What Is a Bear Market? – Is It Time to Sell?
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The stock market is known for its ups and downs but anything in excess can cause panic. While we enjoy the bull market, there is always the fear of a bear market setting in.
A bear market is a period when there are prolonged price declines in the stock market. This decline is usually around 20 percent or more from the highs. Investors track major indexes of the world like Dow Jones Industrial Average and S&P 500 index to identify when the financial markets enter the territory of a bear market. 20 percent is a threshold but oftentimes, the market index plummets deeper than 20 percent over a sustained period and the general trend is downward.
The S&P 500 stock index fell into a bear market in May 2022 and it was triggered by the pandemic spreading across the world. This led to economic shutdowns and massive uncertainty on Wall Street. The market dropped 20% from the record high in January 2022. While a bear market could strike fear in the hearts of many, it can also provide great investment opportunities. Market volatility is unavoidable but a bear market is short-lived and this is a time to make your move.
In this article
What is a bear market?
You might not find any science or strategy for recognizing the bear market but many often refer to a drop of 20 percent or more as the bear market. There is no fixed rule but it often occurs in a period before the economic downtown and indicates that the investors are pulling back. The Nasdaq Composite turned into a bear market in the dot-com bubble burst in 1999-2000 and during the financial crisis in 2008. Even when a company reports poor results the stock dips by more than 30 percent and we can say that the particular stock has fallen into bear market territory.
Bear markets can be caused by the overheating of the economy, overextended consumers, political unrest in the market, or in recent times, a pandemic. The terms bear market and stock market correction are interchangeably used but they show two different sides of negative performance. This means a correction occurs when the stock prices fall by 10 percent or more from the recent highs and it is upgraded to a bear market after the 20 percent threshold is met.
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Whenever you hear that the market could be moving towards a bear market, you need to make the necessary changes to your portfolio. The bear market is a sign of a recession and can often occur midst the long-term bull market. This could be a temporary phase but it is difficult to decide which direction markets are swinging and where they will move next. Hence, keeping a watch on the investments is very important.
The opposite is a bull market where investors are confident and charging ahead and buy at a fast pace. This is when there is a steady rise in stock prices and high consumer confidence. It is a 10 percent rise from the lows reached in the bear market. Two signs need to occur before a bull market can be declared – a rise of 20 percent from the bear market lows and new all-time highs in the benchmark indices. A sustained uptrend in stocks, one that results in new all-time highs is known as a bull market rally. Whereas a bear market rally is a rise in stock prices after the plunge in the bear market, it is a temporary rise before hitting new lows.
How bad is it?
There is an overall negative sentiment surrounding a bear market but do not fear the worst. They are short-lived most of the time. On average, the bear market can last for around 15 months and one of the shortest bear markets lasted one month, at the start of the pandemic in 2020. The average bull market can see gains of over 100 percent and an average bear market sees a loss of around 20 to 30 percent. Long-term investors need to become comfortable with the dips in the market and learn to ride the storm.
Do not become skittish and end up selling your assets from the fear of a bear market. It could cause heavy damage since those who have had no intention to sell earlier could get trapped in a selling frenzy. You could end up selling assets that could be valuable over the years.
How to invest in a bear market
Bear markets are often stressful and concerning but they also give ideal opportunities to investors and when you know where to invest, you can make great investment choices. Here are some investment strategies that can help you get through the bear market and make the right decisions.
Avoid panic selling
The worst action you can take in a bear market is to sell your assets and move the position into cash. It will protect you from loss of principal but it might not be an ideal move for the long term. Whenever there is a low-interest rate environment, it wouldn't make a lot of difference but since bear markets do not last for long, you could lose money sitting in cash with high inflation. This could be even worse. There is a bleak mood in a bear market but you must avoid panic selling.
Have a defensive investment strategy
The best way to invest is to have a defensive investment strategy. Pick defensive funds or stocks that usually perform well in a market downturn. It could be in companies that are necessary, irrespective of the market volatility. This includes personal care and food stocks since they tend to perform well even in a market downturn. Consider shifting your portfolio towards such stocks when a bear market is anticipated as it will prove to be highly beneficial than holding cash.
