A bear market may be a time of contraction, but investors can still find opportunities for profits.
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What Is a Bear Market?
A bear market is a time of contraction in financial markets. It is typically defined as a period where prices have fallen 20% from a recent peak.
Which prices are being measured? Analysts use stock market indexes as a bellwether to paint a picture of broader economic trends. In particular, the S&P 500 contains 500 of the largest companies trading in America, and its performance is often used as a representative benchmark. While bear markets usually describe a period when the S&P 500 falls 20%, the term can also be used when analyzing the performance of other market indexes like the Dow Jones Industrial Average or the Nasdaq Composite, fixed-income securities like bonds, entire market sectors, commodities, or even individual stocks.
What Happens in a Bear Market? What Causes Bear Markets?
During a bear market, the stock market declines, and assets become less valuable. This is different from market corrections, when prices fall at least 10%-—these are usually temporary. The nature of a bear market is longer. In bear markets, stocks (particularly small-cap stocks, or those with small market capitalizations) can experience increased volatility or drastic price changes, due to lower trading volume.
There are more sellers than buyers in this type of environment, and sometimes, a news event, such as a supply shock, can cause frenzied selloffs, or capitulation. Broader macroeconomic changes, such as when the Federal Reserve raises interest rates, can also cause the stock market to contract, although that just might be what the Fed is trying to do. For example, when it increases its Fed Funds Rate, it wants to tighten liquidity and thus curb inflation before it gets out of control.
One negative outcome of a bear market is that the economy could enter a recession, although that’s not always inevitable. In fact, while a bull market might feel better to investors, there are many opportunities for profitable investing in bear markets, too.
How Long Do Bear Markets Typically Last?
Expansion and contraction are normal parts of the economic cycle. Yet compared to bull markets, bear markets are typically short-lived. These charts of bear and bull markets in the S&P 500 since 1932 illustrate this well—there have 12 bear markets compared to 14 bull markets, but the duration of the bear markets is much, much shorter: The bear markets are just 25 months (around 2 years) long in average, compared to an average length of 59 months (nearly 5 years) for bull markets!
Chart of Bear Markets
Chart of Bull Markets
Which Stocks/Investments Do Well in a Bear Market?
Just because you’re in a bear market doesn’t mean you can’t make money. Consider this: Half of the S&P 500’s best days in the past 20 years happened during a bear market. Individual stocks often move independently of broader market trends, and these moves can happen as a result of a variety of factors, from analyst upgrades to earnings reports. Therefore, wise investors should have a solid understanding of their stocks’ underlying fundamentals, and they shouldn’t let market averages scare them off.
When the markets do turn south, savvy investors may want to consider strategies like short selling, which is selling a borrowed stock (through a broker) with the objective that the stock’s value will fall. Investors can also profit from derivative securities like put options. If an investor is bearish on a stock, they can buy a put option and make money when it goes down. Another idea is buying an inverse ETF, which, like its namesake, is designed to perform in the opposite way of the market it tracks.
One tried-and-true investment tactic that can help investors weather any market cycle is dollar-cost averaging, a long-term investment plan that shores-up any short-term volatility by purchasing shares at regular intervals: When the asset’s price is lower, more shares are purchase such that; when its price goes up again, you will have that much more profit.
Bear Market vs. Bull Market
A bull market is one that has been steadily rising, while a bear market is witnessing a decline. Bull markets usually enjoy strong GDP growth, elevated consumer confidence, and high rates of employment.
Bear markets, on the other hand, are times of uncertainty, and fear and anxiety may be the sentiments of the day. Bear markets are often characterized by higher inflation and rising unemployment.
Of course, no trend is sustained forever, and a rally happens when prices rise—sometimes sharply or rapidly—for a period of time. A bear market rally is when stocks increase for a while before resuming their decline. Some investors have coined their own term for this: a “dead cat bounce,” which is a short-lived rally that helps identify the bottom of a bear market, although it does not signal the market’s bottom and can be tricky to identify, which is why it’s also known as a sucker’s rally. It’s always important to pay attention to the fundamentals.
What Does It Mean When Someone Is Bearish on a Particular Stock?
If someone is bearish on a stock, they have the expectation that its value will decline. Likewise, if they are bullish, they believe it will rise.
Are We in a Bear Market?
TheStreet’s James “Rev Shark” Deporre believes that emotion is causing the market’s recent volatility, which is a function of bear markets. However, he also believes there’s a silver lining for investors.
