5 Things You Should Know About Bear Markets

By: Scott Sturgeon, JD, MBA, CFP®

Would you like to receive more content just like this directly to your inbox? Click here to subscribe!

What is a bear market?

Very simply, a bear market is a decline of 20% or more in a stock market from a recent high value. There are a variety of reasons why a bear market might happen, sometimes serving as a sign that an economic recession either is currently or is about to occur. Bear markets don’t always occur in tandem with recessions however, meaning that the current decline in stock prices may be short lived or could last for a much longer period of time.

Is a Bear Market the same as a Recession?

Short answer, no. A bear market is not always accompanied by a recession, but it can often serve as an indicator that the economy is either about to enter a recession or is currently in one. Remember, the economy is not the same as the stock market. The US economy is primarily measured by 3 key indicators – gross domestic product (GDP), unemployment, and inflation. Currently, GDP is projected to reach new highs for 2022, unemployment is near record lows, but inflation is the highest it’s been in decades. This unique combination presents a challenge for the Federal Reserve whose mandate is to balance these three metrics.

By comparison, the stock market as a whole is influenced by a nearly infinite list of different factors, some predictable, but the vast majority of which are not. Regulatory changes, foreign and domestic events, consumer sentiments, events or trends that may happen in the future, all are just a few examples of the myriad of reasons a given stock or the stock market overall goes up or down. Even the possibility of a recession is enough to cause stock markets, and most stocks traded within it, to decline as investors lose confidence in the companies they’re invested in.

Timing May Vary

Looking historically, bear markets can last anywhere from a couple of weeks to several years with the reasons behind each one slightly different from the next. In March of 2020 for example, the shortest bear market in history only lasted a few weeks during the early days of the COVID-19 pandemic. By comparison, the average bear market since World War II has lasted 13 months from a peak to a bottom, followed by an average of 27 months to return to that original peak value.

Inflation, supply chain constraints and the Federal Reserve’s recent increase in interest rates are likely the primary drivers for the current bear market. As prices increased significantly over the last year due to inflation, the Federal Reserve was forced to raise interest rates to essentially slow down the economy. They’re hoping that in doing so, the rapid increases we’ve seen in the price of goods and services will slow down as the economy itself slows. In reality though, this is unprecedented territory and it’s nearly impossible to know whether the Fed’s actions will in fact have their intended outcome. The overarching fear of many companies and investors is that should the economy slow down too much, we will end up in an economic recession, negatively impacting the aforementioned GDP, employment rate and inflation as well.

Perspective is Everything

When markets decline, that initial drop over the course of several months or weeks (or days as was the case in March 2020), can be a slow grind to the bottom. The hard part of dealing with that timeframe is nobody really knows for sure when a bottom will occur.

While this is going on, a lot of investing pundits and media outlets will play up the doom and gloom of the situation. The reality though is whatever that “bottom” ends up being is only relevant for that relatively short period of time from whenever it hit some arbitrary “high”.

In 2012, the S&P 500 increased from roughly 1,200 to 1,400 points over the course of the year. If in January 2012 someone had told you that by investing in the S&P 500, 8 years later the value of your investments would have increased by around 92%, you’d probably be pretty excited! That would mean a $100,000 investment in 2012 would have almost doubled in that 8-year span as the S&P 500 reached 2,300 points in March 2020.

The small caveat to this scenario though is the market had reached 2,300 already, all the way back in February 2017. The next time the S&P 500 approached 2,300 points was in March 2020, in the depths of a bear market, during the early phases of one of the largest global pandemics in recorded history. Despite being in a bear market, your investment over 8 years still generated a 92% return and would likely have moved even higher over the next 18 months. Having a long-term perspective is key!

Bear Markets can make or break financial plans

For a lot of investors there’s unfortunately a natural tendency to want to exit the market entirely during a bear market. Watching the value of your account decline rapidly isn’t fun and can leave a lot of people feeling anxious that they’re losing money.

While it’s perfectly natural to feel that way, the reality is that exiting the market can have a massive impact on your long-term investment returns. When will you reinvest that cash? Will you wait until the market has started to “come back”? How will you know when that’s happened?

Unfortunately, trying to move in and out of the market (what’s referred to as “market timing”) is nearly impossible to do effectively over long periods of time. Since markets are so unpredictable, what you perceive to be an opportune time to buy or sell into the market may actually be a really poor time in hindsight. That’s why it’s so important to have a plan when it comes to how you invest, the methodology you employ, and making sure that approach is part of your overall long term financial plan.

If the recent bear market has you rethinking your current financial plans or wondering if you’re on the right track, CLICK HERE to schedule a free consultation to help provide answers and guidance for your unique situation.

Still curious to learn more about retirement planning? Check out the article below!

The #1 Hidden Retirement Risk You May Not Be Aware Of