In a bear market, securities prices fall substantially, and pessimism pervades Wall Street. Investors are more averse to risk, favoring perceived safer investments. It is the opposite of a bull market, in which consumer and investor confidence swing up. Bear markets are part of the business cycle and a sign of a sluggish economy. Fortunately, they usually do not last long, and bull markets outnumber bear markets by far. Learn how to detect the trends of a looming bear market.
A bear market occurs when stock prices drop at least 20% from its 52-week-high in one or more indices for at least two months. Bear markets can happen in any sector or asset class. In stocks, investors watch the activity of the Dow, the S&P 500, or the NASDAQ Composite to measure a bear market. In bonds, analysts can observe a bear market in U.S. Treasuries, municipal bonds, or corporate bonds. Gold, currencies, and commodities can also experience bear markets.
Bear markets are marked by rising unemployment and inflation. Stagnation, commodity spikes, asset bubbles, and Federal Reserve tightening are common indicators as well. Bear tracks also include overvaluations and the yield curve. Recession often accompanies this economic downturn. Decreasing investor confidence is strong evidence of a lurking bear market. When investors are anxious about market conditions, they tend to divest in droves to avoid losses.
When consumer, business, and investor confidence wane, demand decreases. A bear market is usually preceded by a period of irrational exuberance, a state in which investors follow each other in driving asset prices up. An asset bubble grows, vulnerable to a variety of factors that can pop it. Government interventions such as changes in the tax rate or federal funds rate can cause a bear market. A stock market crash can also trigger a bear market as investors start selling at prices below value. The trend expands to other asset classes. This brings about a contraction in the business cycle.
As history bears out, bear markets usually happen about once every 3.4 years and last only 10-15 months. The market has experienced 25 bear markets of 20% or greater drops in 1928, according to some market historians. In 1990, the shortest occurred, lasting almost three months. The longest bear market lasted 36 months, from 1946 to 1949.
The term bear market invokes the image of a bear swiping its paws downward to attack its prey. Bears and bulls have been linked to investing since the gambling sport of bull and bear-baiting popular in the 1500s. Short-sellers, who sold stocks they did not yet own, profited in a bear market in the 1600s. Cartoons in the late 1800s depicting a stock market crash with bulls and bears helped solidify the animals' places in the financial world.
A bear market experiences a downward turn, but a bull market takes a climb upward of at least 20%. Asset prices increase in a bull market because investors believe that the market is on the rise. As optimism spreads, a new bull market develops. These two forces are constantly striving in any asset class. During a bear market rally, the stock market shows gains for several days or weeks. This can lead many investors to believe that a new bull market has begun. However, the bear is still in on the loose until gains move up by at least 20%.
A secular bear market is a protracted downturn that lasts between five and 25 years, averaging around 17 years. It is characterized by sustained, below-average returns. Bull and bear market cycles can happen during this time, but asset prices eventually drop back to previous levels. This is in contrast with a cyclical bear market that only lasts a few weeks or months.
The 1929 stock market crash gave rise to the worst bear market in history, which ran from September 1929 to June 1932. This contraction caused the value of the S&P 500 to tumble more than 86% downward. It contributed to the onset of the Great Depression. Between 2007 and 2009, a ballooning crisis in subprime mortgages escalated into a universal financial dilemma. The ensuing bear market caused the S&P 500 to plummet by 57%. Interventions by central banks averted total global financial collapses.
Capitulation is panic selling. It happens when investors forgo previous gains by selling their positions at a loss. They want to divest their securities as quickly as possible for fear that stock prices will continue to decline. Many market experts think that capitulation signals a bottoming out in prices and favorable time for purchasing stocks. However, it is difficult to identify. Investors typically agree on a capitulation after it has occurred.
Bear markets typically go through four distinct phases. In the first phase, extremely optimistic investor sentiment gives way to pessimism, and investors start selling off securities. Next, stock prices and trading volume experience sharp falls while once positive economic indicators fall below average. This is where capitulation occurs. In the third phase of a bear market, speculators and market makers attempt to pump up activity in the market with hopes of profiting from price increases. This spurs some trading activity. Lastly, a bear market comes into a recovery phase marked by a leveling off of price drops and rising investor and consumer confidence.
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