What Is A Bear Market? How does It Work? A Complete Beginner’s Guide[2024]

The Dow Jones Industrial Average officially fell into what investment professionals call a bear market in September 2022. That means that the DJIA declined by at least 20% from its most recent high.

If you’re new to markets, big bear market declines can seem scary. That’s why it’s important to understand that the stock market is cyclical, and big ups and downs are normal parts of the economic cycle.

Bear Market Definition

When the economy is on the back foot, investors tend to be pessimistic and stock prices decline.

Economists define a bear market as a decline of 20% or more of a major stock market index, such as the DJIA or S&P 500, for a sustained period. A bear market is the opposite of a bull market, a period marked by market gains of 20% or more.

On average, bear markets occur every 3.5 years, usually lasting for several months.

Characteristics of a Bear Market

There are always ebbs and flows in the stock market. A bear market is signaled by the following characteristics:

• Stock market declines. In a bear market, there are sustained decreases of 20% or more in broad market indexes.
• Economic decline. The broader economy is typically weakening when stock markets enter a bear market. This is characterized by rising unemployment, decreased gross domestic product (GDP) and declining corporate profits.
• Negative sentiment. During a bear market, market sentiment is poor. Investors are pessimistic about the stock market’s prospects, making them more likely to sell assets than hold them. Investors are likely to put their money into safer investments like bonds because of concerns about future market performance.
• Duration: A bear market is more sustained than typical drops in the stock market. To be in a bear market, the decline has to last for at least two months. Bear markets last for about 10 months on average.

How does Bear Market work?

A bear market is the opposite of a bull market, characterized by a significant decline in investment prices. Here’s how it unfolds:

• Price decline: The hallmark is a prolonged drop in prices, generally exceeding 20% from the recent peak. This decline can happen across a broad market index or within specific sectors.
• Economic factors: Bear markets often coincide with a weakening economy. Factors like recession, inflation, or rising interest rates can trigger a decline in investor confidence.
• Investor fear: As prices fall, pessimism sets in. Investors fear further losses and may sell their holdings, driving prices even lower in a vicious cycle. News coverage tends to be negative, reinforcing the fearful sentiment.
• Not all doom and gloom: There can be occasional rallies with short-term price increases. However, the overall trend remains downward.
• Varied length: Bear markets can be short-lived, lasting a few months, or extend for years.

Here’s a crucial aspect: while bear markets can be scary, they are a natural part of the market cycle. They present opportunities for some investors through strategies like short selling or inverse ETFs that profit from falling prices.

Bear vs Bull Market: What’s the Difference?

While its signal a time of pessimism and economic decline, a bull market is defined by optimism and economic growth. A bull market is a period when stock prices are rising and investor sentiment is positive.

During a bull market, stocks in a broad market index increase in value by 20% or more. Bull markets are marked by low unemployment rates, a booming GDP, high levels of growth and corporate expansion. Investors are more likely to hold onto their portfolios and buy additional stocks.

Bull markets tend to be longer in duration than bear markets. The average bull market duration is three years; the longest lasted for 11 years.

Tips for Managing Your Portfolio in a Bear Market

If this is the first time you’ve experienced a bear market as an investor, it can be a nerve-wracking experience. However, there are some things you can do now to help manage your portfolio and protect your investment.

1. Diversify your portfolio. One of the best ways to manage risk in your portfolio is diversification. This means investing in a range of different asset classes. When you diversify your portfolio, you can help offset losses in one investment with gains from another. Investing in index funds can be an easy way to diversify your portfolio without having to spend a significant amount of time actively managing it yourself.
2. Don’t sell. One of the worst things you can do during a bear market is to sell assets. Instead, focus on your long-term goals. If your goal is several years away, such as retirement, the best course is to hold onto your investments so you can profit from the inevitable market rebound.
3. Dollar-cost averaging. Many people postpone investing until the market shows signs of improvement. However, timing the market is difficult, and even highly-paid experts fail at it. Instead, use a strategy like dollar-cost averaging where you invest fixed sums of cash at regular intervals. Over time, dollar cost averaging can lower your investment costs and help you build a diversified portfolio.
4. Adjust your asset allocation. As your needs change, it’s important to revisit your asset allocation and make sure it still aligns with your goals. For example, if you have a longer time horizon, you may be able to afford more risk in your portfolio. However, if you’re nearing retirement, you may want to take a more conservative approach with lower-risk investments, such as bonds and money market mutual funds.
5. Consult with a financial advisor. It’s completely natural to feel anxious or uncomfortable during a bear market. If you’re worried about your portfolio’s strengths or are stressed about meeting your future financial goals, consider meeting with a financial professional. They can review your finances and investment portfolio and help you develop a plan to protect your money.

