A bear market is the opposite of a bull market. And it’s a phrase often used to describe the stock market when one or more major indices, like the FTSE 100 or S&P 500, suffer a significant downward trend. However, a bear market can occur within any asset class, including bonds, currencies, and even commodities.

The technical definition for a bear market is when the price of a group of financial securities falls more than 20% from their most recent high over at least two months. Such downward pressure only typically occurs when there is a spike in widespread pessimism among investors leading to low sentiment and confidence.

This is why bear markets often materialise during a recession or similar economic turmoil. In these situations, it’s not uncommon for unemployment to rise, triggering a drop in consumer spending. Needless to say, that’s not an ideal operating environment for businesses which can lead to missed earnings targets, fueling more pessimism that drags stock prices down even further.

Why is it called a bear market?

The term bear market or bearish market has two potential origins from history. The first and more widely known is in relation to the way the animal attacks its prey. Bears swipe their claws down, serving as a famous metaphor for the downward movement of asset prices.

Similarly, bulls were historically considered to be the opposite of bears, as the two animals were often pitted against each other during blood sports. That’s why the opposite of a bear market is called a bull market or bullish market.

However, another origin may have been in the 1700s when the bear skin trade was booming. Merchants peddling these animal hides often start agreeing to sell bear skins they had yet to receive, speculating that the future price would fall below their agreed price. In other words, they were betting that bear skin prices would fall in the short term.

This practice is one of the earliest examples of short selling. And over time, merchants who participated in this practice were titled “bears”.

Characteristics of a bear market

Beyond the sustained downturn in the financial markets, bear markets also have other characteristics.

• Weakening Economy – As consumers slow their spending, it becomes more challenging for businesses to deliver growth. If earnings become compromised, unemployment rates often rise as companies seek to cut costs and save resources. This creates even more pressure on the economy, slowing economic growth in a cycle that can lead to a recession. However, it’s worth pointing out that in the last century, only around 50% of bear markets occurred during or led to a recession.
• Low Investor Sentiment – With earnings guidance usually being cut, and target milestones not being hit, investors can quickly become pessimistic, selling off their stocks and buying safer asset classes like fixed-income securities. The rapid successive sales of financial assets can stimulate more negativity causing other investors to do the same, resulting in large drops in asset values in the short term.
• Reduced Demand – With the economy weakened and investor sentiment low, the demand for buying shares isn’t usually high. As such, companies preparing to undergo an initial public offering (IPO) may postpone their plans until conditions improve.
• Increased Short Selling – As stock prices tumble, traders often change tactics to profit from the downward momentum by short-selling overvalued businesses. Another commonly used tactic is shorting an index exchange-traded fund to bet against the stock market.
• Fluctuating Interest Rates – Depending on how severe the economic conditions are, central banks, such as the Bank of England or the Federal Reserve, may step in and change monetary policy. During a recession, this often results in interest rates being adjusted, either increasing them to cool off high inflation or decreasing them to stimulate economic growth.

What’s the difference between a bear market and a recession?

While a bear market and recession are often put in the same basket, there is a difference between the two. As previously stated, a bear market refers to a period when financial markets suffer at least a 20% decline in stock prices.

By comparison, a recession relates specifically to the state of the economy as a whole rather than an individual section of it, like the stock market. Defining a recession is more tricky since there are a lot of factors that determine whether an economy is experiencing one. These factors include nonfarm payrolls, industrial production, consumer spending, and employment, among others.

However, a more familiar, albeit less accurate, indicator is two consecutive quarters of decline in a country’s gross domestic product (GDP).

What’s the difference between a bear market and a correction?

A stock market correction is similar to a bear market, but it’s not as severe. They typically refer to a stock market decline that’s greater than 10% but less than 20%.

Corrections can occur over a broad time horizon from a few weeks to potentially months. On the other hand, bear markets are typically far longer. And in extreme cases, they can even last years.

What are the 4 phases of a bear market?

Each bear market throughout history has been triggered by different factors. And yet, there is a great deal of consistency in how these events end up playing out. As such, economists describe a bear market downturn in four distinct phases.

