Bear Market: Definition, Causes And Behaviors
Molly Grace6-minute read
March 22, 2022
If you aren’t super familiar with the economy’s financial markets, you may have found some of the terms used to describe them kind of confusing. What do bears and bulls have to do with investing in the stock market?
You may have a general sense that a bear market = not good. While it’s true that a bear market shows that a market is in a downward trend, there’s a lot more to it than just that – including some potential opportunities for savvy investors.
What Is A Bear Market?
The generally accepted definition of a bear market is a market whose value has declined 20% or more from a recent high point, typically over a period of at least 2 months. Bear markets are generally paired with economic recession and a more conservative attitude among investors.
Typically, when we think of a drop in the market, we think of stocks, but this can also include other types of investments, such as bonds or debt securities like collateralized debt obligations.
Where does this strange term come from originally? Evidence suggests that it may have been inspired by an old proverb about not selling a bear’s skin before you’ve caught the bear.
What Causes A Bear Market?
The market is constantly fluctuating, depending on what investors are doing on a given day (or even a given hour). If you study market trends, you’ll notice that the market can be fairly skittish – sometimes even the slightest sign of uncertainty can cause a dip in stock prices.
Our economic markets are predicated on the idea of supply and demand. If a lot of people want to buy a stock, its price goes up. If few people are interested in buying a stock, its price will go down. But what motivates an investor to want to buy a stock (or not) in the first place?
When it comes to the market, investors are always trying to figure out what’s going to happen next; it’s their money on the line if everything goes south, after all. So they’re always keeping an eye on things that could move the market, including political conflict, shifts in consumer activity, the rate of inflation, interest rate trends or changes in the bond market. Additionally – and perhaps somewhat ironically – the market is often influenced by how investors feel about it. If the people who have money in the market start to panic that there’s going to be a decline, that could create a sort of self-fulfilling prophecy that causes the market to experience a dip.
Ultimately, there are a large number of reasons why a market could take an extended downturn, and there usually isn’t a single cause when it comes to bear markets, but rather a combination of factors.
Bear Market Behaviors And Signs
A bear market is different from a correction, which is when the market drops 10% or more (but less than 20%, which would make it a bear market).
Corrections are fairly common and help keep the market from growing beyond a sustainable level (which can ultimately be bad for the economy). Usually, corrections only last a few months and don’t generally turn into bear markets.
In a bear market, values will continue to drop until they’ve reached at least a 20% decline.
How do we measure these drops? People who track economic trends usually keep an eye on major market indexes, such as the Dow Jones, S&P 500 and Nasdaq Composite. These indexes measure the performance of a portion of the major companies that are traded on the stock market and aim to give us an idea of how the stock market is doing overall. For example, the Dow Jones is made up of just 30 major companies, many of which are household names, like Coca-Cola and McDonald’s.
When one or more of these indexes falls by 20% or more for a sustained period, that’s considered to be a bear market.
When a bear market occurs, people tend to get more risk-averse with their money. Emotionally, this makes sense. If someone has money in the stock market (for example, in a 401(k)), the dip in the market has likely caused their funds to shrink. Not wanting to lose any more money, they start making changes to their investment strategy that include forgoing making further investments or even pulling out the money they currently have in the market. Financially, this behavior can hurt them in the long run, since they could miss out on potential gains when the economy recovers – and historically, the economy has always recovered, it’s just a matter of when.
As for signs you can be on the lookout for to anticipate when a bear market will happen, even the experts have a tough time with this. It’s very difficult to predict with a large amount of certainty whether economic trends will continue or if we’re in for a downturn. However, experts tend to watch the yield curve (which shows the interest rates for different bonds depending on how long they have until they mature) as a major indicator of an impending recession, though it isn’t a perfect predictor. You can also track economic indicators such as employment data, consumer confidence and GDP growth to get a general feel for how the economy is doing currently and where it might go in the next year.
Are We In A Bear Market?
There has been a lot of speculation about whether we’re heading toward a bear market. In 2020, there are plenty of factors that could cause volatility in the markets, including the U.S. presidential election, geopolitical uncertainty and the threat of an international public health emergency.
Eventually, the economy will experience a recession. 2019 marked 10 years for the longest-running bull market our economy has seen, and while we entered 2020 on relatively solid economic footing, whether that will change in the coming months remains to be seen.
Bear Vs. Bull Markets
A bull market is the opposite of a bear market, and it’s what we’ve been experiencing up to this point since 2009. In a bull market, market index values have risen 20% or more and sustained those increases over a period of at least 2 months.
Confidence tends to be higher in bull markets; investors are seeing bigger returns on their investments, and the larger economy usually does well during these times, too.
The Upside Of A Bear Market
Though generally seen as bad news for the economy, a bear market can present an opportunity for investors.
In a bear market, stock values drop significantly. While this may not be the best news if you already have money in those stocks, this is great news for those who want to invest in them, since you can get shares for cheaper than you ordinarily would. Then, when the economy recovers, you’ll make money on those investments.
In general, financial experts tend to advise investors to make sure their portfolios are allocated to weather downturns and keep going with their original investment strategy, even when the market takes a dip. Even if you lose money initially, as long as you don’t pull your remaining investments out of the market entirely, history tells us that you’ll likely be able to regain what you lost.
Buying A Home In A Bear Market
If you’re considering buying a home, you may be thinking that a bear market is the time to do it. After all, with less demand for houses and lowered market values, it’s possible to get into the home of your dreams at a significant discount.
However, if you’re a current homeowner looking to move into a new home, you also have to factor in whether you’ll be able to sell your current home. Though it may initially seem like a good idea to buy a home during a bear market or a recession, you have to take the time to seriously consider whether you can afford to take a loss when selling the home you’re in now.
If the economy is really bad, you may also have to worry about your own job stability, which could affect your ability to make mortgage payments on a new house.
On the other hand, if interest rates have fallen along with the markets, it might be a good time to buy a home, especially if you’re a first-time home buyer who doesn’t have to worry about selling their home first.
Be sure to weigh all the pros and cons and consider your own financial situation before deciding to begin the home buying process during a bear market.
Final Thoughts On Bear Markets
Though economic uncertainty can be scary, it’s all part of the natural cycle of the economy. What goes up must come down eventually (but try remember that it will go back up again, too). If you’re concerned about how your investments – particularly your retirement investments – will weather a downturn, be sure to talk to your portfolio manager about how you can create a strong, bear-proof investment strategy. Be sure to check out our Learning Center for more resources on investing.
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