Bear markets: Why they matter

Jul 10, 2022 | Articles, Stock Market 101

Perceptions of a bear market can push prices down further, prolonging the pain

 

Vidhura S Tennekoon

A 16th-CENTURY proverb advises: “It’s unwise to sell a bear’s skin before catching it.”  That’s one of the stories used to explain why, in modern times, stock market investors refer to someone who sells a stock expecting its price to drop as a “bear.”

It follows that a market in which stocks are persistently declining in value is known as a “bear market,” like the one that many markets around the world are experiencing at the moment.  The opposite, when assets are steadily rising over a period of time, is a “bull” market.

In my classes, I teach my students about the efficient market hypothesis, which states that stock prices are rational, in that they are always fairly priced based on available information—but when there are big swings in the stock market, it’s hard to resist using more emotive terms like “bulls” and “bears,” which call to mind the “animal spirits” of investing.

 

How do you know you’re in a bear market?

The US Securities and Exchange Control Commission defines a bear market as a period of at least two months when a broad market—measured by an index such as the S&P 500—falls by 20% or more.  A milder form of a bear market is a “correction.”  During a correction, prices drop by 10% to 20% from the previous peak.

Not everyone strictly follows this two-month rule.  For example, in March 2020, when the S&P 500 plunged 34% in a matter of weeks due to the onset of the COVID-19 pandemic, many analysts still called it a “bear market.”

 

Why a bear market matters

A bear market may signal that a recession is coming, although it’s not a perfect correlation.  Since World War II, there have been three bear markets—out of a total of 12—that didn’t precede a recession.

A bear market is bad news for anyone with a stock investment, whether it’s a direct stake in Naspers or an indirect one in a retirement fund.  The impact is particularly hard on recent retirees, who are seeing their nest eggs shrink just as they need to start withdrawing income from them.

In addition, entering a bear market can have a psychological impact on investors, creating a self-fulfilling cycle.  Perceiving a bear market tends to prompt investors to sell even more, thus pushing prices down further and prolonging the pain.

Vidhura S Tennekoon is an assistant professor in economics at Indiana University, Indianapolis.

 

10 things you should know about bear markets

Even elite athletes need rest days to stay healthy.  Sometimes financial markets need to reset from record-setting performance, too.  Here’s what you need to know about bear, or down, markets.

  1. Watch for 20%. Market cycles are measured from peak to trough, so a stock index officially reaches bear territory when the closing price drops at least 20% from its most recent high (whereas a correction is a drop of 10%-19.9%).  A new bull market begins when the closing price gains 20% from its low.
  2. Stocks lose 36% on average in a bear market. By contrast, stocks gain 114% on average during a bull market.
  3. Bear markets are normal. There have been 26 bear markets in the S&P 500 Index since 1928.  However, there have also been 27 bull markets—and stocks have risen significantly over the long term.
  4. Bear markets tend to be short-lived. The average length of a bear market is 289 days, or about 9.6 months.  That’s significantly shorter than the average length of a bull market, which is 991 days or 2.7 years.
  5. Every 3.6 years. That’s the long-term average frequency between bear markets.  Though many consider the bull market that ended in 2020 to be the longest on record, the bull that ran from December 1987 until the dot-com crash in March 2000 is technically the longest (a drop of 19.9% in 1990 nearly derailed that bull, but just missed the bear threshold).
  6. Bear markets have been less frequent since World War II. Between 1928 and 1945 there were 12 bear markets, or one about every 1.4 years.  Since 1945, there have been 14—one about every 5.4 years.
  7. Half of the S&P 500 Index’s strongest days in the last 20 years occurred during a bear market. Another 34% of the market’s best days took place in the first two months of a bull market—before it was clear a bull market had begun.  In other words, the best way to weather a downturn could be to stay invested, since it’s difficult to time the market’s recovery.
  8. A bear market doesn’t necessarily indicate an economic recession. There have been 26 bear markets since 1929, but only 15 recessions during that time.  Bear markets often go hand in hand with a slowing economy, but a declining market doesn’t necessarily mean that a recession is looming.
  9. Assuming a 50-year investment horison, you can expect to live through about 14 bear markets, give or take. Although it can be difficult to watch your portfolio dip with the market, it’s important to keep in mind that downturns have always been a temporary part of the process.
  10. Bear markets can be painful, but overall, markets are positive a majority of the time. Of the last 92 years of market history, bear markets have comprised only about 20.6 of those years.  Put another way, stocks have been on the rise 78% of the time.

 

Source: Hartford Funds (www.hartfordfunds.com)