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 at least 20% or more from its 52-week high. For example, when the Dow Jones Industrial Average fell to 23,553.22 on March 11, 2020, we entered a bear market, because that was more than 20% lower than the Dow's most recent 52-week high of 29,551.42.

Bear markets can occur in any asset class. In stocks, a bear market is typically measured by an index like the Dow, the S&P 500, or the NASDAQ Composite. In bonds, a bear market can occur in U.S. Treasuries, municipal bonds, or corporate bonds. Bear markets also happen with currencies, gold, and commodities such as oil. They don't, however, apply to consumer prices. When those fall, it's called deflation.

A ferocious bear market can wipe out years of hard-won gains made in a bull market. That's why it's important not to get overzealous about a bull market and to take profits on a regular basis.

How to Recognize a Bear Market

There are variations on the definition of a bear market, and some say it's a 20% drop from a "recent high," or are even less specific. According to the U.S. Securities and Exchange Commission, a bear market occurs when a broad market index falls by 20% or more over at least a two-month period.

The average length of a bear market is 367 days. Conventional wisdom says it usually lasts 18 months. Between 1900 and 2008, bear markets occurred 32 times with an average duration of 367 days. They happened once every three years.

Bear markets are accompanied by recessions, periods when the economy stops growing and instead contracts, leading to 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 if investors are behaving with irrational exuberance, then it's probably time for the contraction phase and a bear market.

Causes

A bear market is caused by a loss of investor, business, and consumer confidence. As confidence recedes, so does demand. This is the tipping point in the business cycle. It's where the peak, accompanied by irrational exuberance, moves into contraction.

This loss of confidence can be triggered by a stock market crash. That occurs when stock prices plummet 10% in a day or two, as they did in March 2020, when the outbreak of the new coronavirus rocked the financial markets broadly. Crashes are dangerous because prices only have to fall another 10% to trigger a bear market.

Investors also worry about bear markets after a stock market correction, which is less sudden than a crash. That's when prices decrease by 10%, but perhaps over weeks or months.

Worst Bear Markets

  1. The Great Depression bear market was the worst in U.S. history. The Dow fell 90% in less than four years, peaking at 381.17 on Sept. 3, 1929, and falling to 41.22 by July 8, 1932. The major event was the 1929 stock market crash, which followed an asset bubble caused by a financial invention called buying "on margin." This allowed people to borrow money from their broker and only put down 10% to 20% of the stock value. When a scandal rocked the British stock market, investors lost confidence in the U.S. market, triggering the crash.
  2. The second-worst, by percentage, was the 2008 bear market. It began on Oct. 9, 2007, when the Dow closed at 14,164.43. It fell 53.4% to close at 6,544.44 on March 6, 2009. It was caused by the 2008 stock market crash, the failure of Lehman Brothers, and the reluctance of Congress to restore confidence by passing a bailout. It didn't end until the government launched the economic stimulus plan of 2009. The Dow didn't regain its 2007 high until March 5, 2013, when it closed at 14,253.77.
  3. The third-worst, percentage-wise, was the 1973 bear market. On Jan. 11, 1973, the Dow closed at 1,051.70. It had fallen 45% by Dec. 4, 1974. President Richard Nixon helped create this recession by ending the gold standard. That caused inflation as the dollar rose.
  4. The 2000 bear market ended the greatest bull market in U.S. history. It began on January 14, 2000, when the Dow closed at 11,722.98. The benchmark fell 37.8% until it hit its bottom of 7,286.87 on Oct. 9, 2002. This bear market triggered the 2001 recession, and was compounded by the 9/11 terrorist attacks, which shut down stock exchanges and shocked the world.
  5. The 1970 bear market began on Dec. 31, 1968, when the Dow closed at 908.92. It had dropped 30% before bottoming out at 631.60 on May 26, 1970.

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.

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% or more, it is still in a bear market.

Secular Bear Market

Regular bear markets are called cyclical bear markets. 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 the 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.

How the Bear 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 the 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.