What is a Bear Market?
A bear market is when prices decline in a given market for a sustained period of time. The term typically refers to the stock market, but it can apply to any asset, including bonds, real estate, and other commodities. The term usually refers to stock prices in a particular index, such as the S&P 500 or the Dow Jones Industrial Average. Investors can lose money in bear markets if they hold on to their stocks for too long. However, these conditions will only last for so long. After months or years of falling prices, most economies will eventually bottom out and expand as stock prices increase.
Related: What is a Bear Trap in Investing?
What Is a Bear Market?
A bear market is considered a normal part of the economic cycle. After the economy grows and reaches its peak, prices will fall continuously until the market bottoms out, also known as the trough phase. In a bear market, the economy will contract in size. Unemployment tends to be high, corporate profits decrease, and the country’s gross domestic product (GDP) will fall. A bear market is generally defined as prices falling by 20% or more over a sustained period of time — usually two months or more. Stock prices also fell by 20% of their value when the economy was at its peak.
The start of a bear market usually means the economy is headed for a recession, which can last several years or more. During this time, investors will start selling off their stocks if they believe prices will fall. This can trigger a massive sell-off in the market, leading to an increase in the stock supply with dwindling demand. Thus, prices will start to fall precipitously.
A bear market is considered the opposite of a bull market, which is when stock prices rise continuously for an extended period of time. The term bear describes falling prices because a bear swipes down with its paws, unlike a bull, which thrusts its horns up into the air.
What Causes a Bear Market?
Stock prices are often set by investor confidence in the economy, and investors tend to operate according to herd behavior. If market commentators and analysts start to suspect the economy has reached its peak, it will usually convince other investors to sell their stock, and the bubble will burst. This is what’s known as a bear territory.
For this reason, bear markets are often difficult to predict. They happen after periods of sustained economic growth. The winds can suddenly blow in the opposite direction once investors feel that the economy is heading for a recession.
External events can also send stock prices into freefall. War, environmental disasters, pandemics, and trade disputes can dramatically affect consumer and investor confidence. Federal policy can also send stock prices tumbling. For example, new financial regulations and higher tax rates can sap corporate profits, leading to a decline in stock prices.
How Long Do Bear Markets Last?
Bear markets can last a few weeks to several months or even years. Prices will continue to fall as the economy contracts. During a recession, stock prices can fall for years. But this downturn is a part of the economic cycle. Prices will only fall so far before eventually reverting in the opposite direction.
Some bear markets can be short-lived. For example, investors may start selling off their stock if they believe the economy is about to take a turn for the worse, only to find out that this isn’t the case. The economic news may not turn out to be as bad as investors originally thought. Stock prices will then go back up precipitously. Short-term rallies, known as dead cat bounces, can still happen during bear markets.
However, stock prices will continue to fall as long as investors are losing confidence in the economy. Bear markets are often cyclical. This happens when investors sell off stock in anticipation of a recession. The sell-off only encourages more people to sell their stock, which only compounds the trend.
What Is an Example of a Bear Market?
One of the most famous bear markets occurred in 2008 during the Great Recession. The housing market collapsed after years of unregulated lending, risky financial trades, and the popularity of subprime mortgages. This led to a sharp sell-off that eventually bled into other industries. Stock prices fell continuously for 17 months. During this time, the S&P 500 lost approximately 50% of its value.
The COVID-19 pandemic also led to a bear market in 2020. Businesses were forced to close, sending investors into a panic.
Which Investments Do Well in a Bear Market?
Investors are usually encouraged to sell off their stock in a bear market as prices continue to fall. The longer investors wait to sell their stock, the more money they stand to lose. Selling stock in a bear market can mean losing money if investors are forced to sell the stock for less than what they originally paid.
Some investors will buy up stock when prices fall in hopes that the economy will eventually rebound. They will sell the stock when the economy is growing to make a profit. However, it’s nearly impossible to predict when the market will bottom out. At some point, the economy will rebound, prices will go back up, and in some cases, recoup all of the value they lost in a bear market.
Other investors will sell short in bear markets. Selling short is when an investor agrees to sell borrowed shares at a specified price at a later, date fully expecting the price to fall. They will then buy them back at a lower price to make a profit. However, selling short is considered risky, as investors may be unable to predict which way the market will go.
Inverse ETFs tend to be a good investment in a bear market. Their value is designed to go in the opposite direction of the index they are measuring. For example, inverse ETFs will increase by 1% every time the S&P 500 decreases by 1%, and vice-versa.
Investors may have trouble managing their finances in a bear market. The pressure to sell can be overwhelming, but following the trend can also lead to a decline in profits.