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What is a Bear Market? A Complete Guide


Sometimes, during market cycles, the stock markets may plunge, and prices could fall. It may be for a short period of weeks or months, or even drag on for years. Is that a bear market? Depending on specific circumstances, it may well be. But what are bear markets exactly? Read on to learn more about bear markets, their outlook, and their phases. We’ll also explore some recent bear markets and their impact and discuss what one can do during market downturns.   

What is a bear market? 

A bear market is when the markets experience a prolonged or continuous downward price trend. During a bear market, the prices of stocks, exchange traded funds (ETFs) and index funds may drop by over 20% from recent highs due to negative investor sentiment towards the market.  

One way to predict a potential decline in the overall market would be to observe an index like the S&P 500 that tracks the 500 largest companies listed on US stock exchanges and look out for a prolonged decline in prices.

When other securities like stocks, ETFs and commodities experience a drop of about 20% from recent peaks for over a couple of months, it could be a sign of a bear market as well. Bear markets may be a reflection of market recessions and other dire economic downturns. 

Types of Bear Markets 

There are typically two types of bear markets: cyclical and secular bear markets. Cyclical bear markets occur due to normal business fluctuations in an economy. These periodic bear markets appear almost every 6 to 10 years as a readjustment to prolonged periods of booming markets as all major sectors of the economy experience massive growth. 

On the other hand, secular bear markets result from financial policy, slowed economic growth, bursting market bubbles, wars and pandemics. Secular market trends can often hurt investor sentiment, preventing them from investing in large quantities. 

High interest coupons for bonds and treasury bills often cause secular bear markets as investors are incentivised to take advantage of these zero-risk instruments. As their demand for assets in the stock markets reduces, it can cause a bear market. Let’s explore some common features of bear markets. 

Characteristics of a bear market 

So, what should you look for, to tell that you’re in a bear market? 

Causes of a Bear market 

Let’s explore some reasons for bear markets. 

Phases of a bear market 

Before a full market downturn, some events will occur. Here are the phases the market undergoes before a full bear market hits. 

Past Bear Markets

Bear markets are fairly common. Most investors have experienced at least one cyclic bear market in their careers. However, some secular bear markets have made history in the past century. Let’s look at some significant ones. 

The 2020 bear market

In 2020, a bear market resulted from the COVID-19 global pandemic. This bearish trend started in March 2020 and was one of the shortest recorded.  The S&P 500 Index Fund infamously fell by over 30% but slowly regained ground over subsequent quarters. Because of the rapid spread of the virus and widespread lockdowns, there was a global slump in economic performance. In the United States, unemployment peaked at 14%, and many small businesses closed down permanently worldwide. 

The great depression 

The great depression of 1929 is one of the world’s most famous bear markets. It was also known as the catastrophic economic shock, as it took out millions of investors. Wall Street went into a full panic, and many stocks fell below 80%. For the next three years, the industrial sector in the US was underwater, and the unemployment level hit an ominous 24%. That led to a horrible drop in consumer spending habits. Over 4800 banks closed, and millions of civilians lost their savings.  

The dot-com meltdown

In the late 1990s, the world experienced a shift towards adopting the internet. This new trend drew in millions of investors who sunk massive amounts of capital into tech-related companies and businesses. Unfortunately, many investors were not seasoned enough to test the valuation of such companies. As per the NASDAQ, the dot-com bubble was above 5000 points before bursting just before the year’s close. After that, early in 2000, investors lost massive amounts of capital because of poor asset valuation, as most upcoming internet businesses were scams. Plenty of internet company projects were unrealistic and unsustainable, leading to their closure and huge financial losses. 

The housing bubble

The housing bubble resulted from high housing demand, which led to the rise in housing prices. The high demand for housing forced most investors to pump extra capital into the real estate sector. The 2007 housing bubble in the US was primarily due to an increase in high-risk clients’ mortgage subscriptions with loose lending standards and weak regulatory oversight. In years leading to crisis, interest rates continued to hike gradually as homeownership reached a saturation point. Many people with no stable or sufficient income began to find it difficult to afford the loan repayment and default on their mortgages.  

The growing mortgage defaults subsequently led to the fall of mortgage-backed securities and other derivatives which track subprime mortgages as underlying commodities. The loss of value in these mortgage-backed financial products caused a panic that froze the global lending system and eventually burst the housing bubble, wiping out trillions of dollars’ worth of investment in subprime mortgages. Over 9 million jobs were lost and an estimated 10 million lost their homes. 

Practices for investors during bear markets 

Whenever a bear market comes around, here are some actions you may consider. 

#source


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