What is a Bear Market?

What is a bear market?

Bear markets occur when overall prices fall for a relatively extended period. 

Merriam-Webster points out that the bear was chosen to represent a down market due to a proverb that stated that you shouldn’t “sell the bearskin before one has caught the bear.” 

The idea was that a “bearskin jobber” would sell the bearskin to someone else on speculation that they would catch the bear eventually. In stock market trading, that came to represent someone selling stocks because they expected the price to go lower, with the phrase shortened to “bearskin” and then to “bear.”

Bear markets occur when stock prices, usually measured by major stock indexes like the Dow Jones Industrial Average, S&P 500 or FTSE, drop by 20% from their recent high.  Bear markets are different from market corrections. A market correction sees stock prices drop between 10% and 19.9% from their recent high. 

A more extended decline in prices also marks bear markets. On average, bear markets generally last between 14 and 16 months. Corrections represent responses to short-term events, while a bear market represents a longer-term concern about economic outcomes or other issues.

Bear market vs. a bull market difference

While a bear market represents a long-term drop in stock (or another asset) prices, a bull market is an opposite. Instead, a bull market is the opposite — a situation in which prices rise 20% from a recent low. 

The term for a bull market came after a bear market. A bull complemented a bear. The bull attacks by tossing its head (and its horns) upward while a bear swipes down with its paw.

Bull markets are more common throughout history, occurring in 78% of the last 91 years. Additionally, a bull market is likely to last, on average, close to three years. In part, long-term investors buy and hold because bull markets are more frequent than bear markets. Over time investing is likely to result in gains.

3 factors that create a bear market

It’s important not to act like you’re in a bear market when it’s a correction. Instead, understanding the factors that define a bear market can help you make better choices about your stock portfolio. Here are the characteristics of a bear market.

1. Steep decline in stock prices

The first clue that you’re entering a bear market is the steep decline in prices. We often think of bear markets related to stocks, but they can occur in other markets. In general, though, you’ll see a decline of at least 20% from a recent high.

Generally, the decline takes place over months. So you’re not entering a bear market if there’s a flash crash and prices recover quickly. The total drop can be higher than 20%, however. The average total price decline during a bear market is 35.62%.

One dramatic example is the bear market that kicked off when the dotcom bubble burst. The Nasdaq lost more than 34% of its value a month after peaking in early 2000. Overall, the average price decline was more than 36% when the bear market ended toward the end of 2001.

When you see a prolonged decline in stock prices, that could signal that a bear market is on the way.

2. Investors feel pessimistic

Another factor that contributes to a bear market is investor sentiment. When investors feel like prices should be declining, they tend to fall. Pessimistic investors don’t want to hold onto their stock shares if they think prices will fall. As a result, investors sell their shares to capture gains while prices are relatively high. With more demand for sell transactions, prices start to drop.

Bear markets can apply to other asset classes, not just stocks. One example was in late 2012, when pessimism about the bond market led to a bear market in bonds. The bull market in stocks heated up, and there was quantitative easing in the wake of the 2008 market crash. Quantitative easing reduced the yields associated with bonds, and there was pessimism about whether interest earned could keep pace with inflation.

When there is pessimism about the market or asset class, it can lead to price drops and a bear market.

3. Economic outlook

Another factor contributing to a bear market is concern over the economic outlook. Worries about a recession can dovetail into market decline, especially for stocks. 

In early 2022, concerns about a looming bear market began as the Federal Reserve raised interest rates. The Federal Reserve often raises interest rates to slow inflation in the United States. Inflation has been an issue around the world, leading to concerns that measures to slow inflation could weigh on the stock market.

As of May 9, 2022, the S&P 500 was down 16% from its high at the beginning of January. While stocks have yet to move entirely into bear market territory, there are concerns that a slowing economy — which has seen a rather enthusiastic bull market in the wake of the Covid-19 pandemic — could turn things around and lead to a bear market.

Economic outlook can be one reason investors feel pessimistic, and these factors can combine to turn the dramatic price drop from a short-term crash or correction into a longer-term bear market.

How can an investor prepare for a bear market?

Once a bear market starts, it might be too late to mitigate the impact on your portfolio. Instead, it’s essential to cultivate a plan and a mindset that allows you to be prepared for a bear market so that you aren’t stuck. 

Portfolio diversity

First of all, setting up a portfolio with diverse assets is one way to prepare for a bear market ahead of time. Not all assets move in the same direction. For example, in some cases, when there’s a bear market in stocks, there might be a bull market in gold. Real estate values might drop at a much smaller pace than stock prices, providing you some protection when stocks are heading lower.

Creating a portfolio with some degree of diversity can help you limit your losses during a bear market and help you log some gains if other assets are gaining. 

Carefully consider your portfolio strategy and goals and create diversity reflecting your personal risk tolerance and timeline.

Increase your asset allocation to cash, gold and U.S. Treasuries

In addition to simply creating a more diverse portfolio, you can also decide to actively allocate some of your portfolio to cash, gold and U.S. Treasuries. These assets are considered “safe” during a bear market.

