If you’re new to investing, you may have heard the term “bear market” before without fully understanding what it means. In simple terms, a bear market is any time when investors en masse sell a significant portion of their holdings, resulting in a widespread market drop of 20% or more over a sustained period. While bear markets are often marked by investor pessimism and decline, they can also offer an opportunity for investors with longer investing horizons.
What is a bear market?
Markets naturally experience highs and lows but only after a market experiences a sustained drop of 20% or more is it considered to be a bear market. Up until that moment, stock and other asset price declines may only reflect “bearish” market conditions or corrections from recent highs. While no one really knows why it’s called a bear market — why not a raccoon market? — some say it’s because bears have claws that curl down, just as stock prices trend down during a bear market. Whatever the reason, the name stuck.
Bear markets typically occur when the market experiences a significant disruption or change in conditions. Whatever the actual cause may be, whether it’s the rise of inflation and interest rates, an asset bubble popping or a geopolitical event like an oil crisis, investors quickly lose confidence in the stability of the market and begin pulling their investments. Bear markets can last anywhere from a few months to a couple years, but most often, they’re over within a single year. Learn more about volatile markets here: When markets tumble, what can you do?
In a typical bear market cycle, the market begins from a place of strength. The economy is often flourishing, Gross Domestic Product (GDP) is still growing, and stock prices tend to be high. At some point, however, a disruptive event or series of events occurs, and investor confidence begins to wane, leading to small declines in the market. These small declines, in turn, start to snowball, leading to a more significant decline in corporate profits and in some cases, layoffs. Next the economy could begin to falter. GDP may fall, and investor confidence could rapidly decline. A recession sometimes follows, as one did in 2008. What’s next? Well, after some time, recovery begins. Investors begin to re-invest in the market (taking advantage of low prices), confidence is slowly rebuilt, and the economy begins to grow again.
Canadian investors have experienced several bear markets in recent history, including one in 2008 during the U.S. mortgage crisis and one in 2022 following the rapid hike of interest rates by the Bank of Canada (BoC) to counter high inflation.
Bear market vs. bull market
While a bear market describes a decline in asset prices of more than 20%, a bull market describes the opposite — a period when stock prices rise by more than 20%. Here are a few other ways they differ:
- Economic conditions: Bear markets are typically accompanied by weakening economic conditions, including a plateaued or shrinking Gross Domestic Product (GDP), and they often directly precede recessions. Bull markets, on the other hand, are generally marked by strong economic conditions and GDP growth.
- Unemployment: As investor confidence wanes and company profits fall, bear markets can lead to higher levels of unemployment and employee layoffs. During bull markets, we often see higher levels of employment and salary growth.
- Inflation and interest rates: The relationship between inflation, interest rates and the market can be less straightforward. In some cases, the beginning of a bear market may be directly tied to high inflation and the ongoing efforts of central banks to lower inflation. In April 2022, for example, both the Bank of Canada and the U.S. Federal Reserve began hiking interest rates to counter high inflation and by June of 2022, North American markets had firmly entered bear market territory. In other cases, inflation may not play a significant role at all. For example, in early 2020, when the COVID-19 pandemic began, markets experienced a very brief bear market as the world reacted to lockdowns.
Bear markets vs. corrections
On occasion, a correction is mistaken for the beginning of a new bear market. If the price drop is around 10%, for example, rather than 20%, it’s more likely to be the former. Economists may also point to the duration of the correction. If the correction is brief and prices start going back up after a short period, it’s probably not the beginning of a fully-fledged bear market.
Investing in a bear market: Survive and thrive
New investors who may be experiencing their first bear market may want to consider:
- Staying calm. No one enjoys watching the value of their portfolio fall, but sometimes a knee-jerk reaction to sell everything can do more harm than good. Read more here: I’m seeing losses. Now what?
- Focusing on the future. Bear markets can present a unique opportunity for investors who have longer-term investment horizons. After all, younger investors who can afford to stay invested for longer periods of time may be able to scoop up quality investments for lower prices during a bear market.
- Diversifying your holdings. Although bear markets represent an overall decline in the market, that doesn’t mean every stock will be affected equally. Through diversification, the impact of any given bear market may be lessened.
- Taking advantage of dollar-cost averaging. For investors who take advantage of dollar-cost averaging, the overall buy-in is spread out so timing the market becomes less important. Say, for example, you want to buy $5,000 worth of shares in company X. Instead of buying all the shares at once, you divide the purchase into four time periods. If the price of the stock goes down during that time, you’ll end up getting more shares than if you had spent that $5,000 all at once (and keep in mind the price of the stock could also rise during this time).
- Keeping an eye out for recovery. As with all things, it’s important to remember that this too pass. When a bear market ends, recovery begins. Keeping an eye on that recovery may help you weather the storm and stay focused on the future.
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Ultimately, bear markets are a normal part of our economic cycle. Although they may not be particularly pleasant for many investors, they all have an expiration date. Rather than dwell on the negative, it may be helpful for investors with a longer time horizon to look for opportunities a bear market can present. After all, historically speaking, the recovery has more than made up for what’s come before.
Can you make money in a bear market?
Making money during a bear market may not be the same as in a bull market. However, the real gains are often best seen after a bear market ends by those who may have bought or held onto quality investments.
How do you trade in a bear market?
The actual act of trading during a bear market is the same as it is during any other time. However, investors looking to trade during a bear market may want to consider their long-term goals before initiating a trade.
What should I do during a bear market?
Investors should always do their own due diligence before making any investment decision. Re-evaluate your financial goals, time horizon and personal situation to help you determine next steps.