What Is a Bear Market?
A bear market is a phenomenon in which a broad market index such as the S&P 500 or DJIA loses at least 20% of its value in 2 or more months.
These indexes represent the performance of stocks on the stock market, and once they start going down, that means the majority of the stocks are going down, and that's why they are good indicators of a bear market.
According to statistics from INVESCO, a bear market on average is shorter (363 Days) than a bull market (1742 Days). On average a bull market causes a 33% decline in the stock market but a bear market on average causes a 159% increase in the stock market. Thus, historically stock market has been a bull market.
The downward movement of the market is metaphorically associated with how a bear attacks its enemy by slashing its claws downward and that is why it is called a bear market.
Further Read: Bull Market: Definition, Examples, and Strategic Tips
Terms that you need to know
S&P 500 Index: It is a stock market index that tracks the largest publicly listed 500 companies in the USA.
DJIA: Dow Jones Industrial Average is a stock market index that tracks 30 large blue-chip stocks listed on the NYSE and NASDAQ.
Bailout: In a bailout, the government gives financial assistance to a failing business.
KEY TAKEAWAYS
- Bear markets happen when prices in a market drop by over 20%. Indicated by the drop of Broad Market Indexes.
- Bear markets can last for a few weeks or a couple of months, while the longer-term ones can stretch on for several years.
- DCA, diversification, and investing in recession-proof stocks are some investment strategies during a bear market.
- Short selling, put options, and inverse ETFs are some trading strategies by which investors can make money during a bear market.
- Examples of a bear market include the Dot-com crash of 2000-02, the Housing market crash of 2008-09, and the Covid-19 pandemic crash of 2020-21.
What Causes a Bear Market?
Anything that can reduce an investor's confidence in the market can start a bear market. This can be caused by national or international events. Events like wars, bankruptcies, and market crashes can start a bear market. More recently the 2020 bear market was caused by the pandemic.
These events can cause people to start selling their shares thus bringing down the price of those stocks, these falling prices spook even more investors, and then that starts the decline in all stock prices, thereby starting the bear market.
Key Characteristics of a Bear Market:
Long declines: A bear market differs from the usual stock market declines by its sustained nature. To be classified as a bear market, the decline must persist for a minimum of two months. On average, bear markets endure for approximately ten months.
Economic decline: As stock markets enter a bear market, it is common to witness a broader economic backdrop marked by rising unemployment, reduced Gross Domestic Product (GDP), and declining corporate profits.
Negative sentiment: During a bear market, market sentiment is poor. Investors are pessimistic about the stock market’s prospects, making them more likely to sell assets than hold them. Investors are likely to put their money into safer investments like bonds because of concerns about future market performance.
Investing in a Bear Market
Bear markets can cause a big dent in your pocket if no anti-measures are taken. You can use the following methods to save yourself from the potential losses.
Dollar Cost Averaging (DCA): This is a universal strategy to invest in the stock market regardless of a bear or bull market. In DCA an investor invests an equal amount of money in equal intervals of time. Essentially you are ignoring the market and making regular small investments so that you aren't devastated by a loss or overwhelmed by a gain. It keeps you in check. It is a long-term investment strategy.
Diversification: Diversify your portfolio so that your risk is minimized. This is again a good strategy in both bear and bull markets. Almost all the stocks fall in a bear market but not by the same degree so if you have a diversified portfolio that can keep you from bearing big losses.
Invest in recession-proof stocks: Recession-proof stocks are the ones that aren't affected by market downturns. The underlying companies sell products or services that are commodities and will be bought even if there is a recession. Examples of such companies include Walmart, Procter & Gamble, Starbucks, Johnson & Johnson, and Home Depot. These stocks retain their value better than most stocks and are generally safer to invest in.
Also Read: Why Investing Is Important: Don’t Let Your Savings Sit Idle
Trading Strategies in a Bear Market
A few trading strategies can still help you during a bear market although it is harder to make a profit during a bear market. These strategies include:
Short Selling: A short seller borrows shares from a broker for a certain time and sells them in the market and then again after some time he buys back those shares from the market and returns them to his broker in that limited time. A short seller's profit depends on the possibility that the stock price is going to fall in a bear market. Short selling is a risky strategy, but it is a very popular way of making a profit in a bear market.
Put Options: A put option gives the buyer the freedom to sell his securities (stocks, bonds, etc.) at an agreed-upon price within a certain time limit. The option holder can sell the security at the same price even if the prices fall in the market. Thus, this is a pretty good strategy in a bear market. It is generally safer than short selling, but you have to have the authorization to use a put option in your brokerage account.
Investing in Inverse ETFs: An Inverse ETF is the opposite of the ETF that it tracks. When an ETF is going down in a bear market the Inverse ETF is going up. These inverse ETFs are a good investment option during a bear market.
Also Read: Guide to ETFs and Investing in Them
Bear market examples
Bear markets are quite common. Since 1900, there have been 34 of them, including the one that started in 2022, so they occur every 3.6 years on average. Just to name the most recent notable examples:
2000-02 Dot-com crash: The late 1990s saw a surge in internet usage, which fueled a massive speculative boom in technology stocks. However, when this bubble eventually burst, it led to a bear market across all major stock indices. The Nasdaq, in particular, bore the brunt of the fallout, experiencing a staggering 75% decline from its previous high by late 2002.
2008-09 Financial crisis: The year 2008 witnessed a worldwide financial crisis due to the surge in subprime mortgage lending and the packaging of these loans into tradable securities. This crisis led to the failure of many banks, requiring massive bailouts to stabilize the U.S. banking system. By March 2009, the S&P 500 had experienced a decline of more than 50% from its previous high points.
2020 COVID-19 crash: The bear market of 2020 was sparked by the rapid spread of the COVID-19 pandemic, leading to widespread economic shutdowns in many developed nations, including the United States. The unprecedented speed at which economic uncertainty unfolded resulted in the stock market's swift descent into a bear market in early 2020, marking the fastest such decline in history.
Conclusion
In conclusion, a bear market represents a challenging phase in financial markets, characterized by prolonged price declines, investor pessimism, increased volatility, and diminished trading volumes. These downturns can be triggered by various economic, financial, and geopolitical factors. However, understanding bear markets is crucial for investors, as they are an integral part of the financial cycle.
