Bear markets: a term investors and companies fear alike. Known to shake up even the most confident of Canadian investors, bear markets cause widespread panic, bringing investment prices down and causing investors to sell shares at ridiculously low prices.
But truthfully—bear markets don’t have to crush your investment portfolio. In fact, what can be said about bears in general can be said about bear markets: so long as you know what to do when one strikes (hint: don’t run), you’ll make it through the bear.
Here’s what Canadians can expect during a bear market, as well as some strategies ways to come out on the other side feeling positive about your portfolio.
What is a Bear Market?
A bear market happens when investment prices drop by 20% or more over a sustained period of time (usually two months or more). Bear markets typically start after some big event—the bursting of a speculation bubble, for example, or a raging pandemic—crush investor’s confidence in the market, leading to mass sell-offs, less risk-taking and overall pessimism.
Often, bear markets refer to a 20% drop in the entire market, though any individual stock, industry, or sector can find themselves in bear territory, if their prices fall hard enough.
Is a Bear Market Different Than a Market Correction or Recession?
Bear markets aren’t synonymous with market corrections, though the two aren’t totally dissimilar, either. A market correction happens when investment prices drop by at least 10% from a market high (but no more than 20%). When a correction drops below 20%, well—we’re in bear 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).
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.
Bull markets are historically longer than bear markets. Typically whenever we’re in a bear market the bull isn’t far behind.
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 for a price lower than the one you bought it. 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 Can Canadians Take Advantage of a Bear Market?
Every long-term investor will face a bear market in their lives. The good news—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.
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, which could put you on top or (more likely) throw you behind. Here are two strategies to be careful of.
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 of 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 a Margin
Another investing strategy that screams “proceed with caution” is buying on a margin. Buying on a 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 ten.
5. Keep a long-term perspective
Finally, keep in mind—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.
How Can You Prepare For the Next 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 in Canada or even the wider world. 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 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.
Bear or Bull, Keep Your Mind on the Long Game
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, usually within a few months or years. Just look at the bear market of 2020: from late February to mid-March, the S&P/TSX Composite index dropped by about 48%. By November, the TSX had recovered its losses and started to climb back into the green.
That’s why, smart investors don’t focus on weeks: they focus on years.
So when the bear strikes, just dig in. The bull isn’t far behind.