What Is a Bear Market and How You Should Invest in One?
America is not currently in a recession, but the economy continues to flash several ominous warning signs that have created an intense feeling of pessimism. For most households, the primary concern is high inflation, which diminishes the buying power of the dollars they earn — but a bear market that became official in mid-June has only compounded the country’s ongoing economic anxiety.
The steep market downturn that has consumed the last five months has diminished retirement accounts, shrunk college savings funds, reduced overall household net worth and contributed to a general feeling of financial insecurity.
But what is a bear market, how can investors survive one and does such an event ever present a good opportunity? A lot of confusion and misinformation surrounds the term, but what you’re about to read will provide you with a clear bear market definition, a historical perspective on the phenomenon and tips on how to endure the doldrums until the good times roll again.
What Is a Bear Market?
A bear market occurs when stocks on broad major indexes like the S&P 500 or the Dow Jones Industrial Average lose at least 20% of their value for a sustained period of time. They are a normal, natural and inevitable part of stock investing, and while bear markets vary in duration and severity, they never last forever and the market always recovers.
What Causes a Bear Market?
Bear markets occur when investor sentiment turns sour and pessimistic about the market’s prospects of delivering continued gains, which prompts widespread selloffs in anticipation of a downturn. Many factors can trigger this change in collective psychology, but bear markets tend to coincide with a general economic decline, which is typically characterized by a constricting GDP, rising unemployment and shrinking corporate profits.
It’s important to note that those generalities don’t always apply — and the current situation is proof. Stocks have been in a deep bear market for months, yet the job market remains strong and the GDP is showing continued economic production.
Generally, bear markets occur over a matter of months, in a slow, grueling decline, but such declines can also happen quite rapidly. The bear market that coincided with the initial COVID-19 outbreak in early 2020, for example, was the fastest on record, dropping over 20% in just 19 days.
Bear Markets vs. Bull Markets
So-called bull markets are the investing opposite of bear markets. They typically occur at the top of the business cycle when profits rise, businesses expand, unemployment falls and the economy grows. That kind of climate spurs investor optimism and triggers a buying spree in anticipation of market gains.
A bull market becomes official when stocks on major indexes experience gains of at least 20% for a sustained period of time.
One of the most important differences is that bull markets typically last much longer than bear markets, which is why stocks continue to produce sustainable gains over the decades.
How To Invest in a Bear Market
Watching at least one dollar in five evaporate from the value of your portfolio is an unsettling prospect, but emotion-based investing produces bad results.
When a bear market batters your holdings, it’s important not to panic and resist the urge to sell.
Bear markets are a normal part of investing in a stock market that is cyclical by nature. The natural inclination to sell your holdings to stem your losses locks those losses in forever.
Every bear market in history has been followed by a recovery and, eventually, a bull market — and you want to make sure your money is in play when that happens. Remember, no matter what the numbers on your computer screen say, you never lose anything until you sell.
Virtually all credible experts advise against trying to time the market’s cycles, and instead, to build a portfolio that’s designed to weather the market’s ups and downs over the long term.
Rule No. 1 is to diversify your holdings, which you can do with the purchase of a single ETF or index fund. Some stocks fare much worse than others during market downturns, and diversified holdings provide a hedge against risk.
Second, consider dollar-cost averaging. That’s when you contribute a fixed amount of money to your portfolio on a regular schedule. Over time — including through bull and bear markets — you’ll buy more when stocks are cheap and less when they’re expensive, which can help generate sustainable, long-term gains.
Is a Bear Market a Good Thing?
It’s hard to see the bright side when stock values drop by 20%, or sometimes much more — the market lost 50% of its value in 2008. The bright side is that bear markets can weed out low-quality stocks that were overvalued when the market was hot and force the survivors to adapt, adjust and improve.
Is It Smart To Buy in a Bear Market?
Bear markets are the equivalent of a sale for long-term, buy-and-hold investors, who can pick up shares of their favorite ETFs or individual stocks at a deep discount during major downturns. Then, they can enjoy the ride back up when the inevitable recovery takes hold.
What Happens in a Bear Market?
Signs of a coming bear market are not always easy to predict, though there are a few things to look for. These include rallies that don’t last very long or sustained weakness in leading economic indicators. External factors, such as the COVID-19 pandemic and the Russian invasion of Ukraine, can also trigger a bear market.
Bear markets frequently occur before or during a recession. As the stock market is a forward-looking mechanism, it often foretells a recession, especially since economic reports are lagging indicators.
Bear markets often coincide with recessions, but not always. According to CenterPoint Securities, eight of the 11 bear markets since 1948 have been followed by recessions, with the time period between a market peak and the onset of a recession averaging seven to eight months.
Bear Markets vs. Corrections
Not all significant downturns signal the onset of a bear market. When major stock indexes drop by more than 10% but less than 20%, it’s called a correction.
Corrections are normal occurrences and should be expected to happen about once every two years. According to data from Yardeni Research, there have been 39 S&P 500 corrections since 1950, and they have occurred every 1.9 years on average. By contrast, bear markets occur about every 3.5 years, according to Forbes.
How Long Does a Bear Market Last?
As corrections are less intense than bear markets, they also don’t last as long. According to Yardeni Research, the average correction has lasted 189 days. The average bear market, on the other hand, lasts about 10 months, according to Forbes.
However, long-term averages can be misleading, and bear markets have been trending shorter and shorter. The previous three bear markets, in 2011, 2018 and 2020, averaged just four to five months.
What Are the Phases of a Bear Market?
It is helpful to consider bear markets in phases to understand their trajectory.
Bear Market Phases
- Phase one of a bear market can be a little deceiving because it’s marked by optimistic investor sentiment and rising stock prices. This marks the final breath of the bull market and the beginning of a transition to a bear market. When the bull market runs its course, the bear market begins.
- Phase two is the decline that happens when investor sentiment turns negative and the selling begins. The sell-off might be slow and controlled, or it might be accompanied by panic selling.
- Phase three is characterized by speculators entering the market and starting to scoop up bargains.
- Phase four, the final phase, is the bottoming process, when selling gives way to buying and the bear market turns back into a bull.
The Bottom Line
Neither bear nor bull markets happen in a straight line. The stock market’s 10 best days over the past two decades occurred shortly after major downturns, particularly the crises of 2008 and 2020. Missing just a few of those days — which you’re sure to do if you panic-sell during a bear market — can have terrible consequences.
According to CNBC, an investor who put $10,000 into the S&P 500 at the start of 2002 would have had a balance of $61,685 if they held their positions through the end of 2021. But if that same investor had missed only the market’s 10 best days during that same time, they would have ended up with just $28,260.
The bottom line is that building a diversified portfolio designed for long-term investing is the key to success — the trick is to stay the course, even when the inevitable bear market rattles your nerves.
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