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Think long term
Do not make knee-jerk reactions to the market movement. Your portfolio will underperform when the market is down but this does not mean you move in and out of the positions too quickly. Whenever stocks fall, we feel as if they will keep dropping forever and you might want to sell before it gets any worse. When the bull market happens, stocks hit new highs and you want to put in the money so as not to miss out on the gains. But your goal should be investing for the long term. Do not react emotionally to the market swings and invest in stocks you want to own for the long haul. Do not sell them simply because they are down in a bear market.
Quality over quantity
Several companies go out of business in a bear market but this is also a time when you can identify true gems. The companies that do not have any competitive advantages or are over-leveraged tend to get hit the worst and the best quality companies continue to perform. In times like this, you should focus on quality companies with a rock-solid balance sheet and avoid buying cheap stocks in high quantities.
Invest in bonds
You can invest in bonds to protect yourself in a bear market. Since the price of a bond moves inversely to stock prices, in a market decline, bonds tend to benefit. Invest in bonds as a hedge for the short-term since it can help weather the immediate downturn. If you want to hedge overall market risk, you can consider investment grade or high-quality bonds. Try to avoid high-risk bonds.
Invest in dividend-paying companies
Dividend stocks pay a part of the company’s profit to the investors in the form of a dividend. It is a great way to hedge the impact of a bear market since the income from dividends will counteract the losses in all the other assets. Many dividend stocks are usually less volatile than the average stock and can give an extra layer of protection to your portfolio.
Do not try to catch the bottom
It is not possible for anyone to time the market and you must remember that you are not going to invest at the bottom. You should buy stocks you want to own for the strength of the business and even if their price goes down a little, make your move. Do not sit on the sideline and wait for it to hit rock bottom. You can consider a strategy of taking positions gradually over time, even if the prices are as low as they can get. Hence, if the stock continues to fall, you should take advantage of the new lower prices.
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Rebalance the portfolio
It is important to rebalance your portfolio from time to time and a bear market is an opportunity to reassess your decisions. For some businesses, market instability can prove to be a lot to handle and in the absence of the right resources, they could collapse. Do not remain under the assumption that your growth stocks are going to survive the bear market, instead, take out time and re-assess the investments. This does not mean you sell off the assets right away, consider bear markets as an opportunity to invest in the right growth stocks but a rebalancing of the portfolio is essential.
Try to move your allocation towards bonds and ETFs while keeping an eye on the growth vs value stocks for the longer term. When you move towards stable assets, there is a low risk of losing money. Growth stocks should always have a place in the diversified portfolio but value stocks have the potential for long-term success and can survive market downturns. Consider speaking to a financial advisor if you need help balancing your portfolio.
Hold and stay calm
An important thing to do in a bear market is to stay calm and wait. Of course, it might not be easy for you to watch the headlines all day and hear about your friends selling their investments off, but if you make a move out of panic, you could end up regretting later. How you react to a downturn will define your portfolio performance over time. Unless there is an immediate requirement for cash, it is best to avoid selling your investments. Hold on to your portfolio and wait for the storm to pass.
FAQs
Is there a difference between a bear market and a bear market correction?
The bear market is a larger version of market corrections, which is a shallow drop in stock prices for a short period of time. There can be multiple bear market corrections even in a bull market. A correction can become a bear market but usually, they don’t. A bear market lasts longer than a correction.
What are the signs that a bear market is coming?
It is not easy to determine when the stocks have peaked and you are moving into a bear market. But some rules can help make a decision. Watch out for interest rates and if you see the Federal Reserve lowering the interest rates due to a slow economy, it is a sign that a bear market could be coming. Sometimes the interest rates are also lowered after the bear market sets in.
What should beginner investors do in the bear market?
If you are just starting your investing journey, a bear market is a good time to pick top-quality stocks at low prices. Consider your risk tolerance and build a diversified portfolio and do not panic in the downturn. Look at the longer-term picture and let the storm pass.
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The bottom line
Nobody likes to watch the value of their portfolios go down. Bear markets are difficult but thankfully they are short-lived. You might feel like selling during the bear market is an easier thing to do but timing the market is not possible. This is why the best step to take in the market downturn is to pick quality investments and hold on to them for the long term. Remember to keep an eye on the positions that need additional attention like volatile investments but do not make the mistake of selling the stocks. Look at it as an opportunity to put money into stocks that are ideal for the long term and could be trading at a discount currently.
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Editor
Vandita Jadeja is a financial writer and editor at Joywallet. She loves to read and write about money and brings a decade of experience from the financial industry.
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