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Q

What is a bear market?

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A

A bear market is generally defined as a financial market where the value has decreased 20% or more since its most recent high point — meaning its highest value in the past 52 weeks.

Derek Silva

Derek Silva

Published July 13, 2020

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KEY TAKEAWAYS

  • A bear market is a market where the value has decreased at least 20% from its high point in the past year

  • A bear market may foretell a recession, but not all bear markets lead to a recession

  • It’s generally advisable to avoid whole-sale changes to your investments just because of a market downturn

The most common definition of a bear market is a market where value has decreased by at least 20% from its 52-week high point. This drop in value doesn’t have to happen all at once. For example, a market that loses 10% of value one month and then 10% the next month could be declared a bear market. Ultimately, a bear market is one with a sustained decrease in value and not just one that’s experiencing price fluctuations. (The opposite, a bull market, is one with sustained growth.)

The term bear market usually refers to a major U.S. stock market index: S&P 500, Nasdaq composite, or Dow Jones Industrial Average. However, if just one of those indexes is in a bear market, it’s not uncommon for people to say more broadly that the U.S. or “the stock market” has fallen into a bear market.

Bear markets are significant to many investors because they may hint at a recession. As an example, there was a bear market from 2007 to 2009, leading into the Great Recession. More recently, the Dow Jones fell into a bear market in March 2020 (after losses resulting from the coronavirus pandemic), also leading into a recession. But even though the two previous bear markets corresponded to a recession, not all bear markets lead to a recession.

In this article:

What causes a bear market?

People often view a bear market as an indication that the overall U.S. economy isn't performing well, and a bear market may indeed result from the economy underperforming — like when unemployment or U.S. GDP declines.

Bear markets can also result when investors simply lose confidence that the stock market will continue growing. This works as a feedback loop: investors fear a decline so they pull money out of the stock market, stock prices fall, the drop in value increases fear among investors and more people sell stocks and pull money out of the market. Stock prices fall further, on and on until the market’s value has fallen 20% or more.

How does a bear market end?

The exact definition of a bear market varies, so it’s difficult to point to any one moment as the end of a bear market. Commonly, after a market drops 20% or more, it will stagnate for a while. Even if its value rises from its low point and approaches its pre-bear-market highs, investors may wait to officially declare the end of the bear market. The end of a bear market usually comes when the market sees sustained growth and investors have regained confidence that its value will increase in future.

In other words, a bear market can end if investors believe it will end and begin investing bullishly again. Multiple factors may influence investors, including their perception of the U.S. economy. For better or worse, investor sentiment is a big driver of bear markets.

How to invest during a bear market

As an investor, it’s generally advisable to stick to your investing plan and not react emotionally when stock markets fall. Stock prices are constantly fluctuating but the stock market has acted more like a bull market over its lifetime, with steady long-term growth. To help insulate yourself from huge losses during a downturn, you may consider investing in a diversified portfolio.

One type of investment that could help you is an ETF, or exchange-traded fund, since it can offer a diversity of investments with relatively low prices. A mutual fund can also help, but the minimum required investment is usually at least $3,000.

Decreases in stock prices may also present a good chance for investors to invest more. A lower stock price means that investing the same amount of money will get you more shares (or partial shares) compared to a time when prices are higher. Having more shares can mean more gains for you when prices later increase.

Learn more about how to invest during a recession or market downturn.

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Does a bear market lead to a recession?

A bear market may portend a recession when you’re talking about the overall U.S. stock market, but not all bear markets lead to a recession. A recession is usually defined as two consecutive quarters where a country’s GDP decreases. Two quarters is a significant time of sustained decline, and not all market declines will last that long.

It’s also important to remember that the U.S. economy and the U.S. stock market aren’t synonymous. The federal government has placed a large emphasis on the stock market in the recent past — like focusing the Federal Reserve’s lending on big banks during the Great Recession and boosting profits for large corporations with the Tax Cuts and Jobs Act of 2017 — but the stock market is still (at least somewhat) independent of the overall economy.

Consider that the U.S. fell into a recession in early 2020 because of the coronavirus pandemic, and even though markets did see record losses in February and March of 2020, they largely recovered over the next few months and were hovering near their pre-recession highs by midyear. This mini recovery came at a time when unemployment reached its highest point in decades and many working-class Americans were struggling just to pay their rents. The stock market also saw little change in value during June 2020, when COVID-19 cases surged in new areas across the U.S.

All of this is to say that the stock market isn’t necessarily the best indicator of the U.S. economy’s health, because the long-term growth of large corporations can influence investors more than the state of most Americans’ finances.

Bear market vs market correction

In addition to bear markets, investors often talk about a correction when markets fall. A correction is viewed as an adjustment of a market’s value, coming at a time when the market is doing well but may be overvalued. Market corrections often happen during a bull market, and market value resumes its increase after the correction. A stock market correction is defined as a decrease in value of 10%. Corrections are separate from both bear markets and recessions, and a correction may not lead to either.

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About the author

Personal Finance Expert

Derek Silva

Personal Finance Expert

Derek is a tax expert at Policygenius in New York City. He has written about multiple personal finance topics in the past, and his work has been covered by Yahoo Finance, MSN, Business Insider and CNBC.

Policygenius’ editorial content is not written by an insurance agent. It’s intended for informational purposes and should not be considered legal or financial advice. Consult a professional to learn what financial products are right for you.

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