and payments are fixed. If you hold onto the bond, you will receive the promised amount. In bond funds, you could lose money when the manager sells the bonds within the fund.
Regular bear markets are called cyclical bear markets.
How It Got Its Name
Why use a bear to describe an investment trend? In the late 1500s, people enjoyed bull and bear baiting. They gambled on which dogs could kill a bear chained to a post. Surprisingly, bear baiting still occurs in South Carolina, although it's illegal in the other 49 states.
That's how bears and bulls first became linked in people's minds. In the 17th century, hunters would sell a bearskin before catching a bear. In the stock market, short sellers did the same thing. They sold shares of stock before they owned them. They bought the shares they day they were to deliver them. If share prices dropped, they would make a profit. They only made money in a bear market.
The phrases were first published in the 18th-century book, "Every Man His Own Broker," by Thomas Mortimer. Two 19th century artists made the terms even more popular. Thomas Nast published cartoons about the slaughter of the bulls on Wall Street in Harper's Bazaar. In 1873, William Holbrook Beard painted the stock market crash using bulls and bears. (Sources: "Symbolism of the Bull and Bear," Federal Reserve Banks of New York. "Origin of Bulls and Bears," Motley Fool. "Bulls and Bears," Valentine Capital Asset Management.
"The Quirky and Brutal Origins of the Words Bull and Bear," Investing Answers.)