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How to Recognize a Bear Market?

Here is how you can identify a bear market-

• Falling Stock Market Indices 

A downtrend in the major benchmark indices operating in the country indicates a bear market, wherein investors prefer holding their money or depositing the same with riskless instruments rather than investing in the stock market. 

Nonetheless, a bear market can only be declared if the fall in such index values is higher than 20% and prevailing for a period of at least 60 days or more. This differentiates stock market variations owing to external factors or uncertainty prevailing in the economy, which might only have a short-lived impact.

Bearish markets, on the other hand, report figures indicating a slowdown of a country for at least 2 months or more. 

• Recession 

As a stock market bear often creates a negative outlook towards investment, individuals usually prefer hoarding their money in fear of incurring losses. Investors adept with the workings of the stock market often develop a mindset regarding a further fall in the stock market prices in such bearish circumstances, further aggravating the rate of fall of such stock prices. 

Combined with low aggregate demand for general goods and services manufactured, a higher supply caused the general price level to decline sharply, marking a recession. Such economic conditions are characterised by persistently low demands and falling price levels by most functioning sectors of the country, resulting in a fall in the GDP of the country. 

A severe case of recession is indicated through negative growth rates of a country, corresponding with high unemployment rates, along with adverse impacts on the stock market prices.

Causes of a Bear Market

Now that you know what bearish meaning in the stock market is, understand what causes a bear market-

• Unexpected Fluctuations

Fluctuations can arise due to socio-economic turmoil in a country as well. As political decisions impact the performance of major companies operating in an economy, investments are likely to take a hit as well. 

• Global Mindset

With rising interdependence among the countries in the world, any fluctuation in the performance of a sizable major economy is bound to have repercussions in a domestic economy.

An old example can be cited in this respect when tensions between America and China, two of the biggest economies in the world, caused uncertainty among Indian investors as well, leading to a fall in the Sensex points. 

As relations between the two global superpowers are likely to impact the Indian economy as well through fluctuating imports and export revenues, the profitability of domestic industries is expected to vary accordingly.

• World Recession 

A global pessimistic mindset can trigger a worldwide recession, generating a bear market in all major stock markets operating in the world. As companies tend to underperform owing to reduced market demand for their products, the respective share prices tumble on stock exchanges as well. 

Such stock market fluctuations affect both large, mid and small-cap companies, wherein a more significant effect is observed in the small and mid-cap businesses, owing to their high degree of volatility. 

Types of a Bear Market

Listed below are the various types of bear market-

• Secular

A secular bear market trend represents long-term economic conditions in the stock market, occurring due to domestic policies. Secular trends leading to a bearish outlook can have long-lasting effects on an economy, often discouraging investors from partaking in hefty investment ventures. 

High interest on bonds, treasury bills, and other zero-risk instruments encourage individuals to undertake investments in these tools, thereby reducing the total speculative demand for stock market instruments generating a bearish stance in the stock market.

A secular market trend was observed from 1983 to 2002 when the United States of America witnessed the dot com bubble.

• Cyclical

Cyclical bear stocks arise due to business cycle fluctuations in an economy, which usually occur every 7-10 years. Markets often adjust after a prolonged period of boom, characterised by extensive growth rates demonstrated by all major sectors of the economy. 

A cyclical downtrend in stock prices is a common occurrence in a country wherein falling stock prices adjust automatically in a couple of months to regain a positive outlook regarding investments in the stock market.

An example of a bearish market trend was the global economic slowdown of 2008-09, triggered by the subprime mortgage crisis caused due to the overinflated housing asset bubble in America.

Consequences of a Bear Market

A bearish trend depicts a slowdown of an economy, with rising investor pessimism and recessionary trends.

As the total amount of investments undertaken falls significantly in such events, owing to a slowdown of aggregate demand, businesses often face a monetary crunch, thereby reducing their total output.

