Bear Markets and How to Recognize Them

How to Tell If We Are in a Bear Market or a Bull Market

A bear market occurs when the price of an investment falls at least 20% from its high. For example, when the Dow Jones Industrial Average continued a decline on March 11 from its average on Feb. 12, 2020, of 29,551.52, the Dow entered a bear market, because that was more than 20% lower than the Dow's most recent 52-week high.

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 like oil. They don't, however, apply to consumer prices. Instead, when consumer prices 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 regularly take profits.

How to Recognize a Bear Market

The exact definition of a bear market depends on who you ask, but it generally refers to a serious, sustained decline in the value of assets. The Securities and Exchange Commission (SEC) defines a bear market as a broad market index decline of 20% or more over at least a two-month period.

According to investment company Invesco, the average length of a bear market is 363 days. By Fidelity's calculation, a bear market occurs roughly every six years.

Bear markets are sometimes 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. On the other hand, if the business cycle is experiencing an asset bubble, or if investors are behaving with irrational exuberance, then a wise investor will be on the lookout for the first signs of a 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, and prices fall. 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 in a day or two. Crashes can expedite the end of a bull 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.

Bull Market vs. Bear Market

A bull market is the opposite of a bear market—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 bulls 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 takes place 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. However, the stock market never moves in a clean, straight line, and these rallies amount to blips in an otherwise downward trend. It isn't unusual for a bear market to experience days or months of upward momentum, but until it moves up 20% or more, it is still a bear market.

Secular Bear Market

Regular bear markets are called cyclical bear markets. A secular bear market lasts longer and is driven by long-term trends, rather than short-term sentiment. Typical bull and bear market cycles can occur within a secular bear market.

Whenever the market begins to display bearish or bullish qualities, analysts often wonder whether the bull or bear is cyclical or secular. There's no clear answer, especially while the market is in the midst of one of these shifts, and that makes the topic the subject of regular debate.

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 in your portfolio. You can also select bonds or mutual funds that perform better in a bear market, such as gold funds and sector funds that focus 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, unless the issuing entity defaults. In bond funds, the manager may choose to buy or sell bonds before they mature, and you could lose money in the process.

Worst Bear Markets

As of May 23, 2020, these are the worst bear markets in U.S. history.

The Great Depression Bear Market

The Great Depression bear market was the worst in U.S. history. The Dow fell 90% in less than four years, peaking at 381 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.

The 2008 Bear Market

The second-worst, by percentage, was the 2008 bear market. It began on Oct. 9, 2007, when the Dow closed at 14,164.53. It fell to close at 6,547.05 on March 9, 2009. Causes included 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.

The 1973 Bear Market

The third-worst, percentage-wise, was the 1973 bear market. On Jan. 11, 1973, the Dow closed at 1,051.70. By Dec. 4, 1974, the Dow had fallen to 598.64. One factor that contributed to this bear market was the decision by President Richard Nixon to end the gold standard, which was followed by a period of inflation.

The 2000 Bear Market

The 2000 bear market ended what had been at the time 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 7,286.27 on Oct. 9, 2002. This bear market triggered the 2001 recession, and it was compounded by the 9/11 terrorist attacks, which shut down stock exchanges and shocked the world.

The 1970 Bear Market

The 1970 bear market began on Dec. 31, 1968, when the Dow closed at 943.75. It dropped more than 30% before bottoming out at 631.16 on May 26, 1970.

How the Bear Got Its Name

Both "bull" and "bear" have been used to describe market conditions for centuries, so it's difficult to determine an exact origin for the phrase. A connection between bears and market conditions can be traced back to at least the early 18th century. The phrase stemmed from hunters who 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. If share prices dropped, they would buy the stock to close their position and make a profit. They only made money in a "bear market."

Artists helped further popularize the terms during the 19th century. Thomas Nast published cartoons about the slaughter of the bulls on Wall Street in Harper's Weekly. In 1879, William Holbrook Beard painted the stock market crash using bulls and bears.

Article Sources

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