What Is a Bear Market?

Bear and bull figures with the text “What Is a Bear Market?” and The Motley Fool jester cap logo

A bear market is a 20% drop in a major stock index (such as the S&P/TSX Composite) after a recent high. They often happen when investor sentiment is low, usually because a larger challenge in the overall economy threatens the performance of stocks. 

In 2022, the Canadian stock market, largely measured by the performance of the S&P/TSX Composite, has almost entered bear territory. High inflation, interest rate hikes, and a supply chain that grows ever more choked by the day has caused investors to be cautious with their stocks. While we’re not technically in a bear market, investors should still be prepared, as no one knows what will happen in the coming months.  

What exactly does a bear market mean, and how can you prepare for one? Below, we’ll break down bear markets and help you beat the bear. 

What is a bear market?

A bear market is a term used by Wall Street and stock analysts to describe a 20% decline in the stock market. The 20% drop often happens slowly rather than all at once, and it can decline even further than 20%. 

Though typically used to describe stocks, bear markets can apply to any asset, such as real estate, crypto, and bonds. It can also be used to describe a 20% drop in any stock index, such as the S&P 500 or the Dow Jones Industrial Average, as well as the overall market. 

Is a bear market the same as a market correction?

No.

market correction happens when stock prices drop by at least 10% from a market high (but no more than 20%). When a correction drops below 20%, then we’re in bear market territory.

Is a bear market a recession?

Bear markets aren’t recessions, either.

A recession is a slowdown of the entire economy, whereas bear markets are a drop in investment prices. The two can work in tandem, sure, but just because we have a bear market doesn’t mean we have a recession (and vice versa).

Why do bear markets happen? 

Bear markets happen when investors loss confidence in the market, sell more stocks than they’re buying, and take less risk with their investments. 

Often bear markets start when investors notice the economy is shrinking, slowing down, or being threatened by something largely outside of their control (like a war, pandemic, or political turmoil). They might be rattled by high inflation, or they might feel apprehensive when the Bank of Canada or U.S. Federal Reserve raises interest rates. Whatever threats they perceive, they think it’s going to hurt a company’s ability to make money. At that point, they’re more likely to sell stocks, as they’ll do whatever it takes to avoid future losses.

 In sum, bear markets boil down to low investor sentiment. Though larger economic factors can certainly contribute, it’s the low risk tolerance and fear of losing money that causes the mass sell-offs, which then plunge the market into bear territory. 

Are we in a bear market today?

As of writing this, Canada is not yet in bear market territory. Though the S&P/TSX Composite has plunged since its last high in March, it hasn’t fallen more than 14%. 

The same can’t be said about the United States, however. The S&P 500, arguably the best measurement of U.S. stock performance, has fallen by a whopping 23%. The Nasdaq Composite, which leans heavily toward tech companies, has fallen 32%. And the Dow Jones has fallen around 17% (a correction, but not yet in bear territory).  

Though Canada isn’t yet in bear market territory, investors should continue to be vigilant. Many factors continue to weigh heavily on investor sentiment, such as rising interest rates, stubbornly high inflation, supply chain woes, and intense weather disasters. Even international news, from the war in Ukraine to China’s economic slowdown, has been overwhelmingly negative. 

How long do bear markets last?

No one knows for sure, but history says bear markets take a little under a year to hit rock bottom. 

Between 1957 and 2021, the S&P/TSX Composite experienced 10 bull markets with 10 corresponding bears. On average, the bull markets lasted around 5.6 years (67 months), while the bear markets averaged around 11 months total.(1) 

The last bull/bear combination happened in 2020, at the onset of the pandemic. At the time, the S&P/TSX Composite was riding a 131-month bull market that saw a whopping 195% increase. In 2020, a bear market commenced when the index fell by 22%. The bear lasted two months—yes, two months. From then until the recent market correction, the S&P/TSX was in a bull market, rising by 67%.

So again—if a bear market happens in Canada in 2022, we simply don’t know how long it could last. It could be two months. It could be two years. But if history tells us anything it’s this—bull markets almost always last longer than bears. 

