What is a Bear Market?
A bear market is an extended period of fall in the price of the investment. It occurs when the investment falls by more than 20% from its recent high. Not just markets but individual stocks are also said to be in a bear market condition if their price falls by 20% or more amid negative investor sentiment, pessimism, and economic downturns.
Since stock prices reflect the future expectation of investors from a company, a fall in the price of the stock indicates bleak growth prospects. With investors following the herd behaviour and fearing further losses, widespread selling will prolong the fall in prices, leading to a bear market.
Apart from a 20% decline in the value of the investment, this market can also be identified by gauging investors’ willingness to take the risk. If investors are more risk-averse, then the markets are already bearish.
Even though the bear market has a few rallies, the overall trend is downward, and investor sentiment is negative. Over a period of time, investors realise that the stock prices have corrected and are available at attractive valuations. So, they start buying again, officially ending a bear market.
This can last for several years or just a few weeks. Depending on how long these markets last, they can be categorised under three different types.
Types of Bear Market
- Secular bear market: It can last for close to 10 or 20 years, and the markets usually give below-average returns on a sustained basis. Even though there are rallies in a secular bear market, the gains do not last long, and the prices fall to the previous levels. It can occur due to domestic policies or weak investor sentiment. This market often discourages investors from investing in the markets. They will be more inclined towards government securities, high-interest bonds, or low-risk securities, reducing the liquidity in the stock markets. A classic example is during the 2008 subprime loan crisis.
- Cyclical bear market: It can last several weeks to a few months. They arise due to fluctuations in the economic cycles. This market always follows a prolonged boom period, indicating a slowdown in economic growth. But it is immediately followed by a growth phase, regaining investor confidence. A classic example of a cyclical bear market is when a sector experiences slow growth or de-growth in sales.
- Event-driven bear market: It can last a few months and is usually triggered due to an event. Investors anticipate the future due to the occurrence of an event and panic sell their investments. This leads to a bear market. Take, for example, the pandemic. The market crash was due to excessive selling by investors wondering how the future would turn out to be due to the shutdown of all countries’ trade.
Causes of Bear Market
A bear market can be a result of one or all of the following factors:
- An impending recession: An upcoming recession can lead to bearish market sentiment. A negative investor mindset will cause the markets and stock prices to fall, leading to a fall in the money supply to companies. The demand will also be weak, resulting in decreased production and a fall in revenue and profits. A fall in profit will, in turn, lead to a fall in the company’s share price. Companies try to cut costs by laying off staff, increasing unemployment. The vicious circle of recession doesn’t end until the government intrudes and takes some measures to improve economic growth.
- Unexpected events: An unexpected event like a political crisis or any socioeconomic turmoil can also trigger a bear market in the short term.
- Company’s performance: A company’s poor financial performance, management change, fall in promoter holding, or even a demerger can lead to a fall in the price of an individual stock. Sometimes the fall can be very drastic, and it can take months or even years to recover.
- Global factors: With growing interdependence among countries, a major event in a big economy can cause fluctuations in developing markets like India. Take, for example, China. A zero-Covid strategy in the country led to a strict lockdown, causing disruptions in the global supply chain. This is already affecting a few companies in India and across the globe. If China continues this policy, many countries in the global supply chain will face the repercussions.
- Investor mindset: If one big investor sells his stake in the markets, all other investors will follow due to herd mentality. A high supply and low demand will further lead to a price fall, indicating bearish market sentiment among investors.
How to Identify a Bear Market?
A bear market is different from a market correction. Though both cause the markets to fall, the following characteristics will help identify a bear market.
- A decline in the stock market: A decline of more than 20% in the market indices or individual stocks can lead to a bear market, provided the fall in the market is sustained for a long period.
- Fall in economic growth: In this market, the economy will be contraction phase, with gross domestic product (GDP) growth declining, high unemployment, low demand, and falling corporate profits.
- Negative sentiment: The overall market sentiment is negative in this market. Investors will prefer selling their equity investments and choose low-risk ones like bonds and government securities.
- Duration: In this market, the broad market indices should fall by 20% or more, and it should last for at least two months. Anything less isn’t a bear market but a simple market correction.
How to Invest in a Bear Market?
Investors need to understand that the markets and prices of securities fluctuate based on demand and supply forces. A drastic change in investment strategy isn’t required for bull and bear markets separately. However, there are a few tips to keep in mind while investing in a bear market.
Do Not Sell
The biggest mistake investors commit is selling their investments in a bear market, fearing future losses. But if the goal is long-term, there is no need to panic. Sit tight, and hold onto the investment to earn from the market rebound.
One of the first rules of investing is to diversify. It is important to spread the investment across multiple asset classes. When one asset class doesn’t perform, the other will help balance the portfolio returns. In case of bear market conditions, investors should consider putting money in fixed-income securities to spread the risk.
Rupee Cost Averaging
One of the best strategies to follow is to continue investing during a bear market. Doing so will decrease the average cost of investing, and the investor can earn high returns when markets bounce back.
The main principle of investing is to buy low and sell high. But most investors give knee-jerk reactions to market movements. In other words, they sell when the markets fall slightly and buy when the stock gives good returns. They act on their emotions instead of staying invested for the long term to make good returns. When investing in markets, one must always think about the long term to make the most out of it.
Focus on Quality
One must always invest in companies with strong fundamentals and have a competitive advantage over their peers. Only when the economy goes bad can faults in a company be seen. In contrast, good companies tend to stand strong despite basic economic conditions. Hence investors should focus on investing in companies with strong financials, good top management, and high-quality products and services.
Don’t Time the Market and Catch the Bottom
When investing in shares, one should never time the market, especially during a bear market. In a bear market, one can never invest at the bottom. Warren Buffet rightly said, ‘If you aren’t willing to own a company for ten years, don’t think about owning it for 10 minutes.’ So, investors must think about the long term and invest only in shares to hold them for a very long horizon.
Investors must invest in stocks of companies that offer necessities as their products. Ideally, gas, medicines, and groceries are used on a daily basis. Such companies do well even during a recession. Hence, one must invest in such companies to protect their portfolio from recession.
Frequently Asked Questions
A market correction is a fall in prices by 0-20% and lasts only a few days or weeks. In contrast, a bear market is a 20% drop in an investment’s value and lasts longer, usually a few months or years. A bear market is a prolonged market correction.
The dot-com bubble in 2002 and the financial crisis in 2008 are two classic examples of bear markets
A bear market usually lasts for a few months to years. A cyclical bear market usually lasts a few months, whereas a secular bear market lasts a few years.
A bear market has four phases: recognition, panic, stabilisation, and anticipation. In the recognition phase, only some investors see the bear market phase. The stock prices start to fall in the panic stage. There is a lot of volatility and confusion in the stabilisation phase. In the anticipation stage, the stock prices tend to recover, and there is improvement in economic conditions.