A bear market is a period in which prices decline structurally, typically by 20% or more from the recent peak. It is the opposite of a bull market. Bear markets are a normal part of investing, occur on average every 3 to 5 years, and last shorter than bull markets.
When do we speak of a bear market?
The common definition is a decline of 20% or more in a broad market index such as the S&P 500 or AEX. A decline of 10 to 20% is called a correction. Corrections occur more frequently and are less severe.
Not every decline is a bear market. A flash crash or a brief panic can push the market down significantly without there being a structural downturn. Bear markets are characterized by a sustained pattern of lower highs and lower lows.
What causes a bear market?
- Economic recession: declining corporate earnings, rising unemployment, and a contracting economy
- Interest rate hikes: higher rates make borrowing more expensive and investing in bonds relatively more attractive
- Overvaluation: after a long bull market, prices can rise so far that a correction becomes inevitable
- External shocks: pandemics, geopolitical conflicts, energy crises
How do investors behave in a bear market?
The most striking thing about bear markets is that investors are most pessimistic at the bottom. This phenomenon is called capitulation: the point at which the last optimists give up and sell. Ironically, this is often the beginning of the recovery.
The market "climbs a wall of worry": the recovery begins while the news is still bad and the majority is bearish. The investors who perform best are those who buy when others are selling, provided they do so based on a plan and with strict risk management.
Notable bear markets
- Dotcom crash (2000-2002): the NASDAQ fell more than 75% after the internet bubble burst
- Financial crisis (2007-2009): the S&P 500 dropped 57%. Banks collapsed, housing markets crashed worldwide
- Corona crash (2020): the fastest bear market ever. The S&P 500 fell 34% in just 23 trading days, but also recovered at record speed
- Crypto winter (2022): Bitcoin dropped from 69,000 to below 16,000 dollars. Many altcoins lost 90% or more
What should you do during a bear market?
- Don't panic sell. Every bear market in history has been followed by a recovery. Selling at the bottom crystallizes your loss.
- Keep buying through DCA. Dollar-cost averaging works hardest in declining markets. You buy more units for the same amount of money.
- Rebalance. If stocks have declined, their share in your portfolio has become smaller. By buying more, you restore your original asset allocation.
- Check your fundamentals. Are the companies you've invested in still healthy? A declining price at a healthy company is an opportunity. A declining price at a company in trouble is a warning.
- Stick to your plan. If you had a plan for this scenario, follow it. If you don't have a plan, create one before taking action.
Bear markets are uncomfortable but necessary. They correct the excesses from the preceding bull market and lay the foundation for the next one. The investors who understand this and don't panic come out stronger.