What is a Bear Market?

To the average investor, a bear market can be as terrifying as a seven-foot-tall grizzly. Bear markets can reveal the vulnerabilities in your investment portfolio and exacerbate them. Investing is now more accessible than ever before with many of the best investment apps and platforms at your fingertips. Still, you might not feel equipped to handle the stress of a bear market.

Unlike a bull market which indicates a strengthening economy, a bear market is a sustained decline in the stock market and may indicate an upcoming recession.

Typically, a bear market is defined as a prolonged period in which investment prices plummet at least 20% or more from their most recent high, usually for particular stock indices such as the Dow Jones Industrial Average, the S&P 500, or the tech-oriented Nasdaq. But the term can also be applied to any other asset that slumps for an appreciable amount of time.

"Since a bear market is defined by a minimum price drop of 20% from a high, you can have bear markets that happen quickly and ones that occur more slowly," says Teresa J.W. Bailey, CFP and president at Waddell & Associates. 

While bear markets can feel scary, it's important to remember that markets naturally ebb and flow. To some extent, it's inevitable for there to be bear market periods and bull market periods, so try not to panic and make rash decisions. With a better understanding of what a bear market is and how a bear market works, along with some strategies for investing during a bear market — as we'll discuss in this article — you can more easily navigate these downturns.

Causes of a bear market

A bear market happens when an inciting incident, whatever it may be, undermines investor confidence, causing them to sell assets, which lowers asset prices. The momentum of a bear market can often perpetuate itself. As prices drop, investors lose more confidence, which prompts them to sell. 

As investors sell and prices decline, companies might tighten their belts, thereby hurting economic growth and amplifying the cycle. Eventually, however, bear markets historically end once investors regain confidence, asset prices stabilize, and eventually start moving upward again for a prolonged period.

Some examples of inciting incidents — i.e., causes of bear markets — include the following:

Economic recession

While bear markets shouldn't be confused with recessions, as a recession typically involves other economic indicators such as a drop in gross domestic product (GDP) for at least two quarters — it's rare to have a bear market without a recession, and vice versa. 

When the economy contracts, that generally leads to asset prices falling, such as due to investors valuing stocks for less because of declining corporate revenue and a worsening growth outlook.

In many cases, though, a bear market begins as the hallmarks of a recession start to show up — like rising unemployment — but before an official recession begins.

"A slower slide into a bear market typically involves a recession. A recession means that the economy is contracting and there is an increase in the number of individuals who would like to be employed but cannot find a job," Bailey says. "Often a bear market will begin ahead of a recession, as signals emerge that a recession is on the horizon."

High inflation

High inflation can sometimes support a bull market, such as due to inflation being triggered by hot consumer demand. However, it can also trigger a bear market for several reasons. 

For one, higher prices can cut into companies' profit margins if they're having to pay suppliers more. The prices they then charge consumers might not rise enough to give investors confidence in the growth of those companies' net profits. 

Even if companies take advantage of inflation by charging significantly more and temporarily boosting earnings, these events are often short-lived. Eventually, consumers reach a breaking point and pull back on spending, which can lead to an economic downturn, and thus investors might get spooked during periods of high inflation.

Interest rate hikes

Interest rate hikes often coincide with high inflation, and when those kick in, that can mark a shift from inflation fueling a stock market run to causing a stock market decline. That's because higher interest rates make servicing corporate debt more expensive, can limit business investment due to the higher cost of borrowing, and it can weaken consumer spending as individuals face higher costs elsewhere for things like mortgages and car loans. Thus, higher interest rates can cause corporate revenue, profit, and growth outlooks to diminish.

Geopolitical events

Geopolitical events such as wars, surprising elections, or pandemics (like Covid-19) can trigger bear markets too. That's because these events can create uncertainty that causes investors to retreat from assets like stocks more into safe-haven assets like cash or Treasuries. These events can also cause issues like supply chain disruptions that tie into other issues like inflation.

