Bear market

Quick definition

A bear market is when prices are falling in the financial markets.

Key details

• When in a bear market, assets such as stocks, cryptocurrencies and commodities are broadly declining in value in the financial markets.
• Bear markets typically correlate with unfavourable overall economic conditions such as retractions of major indices or recessions. 
• Short selling – or shorting – is perhaps the most effective method of generating returns during a bear market.

What is a bear market?

Everyone would be rather concerned if left alone in a room with a bear; however, they would be even more worried if the said bear was dragging the value of their investment portfolio down. 

That is exactly what is happening in the case of a bear market. It is generally defined as a price decline of 20% or more over a sustained period of time. This could be cyclical, and last for a few weeks, or it could be more long term, lasting for several years or even decades.

While individual markets can turn bearish, the easiest way of identifying a bear market is to look at the major indices like the S&P 500, Dow Jones Industrial Average, or Financial Times Stock Exchange 100.

In general, bear markets are kickstarted by unfavourable economic conditions, though uncertainty, geopolitics and global health factors can also play a role, as evidenced by the short bear market in early 2020 as the COVID-19 pandemic reach its peak. The most recent prolonged bear market occurred during the financial crisis of 2007-2009 when the S&P 500 plunged 50% over a period of 17 months.

Factors that are indicative of a bear market include negative geopolitical news, slowdowns in corporate profits, interest-rate decisions by the Federal Reserve, an erosion in investor confidence, or even just a drop-off (correction) after a prolonged bull market as investors sell to take their profits off the table.

There is also a phenomenon called a secular bear market. This is defined as an extended period of time in which the market yields below-average returns on a sustained basis. Secular bear markets can last for years, or even a decade or more. The market may rally during a secular bear market, but those gains don’t last long, and soon evaporate.

What to do with your stocks in a bear market

Below are some of the strategies you can implement to help protect your capital during bear markets. 

Reduce your exposure to stocks

Stocks are the cornerstone of the centralised financial system, and by reducing your holdings, you can help mitigate the impacts of price declines. The most extreme manifestation of this strategy is to sell everything and put your money into a safe-haven asset like gold or Bitcoin, or into fixed-income assets such as bonds.

Avoid growth stocks and buy defensive stocks

While growth stocks perform the best in a bull market, they usually sink in a bear market, and more defensive stocks tend to hold their value better. Water, gas, and electric utilities are good examples of defensive stocks because people need these services regardless of how the stock market or broader economy is performing.

Short selling

When prices are falling, investing in the belief that an asset will decline in value (short selling) could be a prudent move. While this is a strategy that should only really be attempted by seasoned investors and traders, it can be a great way of turning bearish conditions into a positive revenue stream. 

Selling a put option

A put option gives you the ability to sell a stock at a specific price on or before a certain date. By selling one (the opposite of buying a call option), you can speculate on falling prices. In addition, it can allow you to hedge your portfolio against a sustained period of decline in the markets. 

Trade inverse ETFs

ETFs are a collection of assets from a certain industry that trade on the stock market like a single stock. They are designed to provide exposure to an entire industry or commodity price. Inverse ETFs essentially allow investors to short an ETF, meaning that you can invest your capital in the belief that a sector of the economy will decline in value. 

How to know when a bear market is over

This can be difficult to tell; if everyone could spot the bottom of the market, investing would be effortless. However, there are some things you can watch out for. Generally, keep an eye out for significant price gains and heavier-than-usual trading volume. In addition, look for an economy that is strengthening across the board, including GDP and job growth, improving corporate earnings, and other market-positive events.

Where can I learn more?

The opposite of a bear market is a bull market; click here to learn about that, or feel free to check out our stock, cryptocurrency, or commodities hubs.