What is a bear market?
Bear markets happen when there is widespread pessimism about the state of the economy amongst individual investors who proceed to sell off their assets due to fear of prolonged losses. Bear markets therefore reflect an economic downturn and can be interpreted as early signs of a recession (although not all bear markets have led to recessions)!
Historically, bear markets have been both short-term and long-term trends, ranging from weeks and months, to a matter of years. Bear markets are the opposite of upward trending bull markets which reflect optimism amongst investors about the state of the economy. But more on that later.
KEY TAKEAWAYS
- A bear market is when a broad market index, such as the S&P 500, declines by 20% or more from recent highs over a prolonged period of time
- The downward trend reflects pessimism amongst investors about the state of the economy who proceed to sell of their assets
- Bear markets can last between weeks and years and are interpreted as an indication that a recession is on the way
- An overlooked advantage of a bear market is that it presents investors with opportunities to buy assets at a discounted price, which ultimately has the potential to create significant returns in the long run
Bear market causes
A bear market can be caused by a number of different factors. After all, there are multiple factors that can lead growth prospects and expectations to decline. A weak economy is one, but others include pandemics, wars, geopolitical crises, and other macroeconomic factors such as a change in business models. Signs of a weak economy are usually low employment and slashed business profits.
As individual investors witness such trends, they sell off their assets to protect themselves from plummeting assets. In turn, the overall price of shares drops and the economy shrinks.
Is it good to buy in a bear market?
Bear markets can naturally send investors into panic mode. However, the market has historically bounced back. The most successful investors focus on potential gains rather than potential losses, seeing bear markets as good opportunities to pick up stocks at lower prices. It’s easy to allow doom and gloom headlines to scare you, but it’s important to ignore the noise and focus on long-term returns.
How to respond to bear markets
The most important thing you can do in a bear market is avoid knee-jerk reactions. It can be tempting to follow the crowd and sell your investments when they drop due to the fear that you’ll accumulate further losses. That can lead to costly mistakes, turning a theoretical loss into an actual loss.
Bull vs bear market
While we won’t get too much into what a bull market is here, it’s important to know how a bear market differs from it. In a nutshell, a bear market is when prices go down and a bull market is when prices go up.
As mentioned, a bear market represents pessimism and lack of confidence amongst investors due to a sluggish economy, whereas a bull market represents optimism, confidence, and economic expansion. So, when the trend is up, it's a bull market. If the trend is down, it's a bear market. Ultimately, it’s all down to consumer psychology and the actions they take towards their investments.