A bear market is a type of market condition that occurs when the prices of securities fall significantly from their recent highs. It can be triggered by widespread pessimism among investors.
Although bear markets are usually associated with the overall decline in the stock market or the S&P 500, they can also be triggered by individual commodities or securities. For instance, if a stock or commodity goes down by 20% or more over a certain period of time, then it’s considered a bear market. General economic downturns sometimes accompany bear markets.
Understanding What a Bear Market Is
The prices of stocks are usually influenced by investors’ expectations regarding companies’ future cash flows and profits. As growth prospects dim, the stock market can decline. Fear, herd behavior, and a rush to protect losses can lead to prolonged bear markets.
One commonly used term for a bear market is when the average price of stocks has fallen at least 20% from their high. However, this number is not an arbitrary benchmark and can be used to describe a correction. Another type of bear market is when investors become more risk-averse. This type of market can last for a long time as they tend to avoid taking on too much risk.
Although bear markets can be triggered by various factors, such as a slowing or weak economy, geopolitical crises, and technological changes, they can also be triggered by a burst of market bubbles. Some signs triggering a bear market include low employment, a drop in business profits, and a lack of disposable income.
A bear market can last for several years or even decades. The decline in a secular bear market is expected to last for at least 10 to 20 years. There can be periods of rallies in this type of market, but they cannot be sustainably, and prices then fall back to their lows. On the other hand, in a cyclical bear market, the decline is expected to last for several months.
In December 2018, the US stock market was close to reaching bear market territory. However, major indexes such as the S&P 500 and the Dow Jones Industrial Average started to fall into bear market territory during the week of March 11.
The last time the US stock market experienced a prolonged bear market before that was during the financial crisis, which lasted from 2007 to 2009. During this period, the S&P 500 lost about 50% of its value.
In February 2020, global stocks started to fall into a sudden bear market after the coronavirus pandemic. The Dow Jones Industrial Average dropped 38% from its all-time high of 29,568.77 on February 12 to a low of 18,213.65 on March 23. Despite the market’s decline, the S&P 500 and the Nasdaq 100 were still able to make new highs by August 2020.
The Four Phases of a Bear Market
High investor sentiment and high prices characterize the first phase of a bear market. Near the end of the first phase, investors start to exit the market and take profits. The second phase of the bear market begins when the prices of stocks start to fall sharply. This period is characterized by a drop in corporate profits and trading activity. Some investors will start to panic as the market sentiment begins to fall.
The third phase of the bear market is when the number of investors enters the market. In the fourth and final phase, the prices of stocks continue to fall. However, as the low prices and good news attract more investors, the market can eventually turn into a bull market.