Ah, yes – Bear Markets. Only when we are in a bear market do investors and financial gurus offer alternative investment methods. Otherwise, the core pillars of their investment advice remain the same: “Invest in index funds, buy real estate, and maximize your 401(k).”
In a bear market, however, panic often reigns. Fund managers pull out of positions in fear of a crash, and everyday investors cower in fear as they slowly watch their life savings being pulverized into the ground.
But a ray of hope always shines on a gloomy day.
Bear markets present profitable opportunities for those who can navigate through them.
In this article, we look to dissect the bear market and the investment opportunities they present. Read on to find out how to navigate to a safe harbor amidst the rough waters of the market.
What is a Bear Market
While falling prices may indicate a declining market, they’re not the defining factor of bearishness. One red candlestick on the market charts doesn’t instantly translate into a bear market.
A bear market describes the state of financial securities as they experience prolonged price declines. More specifically, a bear market is a condition where security prices fall at least 20% from recent highs alongside negative market sentiment and widespread fear amongst investors.
While this may be the threshold, it’s important to note that 20% isn’t the limit – and that prices could fall much deeper than this number implies.
To quickly recap, a bear market is characterized by the following attributes:
- A 20% Decline In Security Prices
- Negative Market Sentiment From Investors
- Downturns in the National Economic Outlook
- Declining Company Returns
Bull Market vs. Bear Market
On the opposite end of a market downturn, we have bull markets. The commonly accepted definition of a bull market is when stock market prices rise by 20%, followed by general investor optimism and confidence in the markets.
While they may be direct contradictions, bear and bull markets have more in common than you think.
1. They are both limited in duration – the average bull market tends to run for 3.8 years while the average bear market runs for 289 days.
2. They are infrequent occurrences as there have only been 26 bear and 27 bull markets throughout US history.
3. Finally, bear and bull markets are the primary causes and consequences of widespread investor sentiment, such as optimism or panic.
Bear Market vs. Corrections
The bull market is defined by a rise in stock prices. As investors and traders chase market trends and enter positions at the precipice of upward market movement, they might also want to exit positions as soon as they hit profit levels that they’re satisfied with.
A quick sell-off and a slight dip in the market are better known in the financial world as a correction.
Like a bear market, a correction creates a small dip in the overwhelmingly upward trend of the stock market. Corrections offer pockets of opportunity for investors who “missed the trend” to purchase a rising stock at a relatively discounted price.
Unlike a bear market, the dip is quickly rectified by further buying, often leading to increased gains shortly after. Following a 15% or more significant decline, the average 12-month return stands at a whopping 55%.
Traversing the sloshing waves of the stock market has never been a smooth ride. Corrections are one of the many hurdles you’ll have to power through before becoming a great investor.
Bear Market Rally
Further proving the market’s cyclical nature are bear rallies. They’re like corrections – but they’re actually helpful.
Amidst the dropping prices of a bear market, short-term rallies are a common occurrence in a down environment. They’re defined as quick upward movements in security prices during secular declines. The likely culprit of a bear market rally is institutional buyers looking to capitalize on technical factors like support levels that usually signify a positive change in market sentiment.
The continuous breakdown caused by deteriorating fundamentals has proven these buyers wrong.
Unlucky.
Bear market rallies are a symptom of the roller coaster ride that is investment. Momentary inclines shouldn’t be confused with an exit from the crisis.
Phases of A Bear Market
Coincidentally, a bear market is a lot like the stages of grief. Each phase resembles your mourning when losing something important, like your hard-earned money. This further proves that the actors in the market are irrational and past efforts in predicting the future outcomes in equities are far from being completely accurate.
No matter how much you believe investors are rational beings and that they make decisions solely based on objective truths, the phases of a bear market prove otherwise.
The average bear market, after all, has four defining phases. They are as follows.
- Denial (The Sell-Off)
Right before a bear market occurs, investors find themselves in the middle of a sell-off. While these typically occur after making all-time highs, sell-offs could really happen at any point. Market drops make lower lows, while bounce plays materialize higher highs.
It’s the classic definition of a downtrend.
- Bargaining (Market Rallies)
We said market rallies are a regular occurrence, but you likely didn’t expect it to be an actual phase in the bear market now, did you?
