Bear Markets

Many investors don’t fully understand what bear markets are or how to recognize them. This article helps discuss bear markets, how Fisher Investments defines them and some common characteristics of bear markets. Follow the provided links for more in-depth articles on each topic.   

What Characterizes a Bear Market?

We define a bear market as a fundamentally-driven stock downturn of 20% or more over an extended period of time. The S&P 500 saw 11 bear markets between 1946 and 2018, showing an average decline of 34% and lasting, on average, longer than 16 months.[i]

Aside from these defining factors, people often remember bear markets for the widespread uncertainty and fear it tends 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.

Identifying a Bear Market

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.

Four Bear Market Rules

  • The Two-Percent Rule. At the start of a bear market, stock prices often decline about 2% per month. This indication could provide investors a window of time to gauge the markets and evaluate whether the current situation is truly a bear market or a fear-based correction.
  • The Three-Month Rule. One of the most dangerous things investors can do is risk calling a peak too soon and missing bull market returns. Rather than guessing when a market top might come, this rule encourages you to wait three months before taking action, allowing you to assess fundamental data.
  • The Two-Thirds/One-Third Rule. The smallest price declines tend to occur during the first two thirds of a bear market, and the largest and most dramatic declines typically come during the bear’s final third.
  • The 18-Month Rule. Bear markets rarely last two years or longer. Waiting too long to reinvest in stocks can mean missing out on a dramatic rebound as a new bull market begins.

Bear Market Indicators

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 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.

What Stirs a Bear?

Every 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 from 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.

That’s No Bear!

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 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.

Longer and Stronger

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 -34%, the average bull market—not including the current one—lasted roughly 57 months and offered an average cumulative return of 149%![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? Fisher Investments can assist you through our portfolio management service, contact us directly to set an appointment.

 

[i] Source: FactSet, Global Financial Data, as of 3/19/2015. S&P 500 Price Index Level from 05/29/1946– 3/31/2015. Returns are presented exclusive of dividends. For “Duration,” a month equals 30.5 days.

[ii] Source: FactSet, Global Financial Data, as of 3/19/2015. S&P 500 Price Index Level from 05/29/1946– 3/31/2015. Returns are presented exclusive of dividends. For “Duration,” a month equals 30.5 days.