Bear Market
January 10, 2022
What is a “Bear Market”?
The term bear market refers to a period of sustained fall in the price of securities. This term is most often associated with stock markets. For example, we use the performance of the S&P 500, Dow Jones Industrial Average (DJIA), or NASDAQ in the US to analyze the financial markets in America. If these stock market indices fall for an extended period of time, the term bear market is used by investors. Other asset classes such as real estate, commodities, currencies, and really any investment asset class can also have bear markets. The opposite of a bear market is a bull market.
While there is no formal criteria or measurement for a bear market, there is an unofficial threshold. This threshold is a 20% or more fall in stock prices and does not include the effect of dividends to the total return to investors. A bear market can last for several years but, historically, bear markets are shorter in duration than bull markets.
Key Learning Points
- A bear market is characterized by a downswing in the price of securities over an extended period of time and can last for years
- A bear market occurs, when there is a continuous fall, usually of at least 20%, in stock prices or other assets. It should not be confused with what is termed as ‘market correction’, which is a fall of more than 10% but less than 20%
- For patient or long-term investors, a bear market represents a good buying opportunity as prices of many stocks or assets tend to be undervalued
Bear Market Characteristics
Bear markets generally occur during time periods when the economy is weak, slowing down, or in a recession. There will often be weak GDP growth, rising unemployment, low consumer confidence, and company profits will be falling – all of which drive stock prices down.
Bear markets are caused by a variety of factors. The most notable of which is a marked and protracted economic downturn, rising and persistent inflation, over-leveraged investing, geo-political tensions, unexpected surge in oil prices, pandemics or wars, or any other major economic or financial shock.
A bear market can last for years and occurs when stock prices drop at least 20% from their most recent high.
It’s important to note that the dates of bear markets can only be demarcated in hindsight, as you need to reach that 20% change in the opposite direction to be able to declare a bear market. A common example of a bear market is the 2020 Covid-19 induced stock market plunge or crash into a bear market, more precisely in early 2020. Another example of a bear market is the period of the 2008-2009 global financial crisis. Secular and cyclical markets can both be seen in both bear and bull markets.
Bear markets are often related to low investor confidence who tend to believe that stock prices will continue to fall. Panic, fear, and uncertainty become endemic. As a result, investors continue to sell their market holdings, in order to minimize losses. This only serves to magnify the effect of bear markets. In fact, when a bear market starts, investor confidence tends to nose dive.
In a bear market, the number of Initial Public Offerings (IPOs) by companies across sectors tends to drop sharply.
In a bear market, stock prices or prices of other assets tend to be undervalued. This presents a good buying opportunity for patient and long-term investors. These investors can profit from a bear market, as they can purchase stocks at cheap prices and make a profit when the stock market goes up in the future. Value investors tend to consider a bear market as an opportunity to make a significant amount of money.
Bear markets should not be confused with market corrections, which are a fall of more than 10% but less than 20%.
One should worry about the onset of a bear market if the index is falling steadily week after week. This is one of the more assured signs of an impending stock market crash.
Bear Market Example
As a general rule, when the benchmark stock market index of a country, such as the S&P 500 in the US, falls by 20% or more in a short span of time, it is termed as a bear market. Given below is a table, where we have the stock market index data of Country A and the data is given for February 1, 2021 (Day 1) to March 5, 2021 (Day 30).
The table shows that the index has nosedived by 45.5% during a one-month period (i.e. from 40,569 to 22,000), due to extreme pessimism prevailing among investors. The market has simply crashed and continued to fall incrementally every passing day. However, such massive or irrational fall in the index results in stock prices being undervalued and represents an opportunity for value investors to purchase stocks.
Next, we can see from the table that on some (i.e. four) days, the fall in the stock market index is more than 5% in one trading day, which is in reality a huge fall. The cumulative effect of such a fall or drop in the index builds a bear market. This market is characterized by panic and sellers of stocks are much more than their buyers. Investors are trying to get out of the market to prevent any further losses, so the stock market index has nosedived during the aforesaid period.