Why these assets are considered “safer” than stocks

• Cash: Cash is liquid and doesn’t lose nominal value like stocks and other investment assets. Additionally, FDIC insurance protects your cash in the United States. If a bank fails, up to $250,000 of your account value is protected. To get a little more yield from cash, some investors use Certificates of Deposit (CDs), which offer higher yields in return for locking up your money longer.

• Gold: In many cases, gold is considered “safe” because it exists in physical form. It’s a hard asset, and its price usually goes up during a bear market in stocks. Gold is considered a “safe haven” and a hedge against inflation. There isn’t credit risk with gold because it can still be used as a potential currency if another asset or fiat currency fails.
• U.S. Treasuries: Treasuries are backed by the U.S. government and supported by one of the most stable taxpayer bases in the world. The expectation is that, no matter what happens, the U.S. government will meet its obligations. Treasuries are relatively liquid since they can be easily bought and sold. Additionally, some Treasuries are inflation-protected, helping investors avoid seeing erosion due to inflation.

For those who feel that a bear market might be coming, it can be worthwhile to consider a bucket strategy. With this strategy, an investor would look at how much they need to cover their cash needs for the next two or three years and then sell equities (before they drop) and use the money to buy safer investments like cash, gold and Treasuries. This allows them to have access to money without selling low during a bear market.

Flight to safety

A flight to safety is a strategy that includes selling high-priced stocks to reposition an investment portfolio so that it is less likely to experience loss when prices drop dramatically.

You can watch for signs of flight to safety, including indications that more people are buying Treasuries and gold. Another indication is a growing savings rate. Finally, when more people are setting aside money and putting their assets in cash, rather than keeping it in the market or using it for other strategies, that can be an indication that investors are pessimistic and a bear market could be on the way.

If you see signs that people are getting worried and stock prices are still relatively higher, it could make sense to sell some of those assets and use the proceeds in accounts that are considered safer.

Use options

More experienced traders might be interested in using options to hedge against a bear market. You can buy a contract that allows you to buy or sell at a specific price with options. Perhaps you buy an options contract that locks in your ability to sell a set number of shares at a particular price. Then, if the market drops and your stock shares lose value, you can exercise your option and sell the affected shares for the higher, agreed-upon price. 

Likewise, you could potentially have options that allow you to buy shares at lower prices to get them for better deals. You can also short stocks, earning money from a falling stock market. There are options on these types of transactions as well, providing you with a way to hedge or even profit when stock prices fall.

However, using options can be an advanced strategy, so if you don’t know what you’re doing, you could end up in worse shape. Equally monitoring options usage can be help see if other traders think a bear market is coming. The ‘fear gauge’ or the VIX index to give it its real name, can highlight upcoming volatility. 

Stick with a long-term strategy

Finally, there’s no need to do anything during a bear market, or even leading up to it. Because bear markets historically last for a much shorter period of time than bull markets, your portfolio spends more time increasing in value than it does decreasing.

For many investors, a mindset that acknowledges that markets are cyclical and a bear market is likely to be followed by a recovery can help them prepare ahead of time. For index investors who use a dollar-cost averaging strategy, nothing changes during a bear market. They continue to buy shares on schedule. During a bear market, though, they are able to buy more shares with their dollars, so the gains during the recovery are generally larger.

What stops a bear market?

Bear markets generally come to an end when sentiment turns around, although sometimes intervention is used as a tool to put an end to the stock losses.

Change in sentiment

Over time, as optimism returns to the market and economic conditions improve, investors feel better about taking bigger risks and putting their assets back into the stock market.

Additionally, if enough investors feel that they can buy and get good deals on stocks, the resulting demand can lead to an end to the bear market.

Quantitative easing

Quantitative easing is a strategy used by central banks to reduce interest rates. With this tool, the central bank buys its own bonds, such as Treasuries in the case of the United States. This increased demand for bonds raises prices and drives yields lower. Additionally, by cutting the rate at which central banks lend money to other institutions, it’s possible to lower interest rates.

Lower rates encourage more borrowing and business activity. With the ability to borrow at lower rates, money moves through the economy, improving conditions and leading to more optimism to buy. When the economy improves, the stock market generally sees improvement as well.

Government intervention 

More direct government intervention can also be used to prop up stock prices and put an end to a bear market. The Emergency Banking Act of 1933 was designed to help restore confidence in U.S. financial institutions and helped end a bear market in the midst of the Great Depression (although there were more bear markets throughout the 1930s and into the early 1940s). 

3 famous bear markets

From 1929 to 2020, there were 26 bear markets for the S&P 500. However, some were more dramatic than others.

Great Depression

The Great Depression was kicked off by a bear market that began in September 1929 and lasted 67 days until mid-November of that same year. However, for more than a decade following, there are other bear markets. In fact, the Great Depression was punctuated by 12 bear markets — accounting for almost half of the bear markets since 1929.

This cycle of bear markets included those that lasted as few as 67 days, and lasted as long as 535 days. In fact, the bear market that lasted from the end of 1940 through April of 1942 only ended the cycle after the United States entered World War II and defense-related jobs picked up and contributed to an economic recovery.