1. High Valuation – Investor optimism is high, and consequently, stock prices of exciting and popular companies start to rise. But eventually, expectations reach unrealistic levels, and stock market bubbles begin to form. Eventually, prudent investors recognise the state of inflated valuations and start selling their shares while the price is high.
2. Capitulation – As more investors begin to sell their shares and take profits, it triggers others to follow suit. And when business earnings start to slow, investor confidence plummets, leading to mass panic-selling, sending share prices crashing down to below historically average levels.
3. Speculation – As most investors rapidly try to sell their investments to protect from losses, smart individuals with a higher risk tolerance start identifying high-quality stocks now trading below their intrinsic value. They use the panic and low market sentiment as a buying opportunity to bolster their portfolios.
4. Recovery – Confidence begins to return to the market, and share prices start to climb back up, albeit slowly. Eventually, valuations rise sufficiently to pull the stocks out of the bear market territory. And often, what follows is a much longer bull market referred to as a bear market rally.

How long does the average bear market take to recover?

Each bear market throughout history has occurred under different conditions. And these conditions often dictate the duration. They can be as short as a couple of weeks or last year, in the more severe cases.

Looking at the bear markets in the S&P 500 index over the last century reveals that, on average, a bear market will drop by around 35.62% and last approximately 289 days or roughly 9.6 months. By comparison, a bull market typically lasts much longer, with an average of 1,102 days or three years.

How often do bear markets occur?

Despite popular belief, bear markets are actually a normal stock market occurrence. After all, share prices don’t always go up. And here in the UK, the shares entered bear territory four times in the last ten years in 2014, 2018, 2020, and 2022.

Looking back at the last century, bear markets typically occur every 3.6 years. However, this pattern is rarely on time and, therefore, shouldn’t be depended upon as a trading cycle for trading speculation.

How to invest during a bear market

Understanding the causes and average duration of a bear market can help investors prepare and plan for what to do when the next one inevitably happens. Armed with this knowledge, these volatile periods become less scary and guide investors away from making emotionally driven mistakes that can destroy wealth.

With that said, what can investors do to protect their portfolios and capitalise on the opportunities a bear market creates?

1. Build up cash reserves

Selling during a bear market is often a bad idea, as the market price of an asset is typically below its true intrinsic value. However, individuals without basic financial planning may have little choice but to sell at these terrible prices.

For example, an investor who hasn’t built up a cash cushion in a savings account may discover they have insufficient funds to cover their living expenses. This is especially problematic if they don’t have a steady income from employment or other non-market sources.

This risk can be largely mitigated by simply keeping a suitable lump of cash in a savings account.

2. Focus on the long term

As horrendous as they may seem, bear markets don’t last forever. And making investment decisions based on short-term trends could destroy wealth rather than create it. This applies to both buy and sell trading activity.

For example, suppose a company announces short-term headwinds that will hamper growth. During a bear market, when emotions are running high, the share price is likely to suffer a significant hit as a consequence. And in many cases, it will be an overreaction.

Providing the business model hasn’t become compromised in the short term, the best course of action may be to hold on. It may even potentially serve as a buying opportunity if the group’s long-term strategy remains intact.

3. Diversify across high-quality stocks

Despite its simplicity, diversification is a powerful tool for hedging against risk. By owning a range of top-notch businesses across multiple industries and geographies, a portfolio is less prone to decline should a single position stumble.

4. Do not try to time the market

Many novice and professional investors attempt to try and time the bottom of a bear market using technical analysis. That way, when the time is right, they can start buying shares at their lowest point. It seems sensible on paper, but in practice, it’s extremely difficult to pull off. In fact, almost everyone who tries to time the market, including professionals, ends up missing the mark. And the few that do often mistake skill for luck.

Some of the best-performing days throughout the stock market’s history have occurred during a bear market. And attempting to time purchases will most likely result in investors missing out on these opportunities.

Fortunately, by adopting a simple pound-cost-averaging buying strategy, investors can reap the rewards of these high-performing periods without needing to try and time the market.

5. Speak to a professional if needed

Investing is a complicated life-long journey. And not every investor is capable of making the best decisions for growing their wealth. Speaking to an investment adviser could be the wisest decision for those without the knowledge, time, or interest to manage an investment portfolio.

The bottom line

The stock market goes through different cycles, and a bear market is just one of them. Regardless of how scary they sound, it’s important to remember that bear markets are normal and fairly common. With appropriate knowledge and preparation, investors can turn these periods of decline into wealth-building opportunities.

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.