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Bear markets explained

If you’re a fan of Winnie the Pooh or Paddington the idea of a bear market might sound quite comforting. But in reality, a bear market – signifying large drops in share prices – can cause real danger for investors and their portfolios. In this article we explain what a bear market is, why and when they happen, what they mean for share prices and what you can do to come roaring out the other side.

Published on 05 Jul 20227 minute read

Written by David Craik

What is a bear market?

A bear market develops during times of economic or social crisis such as recession, soaring inflation or war. The markets and investors are shrouded in fret and fear and most share prices dive. A common definition of a bear market is when a broad index like the S&P 500 or FTSE 100 drops by 20% or more over a period of at least two months. Even stocks that are growing revenues and profits will likely be caught up in the bear market tornado and find their share price and valuation dropping. They tend to last for several months. However, there is no fixed definition. The drop-off in markets at the dawn of the Covid pandemic in February and March 2020 was described as “the world’s shortest bear market”.

A bear market is different from a correction where prices drop between 10% and 20% from the previous peak and last for only a short period. You could call it bear market lite, or a bear that might want to merely play with you rather than leap on you and eat a leg or two.

The opposite to a bear market is a bull market. The common definition for this is when stock prices climb without falling more than 20% over at least a two-month period. Investors are ‘bullish’ during this period as it tends to coincide with times of economic growth, strong corporate profits, and low unemployment.

How often do they happen?

According to a Hartford Funds report, since 1928 the S&P 500 index has experienced 26 bear markets. That sounds like a lot but consider that there have also been 27 bull markets in that time and stock market investing remains a positive place to be in the long term – if you can withstand the market ups and downs. Luckily for investors, the average length of a bear market is only around 289 days, which is a lot less than a bull market which snorts and fires its way to an average 973 days*.

(*Bear Market and Bull Market, Forbes, 24 Feb 2022)

Why is it known as a bear market?

A bear is used to describe the market because in the wild the animal attacks opponents by swiping its paws downwards. In contrast a bull attacks its opponents by thrusting its horns upwards into the air.

Anyone who contradicts this is welcome to do their own research…

Why is it risky for investors?

The obvious answer is that plunging markets and share prices batter the value of your investments and portfolio. Those carefully laid short and long-term plans to go on a cruise to Barbados, take out some income for your retirement or to fund the grandkids through university will look less attainable for a while. Again according to Hartford Funds, stocks lose an average of 36% during a bear market.

As such it can have a deep psychological impact on investors. If you are ever going to feel like running for the hills and putting your cash back in the piggybank then this is the time. It can force investors to sell their holdings, withdraw completely and sit on their cash reserves until the bear goes back into its cave. But, for other investors, who thrive on risk this is one of those moments when the markets come alive. They seek out opportunities and the chance of making bigger returns.

What are the characteristics of a bear market?

The first phase of a bear market is characterised by the dying days of the bull market when prices and valuations are high, and investors are cock-a-hoop. But when some investors start to sense that economic and social conditions are deteriorating, they may decide to sell and bank their profits. Prices start to fall and keep dropping as those economic fears materialise and corporate profits suffer. Some of those investors that didn’t sell at the peak then begin to panic and shed their positions. It is a herd mentality known as capitulation.

The next phase sees some investors coming in to take advantage of the drop in the market, raising some prices and bringing some life back to proceedings.

The final phase is when prices continue to fall but at a slower pace. Then more and more investors, not just speculators, return to the market as economic and social news picks up and the bear retreats.

What could this mean for you?

Some investors see opportunities in bear markets. Those with more investment nous and confidence go bargain spotting, finding those temporarily undervalued but fundamentally strong stocks to buy at an attractive price. This can be risky of course because unlike being smothered during a grizzly attack it is hard to gauge where – as it were – the bear market’s bottom is.

For most investors, however, the phrase – ‘It’s time in the market, not timing the market!” – should be your bear market mantra. Even if stocks suffer from bear market volatility, those canny investors who stay calm and committed to their portfolios should benefit once again when the dark clouds have passed.

Having equity investments diversified by country, sector and style is crucial for investors both during good times and bad. That means having those defensive stocks that can more easily ride out the tough times and keep churning out dividends.

Growth stocks have had their time in the sun in recent years, but the recent boom in energy stocks fuelled by soaring oil prices has shown that value investing has its place as well. Airline and leisure stocks are likely to suffer particularly in a downturn as people save their pennies, but demand should bounce back. People need their sunshine and trips to the pictures!

Investing in a range of asset classes is another way to provide diversification. Investments like bonds, commodities and infrastructure can help limit the downsides of stock market volatility, as well as creating opportunities for returns.

Conclusion 

A key message, we believe, is to resist the temptation to sell even if your investor friends are tearing their hair out and starting to talk to trees or traffic cones for advice. If you sell, then you lock in losses that are likely only temporary. You could miss out on the eventual market recovery that typically follows. Of course, you don’t need to do this on your own. If you are invested in funds, then you can let the manager do the worrying instead.

Living through bear markets is part and parcel of being an investor. It’s like putting up with the rain before the sun comes out again. They can cloud your view on markets and make you nervous about the strength and fate of your portfolio.

But if you stay cool, disciplined, and measured you will get through them. 

How Bestinvest can help you

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Important information

This article is solely for information purposes and is not intended to be, and should not be construed as investment advice. Whilst considerable care has been taken to ensure the information contained within this commentary is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.  The opinions expressed are made in good faith, but are subject to change without notice.

You should always remember that the value of investments can go down as well as up and you can get back less than you originally invested. Past performance is not an indication of future performance.

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