This stage occurs when a market low is made, and a rebound holds its ground.
Like bargaining, investors aren’t ready to give up on the markets yet, and droves of buyers enter the market creating higher floors and ceilings.
- Depression (Continued Dropping)
The party can’t last forever and what was initially thought to be a recovery turned out to be a short-lived rally.
Buying starts to wane again. As panic ensures, new lows are made, and the bottom appears to give out.
This marks the worst time in a bear market. Echoes of “market collapse” and “the sky is falling” will likely ring around your head.
- Acceptance (Accumulation)
When the dust has settled and a “somewhat” solid price floor has been made, accumulation begins.
History has proven that all bear markets end. From these ashes rise robust bull markets that magically spawn millionaires left and right.
Examples From History
There have been 26 bear markets throughout history. Some have shown a quick V-shaped recovery, while others left long-lasting impressions with a U-shaped market recovery. The letter shape mentioned describes the figure that the recovery graph would create.
V-shaped recoveries begin with a steep fall instantly, followed by an equally steep recovery. U-shaped recoveries begin like V-shaped recessions but with troughs that last marginally longer.
Examples of a V-shaped recession include the Recession of 1953 in the United States and the recent COVID-19 2020 recession.
Examples of a U-shaped recession include the 1990s Jobless Recovery and 2022s current recession.
Signs A Bear Market is Coming
Bank of America Securities published a document outlining the 19 different indicators of a bear market; they are as follows:
- Rising Interest Rates
- Tightening Credit Conditions
- Minimum returns in the last 12 months of a bull market have dwindled to 11%
- Minimum returns in the previous 30 months of a bull market have been 30%.
- Low-quality stocks outperforming blue chips
- Momentum stocks outperforming blue chips
- Growth stocks outperforming blue chips
- 5% pullback over the last 12 months
- Stocks with low P/E ratios underperforming
- Conference Board’s consumer confidence has not hit the 100 level within 24 months
- Conference Board’s percentage expecting stocks to go higher
- Lack of reward for high company earnings
- Sell-side indicators
- Bank of America Fund Manager survey shows high levels of cash
- Inverted Yield Curve
- Change in long-term growth expectations
- Rule of 20 (Trailing P/E added to CPI is above 20)
- Volatility index spiked over 20 at least once over the last 3 months.
- Earnings estimate revision
A bearish market doesn’t have to express all the above indicators.
The four most important factors to look out for are an inverted yield curve, muted price reactions for earnings beats, tightening credit conditions, and low P/E ratio stocks underperforming.
How Does A Bear Market End
By definition, a bear market ends when the index reaches its new low before going on to set a high, but that’s a vague definition, isn’t it? We previously discussed the phases of a bear market, and following this guide, a bear market ends when a solid price floor has been made and investor accumulation begins.
There is no clear indicator of when a bear market will end – no one runs around the town square, ringing a bell and screaming “Bull Market!” at the top of their lungs. That kind of stuff only happens in movies.
You must look closely at the movements of the Fed, other essential government agencies, and national banks. Bull markets typically coincide with an expanding economy and loose credit conditions.
How To Invest In A Bear Market
It’s a funny thing – investing in a bear market. Whereas general media will tell you it’s the end of the world and of financial markets as we know it, an experienced investor will show you how to not only survive but thrive in a bear market and come out an absolute winner.
Here’s what you can do to win in a bear market:
Think long-term - The financial markets have always been cyclical, and bear markets never last forever. Suppose you continue to invest a fixed amount at regular intervals regardless of the current market conditions. In that case, you buy these securities at a discounted price.
Diversify your holdings - By holding assets in different sectors, you diversify your risk and reduce the risk of major losses. For example, another industry could easily offset the loss in one sector.
Invest in hardy sectors - Sectors that tend to perform well during bear markets include consumer staples and utilities that are necessary for people to live. The demand for these sectors is inelastic and often the last item to be cut when the budget tightens.
Hold cash - Aside from steadily increasing your holding, you should look to accumulate fiat currency. Buying the dip is smart but also assumes an infinite supply of money. No one has that. Do your research, look for positive signs of a bull run, and hold cash in the meantime.
Peccala vs. Bear Market
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