Market bubbles

Market bubbles happen when asset prices run up beyond their intrinsic values, i.e., what they're fairly worth. 

While this is subjective to some extent, a market bubble can then lead to that bubble bursting, causing a quick downturn in prices that drags other assets down with it. For example, a big factor behind the Great Recession was a real estate bubble, where a run-up in housing prices eventually popped, and the quick downturn caused a variety of interrelated assets like derivatives to tumble, which ultimately led to a stock market crash.

Characteristics of a bear market

While a bear market is categorized as a significant decline in asset prices, that's not the only thing typically happening during these cycles. The main characteristics of a bear market include:

Prolonged decline

A bear market typically involves a prolonged decline of at least 20% in major stock market indices. 

How long is prolonged? That depends on your perspective. But a flash crash that just lasts a few days, for example, probably wouldn't be considered a bear market but rather a temporary downturn and recovery, caused by unique circumstances like the panic-induced Black Monday in 1987.

On average, a bear market lasts 11.1 months, with an average cumulative loss of -31.7%, according to First Trust Advisors.

Investors often distinguish between "cyclical" and "secular" bear markets, which differ in their timeframes.

• Cyclical bears: Tend to be short-term, lasting only a few months
• Secular bears: Can endure from around five to 25 years

Secular bears aren't one long slide downward, either: During "bear market rallies," for instance, stock prices rise for a time before plunging again to new lows. 

Because the low point can only be figured out retroactively, after the market's definitely on the rebound, there's always a lag before you can declare a bear market definitely over. (Bull markets have the same issue.)

Bear markets end once the market has increased 20% above its lowest point, which often takes longer than the turnaround that typically marks the end of a recession.

Increased volatility

As mentioned, bear markets aren't always straight drops down. Sometimes there are rallies, followed by further downturns. So, in general, bear markets are marked by increased volatility compared to bull markets, with investor fear and loss of confidence causing quick reactions that cause prices to bounce.

Declining company earnings

Companies may report lower profits or losses, further fueling pessimism.

Bear markets, which often precede or coincide with economic downturns, also tend to involve declining corporate earnings. This can either be a cause or an effect of a bear market. 

For example, if companies report lower profits, that can cause investor pessimism leading to a sell-off. But also, during a bear market, companies might be wary of making growth-oriented moves, like investing in new business development, because they think investors aren't in a position to reward these moves with higher stock prices, for example. Yet the lack of action can then lead to stifled growth, and as investors and consumers lose confidence, earnings can drop too.

Negative investor sentiment

A big characteristic of a bear market is negative investor sentiment. The consensus is often that the market's stopped growing and won't appreciate anytime soon. So, investors move money to traditionally safer assets, like Treasury bills and investment-grade bonds, which can cause stock prices to fall. 

Investing strategies for a bear market

While a bear market often causes investors to flee, there are ways to navigate the storm. The exact moves to make depend on your situation, such as your investment goals and risk tolerance, but some common bear market investment strategies include the following:

Long-term perspective

Focusing on the long term often helps investors make it through a bear market without suffering big losses. For example, if you're a long-term investor, you might avoid selling assets during a bear market. Your portfolio might decline by, say, 30% on paper for a year, but if you don't sell, those losses don't actually occur. Instead, with a long-term perspective, you can wait out a bear market and enjoy the bull market that traditionally follows. 

If you didn't sell during the Covid-19 bear market in early 2020, for example, you would have not only avoided major losses but enjoyed substantial gains since then. The S&P 500, for example, has nearly doubled over the past five years.

Defensive stocks

While some companies might reign in production during an economic downturn, there are some companies that produce just as many goods and services that people need, regardless of the current economic conditions. 

These industries — such as the food or utility industries — often hold their value if they aren't increasing in value. So, companies in these sectors are known as defensive stocks. They might not gain as much during bull markets but often hold up better during bear markets.