Therefore, a country often faces high unemployment problems and a downtrend in the overall price level, causing deflation. A poor stock market performance is a major indicator of recession.

Market Correction Vs Bear Market 

Whilst the best market represents a prevailing fall in stock prices by more than 20% for already two months, a market correction is an automated adjustment of the prevailing stock prices followed by a bull market. 

The occurrence of market corrections followed by a trend of rising stock prices (bull market) makes way for the prices to soar even further, encouraging vigorous investment patterns. This is a classic indicator of a developing economy, wherein a well-performing stock market generated a positive impact on the GDP of the country as well. 

Bear share markets have the opposite impact on an economy, as investors withhold any new stock market deposits in fear of incurring losses. This pessimistic approach reduces the cash flow of the capital market, which, in turn, lowers the total output generated in the respective financial year (GDP). 

Bear in Share Market – History 

Cyclical movements in the business cycle are known to cause a recession in an economy, characterised by a downtrend in the overall price level. This includes a fall in the average stock prices resulting from reduced demand, which, in turn, lowers the value of benchmark indices in a country. 

The first sign of an upcoming recession is a significant value drop in major indices associated with the foremost stock exchanges of a country. For example, in the event of a recession, the first warning sign is a massive fall in the Sensex and Nifty points associated with the Bombay Stock Exchange and National Stock Exchange, respectively. 

 Looking back at the event causing a recession in India and its corresponding impact on the stock market of India, major bearish markets should be taken into account to develop a clear understanding – 

• The Great Depression of 1929 

Reported as the most prolonged depression of the modern world, the great depression was triggered by a bearish market trend and was persistent for about 10 years. As years prior to 1929 saw an immense speculation drive, many individuals purchased overinflated assets at prices higher than their absolute value.

Such a rise caused companies to resort to excess production, thereby leading to excess supply in the market. This caused the average price level to fall significantly, causing deflation, the effects of which penetrated the stock market as well.

The stock market crash of 1929 first marked the onset of the great depression, when a massive sales volume of approximately 12.9 million shares was recorded on 24 October 1929, which came to be known as Black Thursday, marking the beginning of the bear in the share market.

• 2008 Recession 

A global financial slowdown, commonly called the 2008 Recession, was witnessed following the subprime mortgage crisis in America, followed by the collapse of one of the biggest financial institutions in the world, Lehman Brothers Holdings Inc.

Owing to globalisation, India also felt the effects of this economic slowdown, as witnessed by a fall in Sensex points by 1408 points on 31st January 2008.

As the world faced the brunt of this recession, Indian investors undertook a bearish investment pattern and preferred withholding their money and depositing the same in risk-free tools. 

What Should Investors Do During Bear Market?

A stock market bear witnesses receding investments from individuals having a lower aptitude for risk initially during initial plummeting prices.

Such an investment strategy often leads to significant losses on the part of investors, thereby reducing their speculative investment demand even further. Individuals disregard the importance of long-term growth in this regard and sell procured securities in fear of short-term losses.

A bear market automatically adjusts in a couple of months to reflect the real value of stocks, leading to capital gains for shareholders who purchased respective securities at reduced costs.

How to Invest in a Bear Market?

The primary point to be noted in this regard is that stock prices don’t remain stable in the market and fluctuate readily, corresponding to changes in the business cycle. As a result, securities purchased at reduced costs can be sold later on when the market recovers from a bearish outlook, helping investors realise substantial capital gains in the process. 

Also, the immediate sale of securities leads to substantial losses on the part of investors, while withholding the same can be a profitable venture. In the long run, when the prices adjust to a bullish outlook (rising prices), the profitability of major operating companies increases significantly, which, in turn, ensures significant dividend payouts in the future. Investors looking to receive a steady periodic cash flow should opt for holding their investments in the future in the prevailing stock market bear for wealth accumulation in the future.

A persistent fall in the stock market prices (higher than 20%) should not cause investors to panic, as the market is bound to adjust automatically in the long run. Holding funds invested not only allows individuals to escape short-term losses but also leads to long-run profits (through both long-term capital gains and dividend pay-outs) when the economy adjusts automatically and a positive outlook regarding growth is undertaken by investors.

A rise in stock prices drags an economy from recession and paves the way for robust growth through higher output generation and rising GDP.

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