Understanding Bear Markets: What Investors Need to Know

The securities market can’t climb forever. Eventually prices will begin to fall. We call this period of decline a “bear market.” It’s not the end of the world for investors, but it’s a concept you should understand as you grow your retirement savings.

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What is a bear market?

A bear market is a condition that describes a declining investment climate. It’s when securities prices fall 20% or more from their 52-week high. It comes with widespread pessimism and negative sentiment from investors.

Experts typically associate bear markets with declines in an overall market index or a generally safe index like the S&P 500, but it can also apply to individual securities. Investors can be “bearish” on a particular security, which means they expect it to trend downward for some time, but that doesn’t mean their low confidence applies to the rest of the market.

Twenty percent is just the threshold we use to identify bear markets. During the course of a bear market, securities usually plummet far more than 20%. Their descent may slow from time to time, and occasionally rise a bit, but the general trend is downward.

Bear markets can be secular or cyclical. A secular bear market can last from 10 to 20 years. It’s characterized by prolonged below average returns. Secular bear markets can have slight rallies, but the gains aren’t retained and prices continue to fall. Cyclical bear markets are similar, but last for just a few weeks or for several years. The last prolonged bear market in the United States occurred around the 2008 financial crisis. It lasted for nearly two years.

Does a bear market mean everyone loses money? Not at all. In fact, some investors look forward to bear markets for their money-making potential. Short selling, put options, and inverse ETFs are just a few ways investors can profit from a bear market.

Furthermore, it’s worth pointing out that it’s smart to start an investment portfolio even if you think a bear market is coming. You have high chances of making money over any 30-year period, even if there’s a bear market in there. At the very least, you should open a high interest savings account.

Origin of the name

The origin of the phrase “bear market” is murky. Some people say it comes from the way bears swipe downward when they attack. The bear market’s opposite, the bull market, is supposedly named after the bull that sweeps upwards when it attacks. This is poetic, but there’s no evidence for this claim.

The term most likely originated from a proverb that cautions traders against the temptation to “sell the bear’s skin before one has caught the bear.” In the 18th century, middlemen would sell bearskins they hadn’t purchased yet. They would speculate on the future price of the bearskin, hopping the trappers would lower their prices. These middlemen earned the pejorative “bearskin jobbers” because they benefited from a poor economy. The slur was eventually shortened to just “bears.”

The bear market’s opposite is the bull market. The phrase “bull market” doesn’t have an organic story of its own. At the time, bears and bulls were widely considered opposites due to a popular British bloodsport of bull-and-bear fights.

Causes of bear markets

Economies are complex, so it’s rarely easy to point to a single factor that causes bear markets. There’s often a variety of factors at play. But in general, a bear market is caused by low investor confidence. Investors lose confidence when they believe the economy is weak or slowing down. Here are some signs that tell investors the economy is slowing:

• Low disposable income

• Low employment

• Weak productivity

• Decline in business profits

• Certain government interventions

During a bear market, investors tend to view market news pessimistically. They disregard good news and focus on the bad, which ultimately drives prices—and everyone’s confidence—even lower.

Interestingly, none of those signs have to actually appear to trigger a bear market. Investors need only believe they will appear. If investors have low confidence in the market, they will resist buying more assets and they will sell holdings before their value falls. This can actually trigger a bear market.

Bear market vs. correction

It’s important not to confuse a bear market with a correction. A correction is a short-term trend that lasts fewer than two months. During this period, securities that were substantially overvalued fall to their proper value. When a broad correction occurs throughout the market, some investors panic and start to cry “bear market” early.

A correction is a great time for investors to enter into the market because it identifies the “bottom” of a particular security. A bear market, however, is a poor entry point for investors because there’s no telling how far the security will fall. This is why breaking out of a bear market is so challenging. No one wants to invest until prices begin to rise, which doesn’t happen until people invest.

Identifying bear markets

It’s always easy to identify a bear market years later, but much harder to tell when you’re at the beginning of one. There’s no way to look at the market and declare, “This is the top. It must go down from here.”

Furthermore, the beginning of a bear market always looks like a simple and healthy correction. Even the most pessimistic investors hold on to their assets during a small drop, hoping they will rally and increase again.

Federal interest rates are the most telling sign of a bear market because they affect so much of the economy. Federal banks lower interest rates in response to lagging economies in order to encourage investment. If they didn’t expect a downturn, they wouldn’t be lowering rates. (Keep in mind that’s a very basic explanation of federal interest rates.)

Bull vs. bear market

The opposite of a bear market is a bull market. Whereas bear markets represent market declines, bull markets represent sustained market climbs. Bull markets are measured the same way as bear markets. We’re in a bull market once we have 20% growth or more from its 52-week high.

During a bull market, investors feel optimistic that their investments will improve, which encourages more investment, thus investment improve. Just like a bear market is a self-propagating cycle downward, a bull market self-propagates upward until something scares investors to start selling their holdings.

Current climate

As of January 2020, we are in a bull market that began in 2009. 2019 was an especially positive year for investors. Securities have recovered remarkably since the financial crisis of 2008.

When will the bull market become a bear market? That’s hard to predict. There’s always someone claiming that a bear market (and even a recession) is just around the corner. We heard it around the European debt crisis in 2010, the U.S. debt-ceiling fight in 2011, and the devaluation of China’s yuan in 2015. Today, doomsayers predict a bear market due to everything from the U.S.-China trade deal to U.K.’s Brexit to other world events.

However, there is one ominous sign of a bear market: the inverted yield curve. This concept relates short-term bonds to long-term bonds. In most circumstances, rates for long-term bonds are higher, meaning you get more profit for lending money (by buying bonds) for longer periods of time.

At the moment, however, the typical curve has inverted. There’s more money in lending for shorter periods of time. This means investors are anxious about the future and unwilling to commit their money for long periods of time. That’s exactly the kind of low confidence that triggers bear markets.

Do we know a bear market is coming for sure? Nope. We won’t be sure we’re in a bear market until we’re deep into one. What we know is that there will be a bear market at some point. The market doesn’t have a ceiling, so there’s no telling how high it will go, but it will turn down eventually.

Bear market history

The easiest way to track bear markets is to look at a reliable index such as the S&P 500. The S&P has had numerous dips and corrections over the last hundred years, but only nine bear markets.

Bear Market DateS&P LossDuration (Months)NotesSeptember 1929 to June 193286%34Marked the beginning of the Great Depression in the United States.May 1946 to June 19430%37Triggered after World War II when the postwar surge tapered off.December 1961 to June 196228%6Sparked by the failed Bay of Pigs invasion that ignited Cold War fears.November 1968 to May 19703618Triggered by riots, assassinations, and tensions in Vietnam, as well as high inflation.January 1973 to October 197448%21Triggered by a combination of high inflation and high unemployment.November 1980 to August 198227%20Referred to as the “Volcker Bear” due to the Federal Reserve Chairman Paul Volcker’s interest rate hikes that made borrowing difficult.August 1987 to December 198734%3Due to the introduction of computerized trading and devaluation of the U.S. dollar.March 2000 to October 200249%31Brought on by the dot-com bubble burst.October 2007 to March 200957%17Due to the collapse of the U.S. housing market.

The bottom line

If you aren’t a professional investor, the big takeaway here is that bear markets are natural occurrences. Yes, they’re tough to withstand, but they aren’t permanent. The market will almost certainly improve eventually.