Value investing

Bear markets are often good opportunities for bargain-hunting, particularly for value stocks, which are companies that typically have strong financial fundamentals but whose stock price is less than the book value (i.e., what their assets vs. liabilities indicate). 

Fundamentally sound companies may be temporarily depressed, their shares slashed by the bear's claws. Yet if the market returns to its original point and these undervalued stocks more accurately reflect their book values, you'll be able to capture that increase. 

That's not to say that growth stocks are necessarily bad plays during bear markets, but sometimes high-growth companies don't make it through bear markets unscathed, such as if they don't have the capital to withstand a drop in consumer spending and thus need to pull back on growth initiatives.

Dollar-cost averaging

Similar to the idea of taking a long-term perspective, using dollar-cost averaging can also help you navigate market volatility and the unknown length of a bear market. 

Dollar-cost averaging typically has you investing a set amount of money into a certain stock or fund over a period of time instead of buying all at once. The idea is that spreading out your investments over time will smooth out momentary spikes in any direction, meaning your cost basis will more closely follow the overall market trend. By continuing to invest during a downturn, you can then lower your cost basis and effectively increase your net returns assuming there's a sufficient market recovery.

Diversification

Diversification is usually a best practice in any environment, but it can be especially valuable during a bear market. By spreading your investments across different companies and asset classes, you're not as exposed to risks like a bear market causing a particular company to face bankruptcy. Also, if assets like stocks fall during a bear market, other assets like bonds might hold up better, so diversification can help limit volatility.

Consult a financial advisor

As always, working with a professional such as a financial advisor can help you understand how to navigate a difficult environment such as a bear market as it pertains to your situation. Even if a financial advisor doesn't suggest anything drastic, sometimes you just need a reliable sounding board who can help you avoid making bad decisions like panic selling.

Bear market vs. corrections 

Bear markets shouldn't be confused with market corrections, which are drops of more than 10% but less than 20% in the stock market. According to the Schwab Center for Financial Research, 80% of the corrections that occurred since 1974 have not resulted in a bear market.

Sometimes corrections are more technical in nature. As the name implies, a correction could be investors reacting to issues like overexuberance in the market — but not necessarily a full-on bubble — and so prices "correct" back to a more justifiable level. Corrections are often shorter than bear markets too.

Bear market vs. bull market

A bear market is the opposite of a bull market. These are natural cycles, where sometimes markets trend down due to issues like economic contractions or geopolitical uncertainty, while other times they trend up due to factors such as strong economic growth or low interest rates that prompt demand for assets like stocks.

You can keep a bear versus bull market straight by envisioning the two animals' characteristic behavior: a hibernating bear (a sinking or sluggish market) and a charging bull (a surging market).

Why is it called a bear market?

Economists and etymologists alike love to debate how bear markets got their name, but it most likely arose from an old proverb about how it's bad "to sell the bear's skin before one has caught the bear," meaning to unload something you didn't actually own, according to Merriam-Webster. From there, "bears" came to be a slang term for speculators betting that prices were going to drop.

Should you invest in a bear market?

Hardly anyone is happy when the bears show up on Wall Street, but they are an inescapable fact of the financial landscape. Although bear markets can cause pain, they can also induce a necessary cooling-off period for the stock market. And they help distinguish truly valuable investments from those that were overly inflated when the bulls were in charge.

If you're new to investing, a bear market can be a great time to create a diverse investment portfolio, such as within a brokerage account. and establish your financial goals. While it's hard to time the market and know where exactly you are within an investment cycle, investing during a bear market often means you're buying in at a relatively low price point.

"Investing within your employer's 401(k) is also an easy way to begin investing, because the selections are limited, and you won't be overwhelmed by too many choices," says Bailey.

You can also consult a financial advisor for expert advice. The best financial advisors can help you make smart investment decisions during a bear market to help you reach your short-term and long-term goals. 

FAQs about bear markets