Bear Markets Explained

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Bear Markets Explained

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As financial markets perform cyclically, it is theoretically unavoidable to run from down or “bad” market conditions. These highs and lows are often brought about by various market trends, sentiments and economic changes.

Although deemed a negative term, Bear markets can be profitable for investors who leverage the downturned markets to make gains and take higher risk margins at a time when the average trader is highly cautious.

Let’s look into the definition and the principles of the bear market, and why it plays a significant role in a trader’s investment decisions.

What is a Bear Market?

A bear market refers to a prolonged decline in investment prices, where broadly speaking, an overall market or index falls by 20% or more from its most recent high.

Bear markets don’t necessarily have to affect an entire market segment, but they can also be observed when individual assets (like securities or commodities) face a decline of 20% or more over a sustained period of time (i.e. two months or more).

Although a bear market may experience occasional “relief rallies,” the general trend is downward, often plummeting much deeper than the 20% threshold.

Bear markets are typically marked by low investor confidence and pessimism. During such times, investors tend to overlook positive news and continue selling their investments, leading to even lower prices.

Origin of the Term “Bear”

It is believed that the terms “bear” and “bull” originated from the way in which these animals attack their opponents. Bulls use their horns to thrust upwards, while bears swipe downwards, which was then figuratively used to describe the movement of a market.

  • If the trend is up, it is considered a bull market.
  • If the trend is down, it is considered a bear market.

Alternatively, another explanation for the term Bear market comes from the Middle Ages when intermediaries in the sale of bearskins would sell skins they had yet to receive.

Thus, they would speculate on the future purchase price of these skins from the trappers, hoping they would drop. But in this case, the trappers would make money by selling animal skins for more than they paid for them.

Therefore, these middlemen became known as “bears” – short for bearskin jobbers – and the term stuck for describing a downturn in the market.

What Triggers a Bear Market?

Bear markets can be caused by a variety of factors, including but not limited to:

  • Weak or sluggish economy
  • The bursting of market bubbles
  • Pandemics
  • Wars
  • Geopolitical crises

It is important for every trader to monitor the movement of the economy and look for changes like low employment, disposable income, productivity, and business profits – which are the first indicators of a slowing economy.

A bear market can also be caused by changes in tax rates or the federal funds rate. It can also be triggered by a decrease in investor confidence: when investors anticipate negative events, they tend to sell off their shares, avoiding losses.

Bear Market Phases

Usually, bear markets go through four different phases.

  1. The first phase is characterized by high prices and high investor sentiment.
    As we approach the end of this phase, investors start dropping out of the markets and take in profits.
  2. In the second phase, stock prices tend to fall sharply with trading activity and corporate profits dropping.
    Economic indicators, that may have once been positive, become below average. This is where panic starts to spread amongst investors.
  3. The third phase shows speculators entering the market, consequently raising trading volume and some prices.
  4. In the last phase, stock prices keep dropping, but at a slower pace.
    As low prices and good news start attracting investors again, bear markets start turning into bull markets.

How Long Do Bear Markets Last?

Bear markets can usually last anywhere between a few weeks to multiple years, there’s no fixed period of time.

A secular bear market can last anywhere from 10 to 20 years, and is characterized by below-average returns on a sustained basis.

  • During secular bear markets, rallies occur but are not sustained, and prices eventually revert to lower levels.
  • On the other hand, a cyclical bear market can last from a few weeks to several months.

Secular Market vs. Cyclical Market

By definition, a secular market is a market driven by forces that could last for many years, which causes the price of a particular investment to rise or fall over a long period.

In a secular bull market, positive conditions (such as low-interest rates) push stock prices upwards.

However, a cyclical market is shorter in duration and typically exhibits seasonal or cyclical business conditions.

Cyclical stocks tend to move with macroeconomic conditions, such as consumer spending or economic growth. However, once the growth is not as strong anymore, these stocks are typically sold off.

Bear Market Examples

As mentioned before, markets move in a cyclical pattern which has brought about various bear markets throughout the years.

Some notable bear markets worth mentioning are as follows:

Dot-com Crash (2000-2002)

During the late 1990s, the widespread adoption of the Internet caused a massive speculative bubble in technology stocks.

Following the burst of the bubble, all major indices experienced a decline, but Nasdaq was impacted the most. By the end of 2002, it had plummeted by around 75% from its previous peaks.

Financial Crisis (2008-2009)

One of the most severe Bear markets that affected the global economy was the 2008 financial crisis.

The crisis saw the S&P 500 fall below 50% as multiple banks failed, and massive bailouts were required to prevent the U.S. banking system from collapsing.

COVID-19 Crash (2020)

In 2020, the COVID-19 pandemic spread across the world and resulted in economic shutdowns in many developed countries, including the United States.

The resulting economic uncertainty caused the stock market to plummet into a bear market in early 2020. This was the most rapid decline in stock market history due to the speed at which the pandemic spread.

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