How often do bear markets occur?

Bear markets happen as frequently as bulls, though again the duration of a bear market is usually much shorter. 

Since 1957, the Toronto Stock Exchange has experienced 10 bull markets and 10 bears. On average, the bulls lasted 67 months, with the bears lasting 11 months. So, we can say that on average a bear market happens at least every 67 months. 

Of course, that’s just an average. Sometimes, bull markets last much longer than 67 months. For instance, between 1958 and 1969, the S&P/TSX Composite was in a 133-month bull market, which ended in 1970. The resulting bear market lasted only 17 months. More recently, the index was in a 131-month bull market between 2009 and 2020. 

But bear markets do happen frequently, at least as frequently as bulls. In fact, it’s likely you will experience more than handful of bear markets in your lifetime.

Should you sell in a bear market?

Generally speaking, it’s a bad idea to sell stocks during a bear market. Because the price of your stocks will likely take a dip, you’ll sell your shares for a loss. What’s worse—you’ll often kick yourself later when those same stocks rebound. 

But don’t get me wrong—you shouldn’t hold on to all stocks, only those that correspond to quality businesses. If you’re holding quality stocks, then you have nothing to worry about. When the market picks back up—because it always does—those same quality businesses will attract investors again. 

But sometimes a stock won’t recover from a bear market. This happens frequently with small-cap, micro-cap, and sometimes even mid-cap companies, that is, companies so small that a revenue loss totally depletes their business. If you think a company is heading south after a bear market, it might be wise to pull out before it goes bankrupt. 

Are bonds a good investment in a bear market?

Bonds might be a smart investment during a bear market. The bond market doesn’t correlate to stocks, meaning bond prices can go up even while stock prices are plummeting. Not only that but bonds promise to pay back your investment, plus interest, which gives you an extra source of income. If you’re heavily invested in stocks right now, bonds could help you diversify your holding.  

What’s the difference between a bear market and a bull market?

A bear market is a market downturn, but a bull market is an entirely different animal. Bull markets occur when the stock market’s most recent low rises by 20% or more. In a bull market, the economy is strong, employment rates are high and investors buy more, take more risks, and generally feel more optimistic.

Is a bear market bad?

A bear market isn’t a time to celebrate, but your experience is only as bad as you make it. A surefire way to lose money in a bear market is to sell stocks. By resisting the urge to sell your shares, however, you avoid finalizing otherwise temporary losses.

Savvy investors may even come out ahead (more on that below), but at the very least, you can avoid turning an unfortunate event into a bad, bad loss by keeping yourself invested.

How to prepare for a bear market 

While nobody can predict when the next bear market will strike, you can strengthen your investment portfolio for when it does. Here are three ways to prepare yourself for a bear market.

1. Build an emergency fund

When a bear market hits, a larger economic downturn is usually taking place. You may lose your job. You may go out of business. You may be left worrying if one or the other will happen to you.

Whatever your situation, an emergency fund can keep you on your feet — and away from your stocks. The more cash you have available (3–6 months worth of funds should be sufficient) the less tempted you’ll feel to cash out your stocks.

2. Diversify your portfolio

Bear markets might affect all companies, but it doesn’t affect all companies equally. While some might get crushed, others will be only mildly affected, while still others might benefit from the bear market.

Because you can’t predict which companies will outperform others, your best defense is to diversify your portfolio. That means you should invest in a broad range of companies across multiple industries and market sectors. While diversification alone probably won’t stop your portfolio from losing some value, it can limit the damage caused by company- and industry-specific catastrophes.

3. Practice balancing your portfolio

Finally, keep a steady eye on your asset allocation, or how much of your money is invested in low-risk assets (like bonds) versus high risk ones (stocks). Those who balance risk between the two will most likely experience far less losses than those who invest solely in stocks.

How to weather a bear market

Every long-term investor will face a bear market in their lives. The good news is that a bear is just a bull on the verge of rising. To make it through the bear on top, here are some investing principles you should practice.

