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Many investors don’t fully understand what bear markets are or how to recognize them. This article helps discuss bear markets, how to identify them and some common characteristics of bear markets. Follow the provided links for more in-depth articles on each topic.
We define a bear market as a fundamentally driven stock downturn of 20% or more over an extended period of time. Dating back to 1929, the S&P 500 saw 13 bear markets showing an average decline of 40% and lasting, on average, longer than 21 months.i
Aside from these defining factors, people often remember bear markets for the widespread uncertainty and fear they tend to cause for investors watching their account values decrease. This fear often leads investors to panic and deviate from their investment strategy, which may ultimately hurt their long-term returns if they miss the subsequent rebound.
A correction—or sentiment-driven market drop of roughly 10% to 20%—can also breed significant uncertainty and fear. But you may be able to distinguish a bear market from a correction if you look for and properly interpret the cause of a recent drop in stock prices. For example, bear markets rarely start with a sudden, fear-based drop, while corrections often start with a bang.
Instead, bear markets tend to begin with an inconspicuous slowing of market momentum at a time when most investors are experiencing a false sense of security or when market euphoria is at a high. As underlying fundamentals show weakness or warning signs, euphoric investors pay no heed to them, looking instead for reasons stocks should continue their rise.
We have four basic guidelines to help us identify bear markets. While these rules may not be applicable for every bear market, they can be helpful in distinguishing bear markets from corrections.
Although no single indicator can accurately signal a bear in advance every time, we believe a combination of leading indicators coupled with research and analysis can help you identify a bear market in its early stages and potentially avoid some of the ensuing decline.
We believe fundamentals play a key role in determining the current state of the market. Weak corporate earnings, inverted yield curves (when short-term bond rates are higher than long-term bond rates) and faltering revenue growth are all examples of negative fundamentals.
Just as important as fundamentals, history has shown that euphoric investor sentiment can be a lead up to a bear market. When euphoric investors keep finding reasons why stocks should keep rising while ignoring decelerating or negative fundamentals, companies may have a difficult time meeting the high expectations placed on them. When investors dismiss negative fundamentals and stocks keep rising, a bear market could be on the horizon.
Bull market climbs the proverbial “Wall of Worry”—short-term worries that cause short-term investor fear and volatility during a broader bull market. These ongoing fears can lead to stock market volatility and maybe even bull market corrections, which are often mistaken for bear markets. But these corrections are typically short, sentiment-driven downturns that lack the size and scale of a true bear market.
In contrast to the Wall is the “Wallop”—an economic negative large enough to knock several trillion dollars off of global GDP. Scaling a wallop is most important when analyzing potential negatives. Often investors mistake an events impact without realizing how it fits into the bigger picture. Overestimating the potential impact of any event could cause investors to react poorly to the certain events, potentially causing them to miss out on ensuing bull market returns.
With so many factors to consider, it can be difficult to determine what will lead to the start of the next bear market and a standard bull market correction. Corrections are short, sharp, sentiment-driven market declines of roughly 10% to 20%. These downturns are unpredictable swings—usually based on fear and often lacking the weak economic fundamental backdrop of a bear market. Consistently timing market corrections is near impossible as they start with a bang and end just as quickly. Further, going defensive at the wrong time can potentially set you back from meeting your goals. We believe you’re often better off staying disciplined and riding through corrections and other bull market volatility.
Finally, we debunk one of the most prevalent yet dangerous investing myths: One big bear and you’re done! Even if you stoically weathered every bear market without making one defensive move, your equity portfolio would still have grown to generate a cumulative profit over the longer term as bull markets are generally longer and stronger than their preceding bear markets! Although the average bear market lasted about 16 months with an average cumulative return of -40%, the average bull market—prior to the most recent one—lasted roughly 57 months and offered an average cumulative return of 164%!ii
Don’t let one big bear market scare you out of stocks for good. You may need their long-term growth in order to meet your longer-term investing goals.
Worried about what you’ll do when the next bear market hits? Fisher Investments Canada can assist you through our portfolio management service. Contact us directly to set an appointment."
i Based on the technical definition that a decline of 20% or more constitutes a bear market.
Price level returns are reflected in USD. Currency fluctuations between the dollar and pound may result in higher or lower investment returns. The S&P 500 Composite Index is a capitalisation-weighted, unmanaged index that measures 500 widely-held US common stocks of leading companies in leading industries, representative of the broad US equity market. Source: FactSet, as of 30/06/2017.
ii Based on the technical definition that a decline of 20% or more constitutes a bear market.
Price level returns are reflected in USD. Currency fluctuations between the dollar and pound may result in higher or lower investment returns. The S&P 500 Composite Index is a capitalisation-weighted, unmanaged index that measures 500 widely-held US common stocks of leading companies in leading industries, representative of the broad US equity market. Source: FactSet, as of 30/06/2017.
