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Bear Market

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A bear market happens when prices keep going down in a market for a long time. It means that the prices of things like stocks fall by at least 20% from their recent highest points. People feel very negative about the market, and investors are not hopeful.

Usually, when we talk about a bear market, we’re talking about the overall market or big indexes like the S&P 500 dropping. But even individual things like stocks or commodities can be in a bear market if they drop by 20% or more over a few months, usually two months or longer. Sometimes, bear markets happen when the economy is not doing well, like during a recession.

Bear markets are the opposite of bull markets, where prices generally go up over time.

Understanding Bear Markets

Stock prices usually show what people think companies will earn in the future. When expectations for growth decrease and people’s hopes are disappointed, stock prices can go down. Sometimes, everyone starts to act the same way, driven by fear and the desire to avoid losing money. This can keep prices low for a long time.

One way to define a bear market is when stocks, on average, drop at least 20% from their highest point. But this number isn’t set in stone, just like a 10% drop is considered a correction. Another way to define a bear market is when investors become more careful than adventurous. In this kind of market, people avoid risky investments and stick to the safer ones they believe in, which can last for months or years.

Bear markets happen for various reasons. It could be because the economy is weak, slowing down, or not doing well. Events like pandemics, wars, or big changes in how the economy works, like moving online, can also cause a bear market. Signs of a weak economy include low jobs, less money for people to spend, not much getting done, and businesses not making as much money. Sometimes, when the government tries to fix things, it can also start a bear market. For instance, if taxes or interest rates change suddenly, people might start selling stocks to avoid losing money.

Bear markets can last for a few years or just a few weeks. A “secular” bear market can go on for 10 to 20 years and brings lower returns overall. Sometimes, there are short periods of gains, but they don’t last, and prices go back down. A “cyclical” bear market, on the other hand, can last from a few weeks to several months.

In the United States, major stock indexes came close to a bear market in December 2018 and then again in March 2020, during the early days of the coronavirus pandemic. The last big bear market was during the Financial Crisis from 2007 to 2009, lasting about 17 months, when the S&P 500 lost half its value.

In February 2020, because of the coronavirus pandemic, global stocks suddenly went into a bear market. In just over a month, the Dow Jones Industrial Average dropped by 38% from its highest point in February to its lowest point in March. However, both the S&P 500 and the Nasdaq 100 reached new highs by August 2020.

Phases of a Bear Market

Bear markets usually go through four different phases.

During the first phase, prices are high and investors feel positive. Towards the end of this phase, investors start leaving the markets to secure their profits.

The second phase sees stock prices dropping sharply. Trading activity slows down, and corporate profits decrease. Economic indicators that were once positive now show below-average performance. Some investors start to panic during this phase, which is called capitulation.

In the third phase, speculators enter the market. Their involvement raises some prices and increases trading volume.

The fourth and final phase sees stock prices continuing to decline, albeit slowly. As prices fall and good news emerges, investors become interested again and bear markets transition into bull markets.

Bear Markets vs. Corrections

A bear market isn’t the same as a correction. A correction lasts for less than two months, but a bear market is longer and harder to predict. When there’s a correction, it can be a good time for value investors to start buying stocks. However, bear markets are tough because it’s really hard to know when they’ve hit the lowest point. Unless investors are short sellers or use special strategies, trying to make up for losses in a bear market is tough.

From 1900 to 2018, the Dow Jones Industrial Average (DJIA) had about 33 bear markets, coming around once every three years. One of the biggest bear markets was during the global financial crisis from October 2007 to March 2009. In that time, the Dow Jones Industrial Average (DJIA) dropped by 54%.

The most recent bear market was because of the global COVID-19 pandemic in 2020. For the S&P 500 and DJIA, it was tough. The Nasdaq Composite also entered a bear market in March 2022 due to concerns about war in Ukraine, economic sanctions against Russia, and high inflation.

Short Selling in Bear Markets

Investors can try to make money in a bear market by short-selling. This means they borrow shares and sell them with the hope of buying them back at a lower price later on. It’s a risky move because if things don’t go as planned, they can lose a lot of money.

To short-sell, an investor needs to borrow shares from a broker before they can sell them. The profit or loss for a short seller is the difference between the price they sold the shares for and the price they buy them back at, which is called “covered.”

For instance, let’s say an investor shorts 100 shares of a stock at $94 each. If the price drops and they buy the shares back at $84 each, they make a profit of $10 per share, totaling $1,000. But if the stock unexpectedly goes up, they’ll have to buy back the shares at a higher price, leading to big losses.

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