1. Don’t panic sell

Look, let’s be real — it’s tough to watch the value of your investment portfolio plunge in a short period of time, especially when your retirement dreams are wrapped in it. Your instinct will be to sell now before you lose more.

Think twice before you do.

Again, you only lock-in temporary losses by selling your shares. By keeping your eye on the big picture and not letting fear commandeer your reason, you can prevent knee-jerk decisions from bringing your investment portfolio to a screeching halt.

2. Be careful of risky investing strategies

Selling your stocks isn’t the only way to lose money in a bear market. In fact, bear markets might tempt you to engage in high-risk strategies, that could put you on top or (more likely) throw you behind. Here are two investing strategies to be careful of.

Stock-shorting

When you short a stock, you borrow shares from your brokerage (or another investor) and sell them for cash. You keep the cash and wait for the stocks to hit a lower price. When it’s low enough, you buy back the stocks, return them to their owner, and keep the difference.

On paper it sounds like a smart strategy. In reality, it’s extremely risky. For one, you could easily misjudge the market: no one knows when stock prices will be their lowest and if you fail to buy back your stocks before market prices rise, you could be out a lot of money.

Secondly, the risk (and work) may not be worth it: you’ll never make more short-selling than you would in long-term investing. In fact, you’ll never do better than doubling your original investment and that’s only if the stock price goes to zero.

Buying on margin

Another investing strategy that screams “proceed with caution” is buying on margin. Buying on margin means you borrow money from your brokerage, putting your stocks up as collateral. For example, if you have $10,000 in stocks, your broker may agree to lend you $5,000, which gives you $15,000 to invest with.

Why borrow money in a bear market? Well, the idea is that you can buy more shares at a discount. When the bear turns into a bull, you can sell those shares at higher prices, pay back your broker, and pocket a little profit.

Again, buying at a margin sounds good in theory, but in practice it can be risky. Your biggest risk is that the market stays in a bear longer than you expected. At some point, you have to pay your broker the money you borrowed. If you can’t do that with stock gains, then guess what — you’ll have to sell your stocks (or put more money in your account) to pay back your loan.

3. Buy quality stocks, if you can

Buying stocks during a bear market is like buying holiday decorations the day after the holiday: everything’s on sale. Stock prices might be crazy low, providing you with a once-in-a-lifetime opportunity to buy quality stocks at a bargain.

But it’s a bargain only if the stocks are quality: you still want to be prudent about the companies with which you choose to invest. Learn to spot undervalued stocks in a bear market, and you’ll snag some good deals. Similarly it’s only a deal if you can afford to buy the stocks. You don’t want to use your emergency fund to buy stocks, nor do you want to jeopardize your finances, no matter how low the prices get.

4. Invest consistently

As long as you still have income and your finances are stable, don’t stop investing. Period. It may feel counterintuitive to put money in a market that’s tumbling, but remember — it won’t fall forever.

One strategy to keep yourself investing is dollar-cost averaging. Dollar-cost averaging is the practice of investing consistently at regular intervals, rather than investing a lump sum all at once. It’s similar to contributing to a company-sponsored 401(k): every few weeks (or however long you set your interval), you invest a specific amount in stocks, and, no matter what happens in the market, you keeping investing that amount.

Dollar-cost averaging gives you structure: instead of trying to figure out the market, which often leads to bad investing decisions, you dedicate a specific amount to stocks each month. Not only does this help you stay invested, but it can help you buy more shares during a bear market. Imagine you put $100 toward stocks every two weeks, and stock prices fall from $100 to $10: instead of buying one share, you buy 10.

5. Keep a long-term perspective

Finally, keep in mind that bear markets are way shorter than bull markets and the returns you gain in bulls have historically been higher than the losses you experience in bears. At the end of the day, those who beat the bear are those that stay invested for the long term, no matter how bad the short-term losses are.

Foolish bottom line on bear markets 

When you look at the history of bear markets, you’ll notice two things: one, bear markets always happen; and two, bull markets always follow bears. So, when the bear strikes, just dig in. The bull isn’t far behind.