What Is A Bear Market?

What Is A Bear Market?

The global financial markets go through cycles of booms and busts over time. Periods of rapid growth are followed by market pullbacks and corrections.

When a market correction sinks the market by at least 20%, meaning that asset prices across the board keep falling, this is thought to be a bear market. 

It must be noted that bear markets are typically much shorter than bull markets, as they often trigger governments to respond and address the issues before the bear market turns into a nationwide recession and causes more hardships in otherwise unaffected areas of the economy. 

To evaluate bear markets, it is helpful to look at the performance of the S&P 500 to see how the benchmark equities index reacts to market pullbacks and pessimistic sentiment. 

When investor confidence is down, even the stocks with strong fundamentals and profitability struggle for price growth, as investors are not expecting a bullish run in the short-term and are refraining from speculative investments. 

Another characteristic of bear markets is the shifting focus between asset classes, which is largely tied to inflation and interest rate increases during a bear market. 

If you are a beginner investor and would like to know more about bear markets, this investfox guide is for you. 

Characteristics Of A Bear Market

Bear markets are characterized by distinctive asset performance and pricing. Traders can follow these factors to determine whether they are in a bear market or not and how likely a bear market is to occur on the horizon. 

Some important characteristics of bear markets include:

  • Declining Prices: Bear markets are defined by a sustained period of falling asset prices, typically a 20% or more decline from recent highs
  • Pessimism and Fear: Investor sentiment is negative, with widespread fear and uncertainty about the economy and financial markets
  • Economic Challenges: Bear markets often coincide with economic downturns, such as recessions or economic contractions
  • Reduced Trading Volume: As prices decline, trading volume may decrease as investors become hesitant to buy or sell
  • Volatility: Increased price swings and heightened market volatility are common during bear markets
  • Lack of Confidence: Investors lack confidence in the market's ability to recover, leading to a "wait-and-see" attitude
  • Reduced Consumer Spending: Economic uncertainty can lead to reduced consumer spending and business investment, further contributing to the bear market's negative sentiment
  • Interest Rate Cuts: Central banks may respond to a bear market by lowering interest rates to stimulate economic activity
  • Corporate Earnings Decline: Falling stock prices often reflect a decrease in corporate earnings, which can be a leading indicator of economic challenges

Bear markets can vary in duration and intensity, with some being short and shallow, while others are prolonged and severe.

Important Considerations About Bear Markets

It must be noted that bear markets are considerably different from bull markets, not just in the direction of asset prices, but in duration, severity, and speed as well.

When investors are in panic, mass sell-offs can ensue, leading to dramatic drops in asset prices. 

Such steep declines can spill over into other sectors of the economy, causing a nationwide recession. 

Governments take these declines into consideration and seek to stimulate the economy wherever possible to avoid economic downturns, which increases unemployment, destroys wealth and leads to instability in the economy. 

Bear Market Example

A good example of a short bear market has been the year 2022, when most stocks declined considerably, with talks of recessions dominated the media conversations and investor sentiment showed signs of considerable decline. 

For this reason, bear markets are closely monitored and governments are alarmed of a potential recession when asset prices drop too low. 

Looking at the S&P 500 price chart, we can see the sudden drop in 2022, which shed billions of dollars in shareholder value across the board:

sp 500.png

As we can see on the chart, the S&P 500 declined considerably in 2022, before rebounding by the start of 2023. While the trend was much shorter than the bull market that kicked off in 2008, the sheer degree of price decline can qualify the year 2022 as a bear market. 

Key Takeaways From What Is A Bear Market

  • Bear markets occur when asset prices and the broader market drop by at least 20%
  • Bear markets can cause full-scale recessions when left unchecked, which is why many governments tend to interfere and stimulate the economy before such an event happens 
  • Bull and bear markets exist in a cycle where bear markets are followed by bull markets, and vice versa 
  • Bear markets can cause panic among investors, which is why most bear markets start with a rapid decline in asset prices 

FAQ On Bear Markets

How do bear markets work?

Bear markets are marked by a sustained decline in asset prices, typically 20% or more, driven by pessimism and economic challenges. Investors sell stocks due to fear and uncertainty, causing a self-reinforcing cycle of declining prices.

Are bear markets dangerous?

Bear markets can be dangerous for investors, as they often lead to significant losses in asset values. Investors who sell in a panic or lack a diversified portfolio may experience substantial financial setbacks.

What happens after a bear market is over?

After a bear market ends, a recovery phase begins, marked by a sustained upturn in asset prices. Investor confidence gradually returns as economic conditions improve. Bear markets are typically followed by bull markets, characterized by rising prices and optimism.