A Bear Market Explained – Dividend Power

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A Bear Market Explained – Dividend Power


An essential financial literacy term an investor must know is “bear market.” If you are in the stock market long enough, one will occur because they are a natural part of investing. The definition of a bear market is when stocks decline by at least 20%, usually over a prolonged period. The most famous one happened during the Great Depression. More recent examples are the dot-com crash from 2000 to 2001 and the U.S. subprime mortgage crisis from 2007 to 2008.

A Bear Market Explained and Its Definition.

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Bear Market Definition

According to economists and investors the definition of a bear market as when the stock prices fall by 20% or more from a recent high. Declines of this magnitude happen because of impending or actual recessions, rising interest rates, and poor earnings. The great majority of stock prices decline, and investor sentiment is typically strongly negative.

Bear markets can be a few months or last many years. The average bear market length is 289 days or roughly 9.6 months, based on the S&P 500 Index. A cyclical bear maker may last a few months, while a secular bear market will last several years. The average decline has been 36%.

Stages

Bear markets are divided into four stages. Typically, they occur in the following sequence.

Stage 1 – Initial Selling – This stage is defined by stockholders selling shares to take advantage of a recent high. Investors’ sentiment is usually still strongly bullish. However, economic news may become negative, starting a shift in opinion.

Stage 2 – Persistent Selling – This stage happens when investor sentiment becomes more bearish due to negative news. Corporate sales and sales growth may slow or even turn negative. Poor economic news exacerbated by contributing factors causes stockholders to sell more shares. Margin calls may reinforce the downward trend.

Stage 3 – Stabilization – Eventually, prices are low enough that speculators start buying shares putting upward pressure on prices. However, stock prices may fall further as retail and institutional investors stay on the sidelines and may even sell more shares. But good economic news may cause selling to slow, and buyers start to tiptoe into the market. Stock prices may be volatile, periodic gains followed by declines in this stage.

Stage 4 – Recovery – Bull markets follow Bear markets. Investors expect revenue and earnings to rise in the future. The combination of low stock prices and anticipation of better economic times causes buyers to reenter the market.

Correction or Bear Market?

A correction is defined as when stock prices drop at least 10% but less than 19.9%. A correction is a short-term decline. A total of 33 corrections have occurred since 1928. Corrections can turn into bear markets, but many do not. Moreover, corrections are often good entry points because stock prices recover relatively quickly and move higher.

Why Do Bear Markets Occur?

Bear markets occur because of negative expectations of future earnings and cash flow. At the end of a growth cycle, companies struggle to increase sales and profits. Investor expectations are not met. Consequently, they sell stock holdings. Other shareholders watching stock prices try to limit losses and sell, too, leading to a downward trend.

Risk aversion and bearish sentiment prevent stock prices from recovering. Short-lived rallies in the middle of the long downward trend are probably relief rallies or dead cat bounces. However, eventually, the stock prices bottom and a bull market starts again.

The underlying reasons for a bear market vary. But typically, a weak or slowing economy will pressure revenue and profits triggering stock selling. In addition, the economy may enter a recession characterized by two consecutive quarters of Gross Domestic Product (GDP) contraction. However, a recession and a bear market do not always occur concurrently. In fact, according to the National Bureau of Economic Research, 15 recessions have occurred since 1928, less than the 22 bear markets in the same period.

Other factors influencing a bear market are pandemics and wars. For instance, the COVID-19 pandemic caused widespread fears in consumers and regulatory action by governments, severely affecting economic activity. Similarly, the Russo-Ukrainian War impacted global economies by spurring inflation and reducing the supply of grains, oil, and natural gas, contributing to a bear market.

Other contributing causes include high unemployment, the slowdown in housing sales, high inflation, lower productivity, and government actions. Commonly, high inflation is a negative for stock markets because national governments raise interest rates to reduce economic activity. The effect is often a correction or a bear market.

Bear Market Facts

According to Yardeni Research, since 1928, the shortest bear market was 33 days from February 19, 2020, to March 23, 2020, during the COVID-19 pandemic. Bear markets impacting the S&P 500 Index are shown in the table below.

The longest bear market was 929 days or 30.54 months or 2.54 years from March 24, 2000, to October 9, 2002, during the dot-com crash.

The frequency of bear markets is decreasing. For example, between 1928 and 1945, there were 12 bear markets, approximately one every 1.4 years. But since 1945, the United States has only experienced 14 bear markets, about one every 5.4 years.

Bear markets are shorter than bull markets. The average bear market is ~9.6 months, but the typical bull market is ~2.7 years. Furthermore, the average decline is ~36% for bear markets and the average gain is ~114% for bull markets.

Bear Markets Since 1928
Source: Yardeni Research

Example of Bear Markets

Great Depression

Numerous well-known examples of bear markets exist. The most significant illustrations are during the Great Depression from 1929 to 1941. The United States stock markets experienced nine bear markets during that time. While the downward trend was periodically interrupted by gains, the overall decline exemplified a secular bear market. The Dow Jones Industrial Averages (DJIA) peaked in September 1929 and then started to drop. The fall was accelerated by Black Monday, October 28, 1929, when the Dow 30 plunged 13%. It dropped another 12% the next day. These two days are called the Stock Market Crash of 1929. The bottom was reached in 1932, 89% below the high in September 1929. The prior peak was not attained again until November 1954.

Dot-Com Bust

A more recent and well-known example is the dot-com bust following the bubble. The market peaked in early 2000, followed by a long fall. The S&P 500 Index sank approximately 49% from March 2000 to October 2002. The NASDAQ Composite Index was decimated by 75%, erasing almost all its gains during the bubble. Many dot-com companies went bankrupt. The causes of the crash were severe overvaluation, not focusing on fundamentals, too much venture capital, and a fear of missing out on investors. The S&P 500 Index did not attain the previous high for 17 years in 2017, while the NASDAQ took roughly 15 years until 2015.

COVID-19 Pandemic

More recently, the stock market entered a brief bear market from February to March 2020. The effect of the coronavirus was decimated demand because of consumer fears and government lockdowns. However, unprecedented global stimulus caused a turnaround in stock prices. The S&P 500 Index dropped approximately 34% but quickly reversed direction and moved higher.

Bear Markets Are Normal

Bear markets by definition are a 20% or more decline in the stock market. They are challenging to handle, are a normal part of the investing process. An investor with enough time in the stock market will experience one. The unrealized losses are painful and often make people skittish. However, bull markets eventually come back. That said, investors focusing on speculative and riskier stocks may wait many years to recoup their losses. Hence, stick to high-quality stocks.

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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.



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