Oil shock of 1973-1974

The longest bear market in recent history, lasting 630 days, took place during the oil shock of 1973 and 1974. Even though there had been a recession lasting from late 1968 to almost hte middle of 1970, that recession hadn’t been as long, nor had it seen as dramatic a drop.

The oil shock bear market saw a price decline of 48.20%. Concerns about access to oil, which is still a major component of the U.S. economy, caused stock prices to decline. This oil shock was the result of an embargo against the U.S. by Arab countries upset that the U.S. sent aid to Isreal during the Yom Kippur War.

By the end of the oil shock, the stock market was recovering again, and there wasn’t another bear market until the end of 1980.

Great Recession

While the dotcom bubble burst led to a recession, as well as the Iraq War a couple of years later, neither saw as big a drop in prices as the Great Recession. This time period saw to bear markets, one lasting 408 days starting on November 9, 2007, and encompassing the crash of fall 2008, and another lasting 68 days in early 2009. 

During the initial bear market that kicked off the great recession, prices declined by more than 51%. This bear market ended as the U.S. government moved to bail out major failing banks and use quantitative easing. The end of that bear market resulted in a long-term bull market that lasted until the brief 33-day bear market that emerged at the beginning of the Covid-19 pandemic.

What opportunities are available during a bear market?

While a bear market can be challenging to get through when you’re watching your portfolio value drop, there are opportunities when the markets are down.

Panic selling

At the time of a bear market, many people panic and unload their stocks. When this happens, prices can drop. Panic sellers are desperate to sell — and they are willing to take lower prices. This can be especially helpful for index products. For those buying index products, the market can drop as a whole due to widespread panic selling. As a result, it’s possible to get a large swath of the market for a lower price. If you have index products, a bear market can give you a chance to buy more at a discount. Then, you benefit later, during a recovery.

Chance to invest in tomorrow’s companies at a discount

Trending individual companies can be overvalued. In a lot of cases, you can have a hard time getting these companies at an affordable rate. As a bear market results in lower prices, even popular companies see stock price drops and become undervalued. This can give you the chance to purchase the stocks of up-and-coming companies at a discount.

On top of that, you could potentially see benefits for dividend stocks. With lower prices, you can purchase more shares, which results in more dividends paid out. Over time, this can provide you with a way to see bigger increases in your portfolio.

A low market can be less risky

When you’re close to the bottom of the market, it’s often less risky. Because the market has dropped so much, there’s less of a chance that it will fall further, so you have a better chance that it will head higher.

Bear market: general terminology

Asset – Property that has the potential to increase in value or provide ongoing revenue.

Bear market – A period of time marked by lower stock prices. In general, a bear market is triggered when prices drop at least 20% from recent highs for a period of time.

Broker – Someone who is empowered to buy and sell stock shares on an exchange.

Bull market – A period of time marked by higher stock prices. In general, a bull market is triggered when prices rise at least 20% from recent lows for a period of time.

Correction – Drop in stock prices that is relatively short-term and represents a fall of between 10% and 19.9% from a recent high.

Execution – The fulfillment of a stock order.

Initial public offering (IPO) – This is a process that a company goes through to sell shares on a stock exchange for the first time.

Price rally – When prices on stocks increase at a rapid pace.

Share – A representation of ownership in the company. This represents a “share” of ownership and provides certain rights.

Stock – Represents ownership in a company. Ownership can be bought and sold.

Stock exchange – A place where brokers buy and sell stocks. In many cases, digital order matching is made to match buyers with sellers.

Stock market – A term that describes the whole of exchanges and transactions taking place with stocks.

Stock portfolio – Collection of stocks that someone puts together.

Ticker symbol – A collection of three or four letters that represents a stock on the exchange. This makes it easier to identify and buy stock shares.

Volatility – Measures how much prices are moving up and down. Wider price swings indicate more volatility.

Conclusion

Bear markets can feel stressful and be a scary experience as you watch your portfolio value drop. However, it’s important to understand that bear markets usually come to an end. If you can buy more shares while the market is low, or stick to your portfolio strategy during the bear market, you are likely to see good results in the long run.

FAQs

How often do bear markets last on average?

The average length of bear markets since 1929 has been 289 days.

Can you make money from a bear market?

Yes, it’s possible to make money from a bear market. A short, where you buy a security that depends on prices falling, can be one way to make money. Additionally, it’s possible to make money during the recovery after you buy more shares during the stock market drop.

What does a bear represent a bear market?

Part of the reason is due to a saying about not selling bearskin before killing the bear. Additionally, it could also be due to the idea that bulls attack by going up while bears attack by swiping down.

Can an investor predict a bear market?

It is impossible to know when a stock market crash will actually happen. However, it’s possible to watch for signs that a bear market is coming. By paying attention to investor sentiment and economic conditions, you can get an idea of whether a bear market might be coming. You might not know when the exact crash will come, but it’s possible to see signs and make adjustments. 

What investments do well in a bear market?

When the stock market has a bear market, there are some assets that move differently, such as gold. Another strategy is to purchase more shares at a lower price and build up your portfolio at a discount, so that during a recovery you can potentially see higher gains later.