when the broad market is down by 20 percent or more from
the previous month for a “sustained period of time”—usually two
or more consecutive months. Some folks place the decline at 15 percent
or more; however, the 20 percent number is more common.
That’s the technical definition. What matters to you is that
the broad markets, and most likely your portfolio, are dropping like
rocks and “investor confidence” is right behind them.
MARKET CORRECTIONS
You have to understand the definition of a bear market in order to understand
the underlying causes. Bear markets and “market corrections”
are not the same. Market corrections are declines of short duration, although
they can be severe.
The Standard & Poor’s 500 Index (S&P 500) lost some 10 percent
of its value in just a few days in October 1997. Investors in that month
had to decide if this was a market correction or the beginning of a bear
market. Investors who panicked and dumped stocks for “safer” havens
like bonds and cash instruments watched the market roar back, which put
them in the unenviable position of selling low, then buying high to get
back in the market. Investors who rode it out saw continued increases
until things began to unravel in the spring of 2000. Of course, they then
faced the same question again. This time it was a bear market.
THE PSYCHOLOGY OF BEARS
Bear markets are not just movements of stock prices in a downward direction.
They also represent a state of mind in the investing community.
During the roaring bull market of the 1990s, the general mood of
investors was that stock prices were going to continue to rise. Your entry
point didn’t really matter because prices were going up. No rational investor
will admit to this mindset, but investor confidence was very strong.
No one wanted to be sitting on the sidelines while the markets, particularly
the Internet/tech stocks, were flying high.
In a bear market, the reverse is true. Investors expect prices will keep
falling and take measures to protect their portfolios. Part of this protection
usually means dumping higher risk investments for more stable ones.
This pressure to sell only adds to the momentum of a declining market.
It usually takes time and sustained good news for a bear market to reverse
itself. As we said, this is one difference between a bear market and a market
correction.
THE RECEDING BEAR
A bear market and an economic recession are not the same things. Although
many of the same factors cause both, the stock markets do not always
move with the economy, nor does the economy always move with
the markets.
For example, analysts usually consider low unemployment good for
the economy because more people are working and they are buying more
goods and services. However, the stock market may view low unemployment
quite differently. Low unemployment means employers must compete
for workers, causing wages to rise. Rising wage rates may drive down
profits.
Investors purchase a stock based on the expectation of future profits.
If those future profits are threatened, the stock’s price may drop as
buyers look elsewhere for growth. Of course, it’s not quite that simple.
Rising wages can bring on inflation, which is one of the major causes of
bear markets.
This is not to suggest there is no connection between recessions and bear
markets. Sometimes a bear market will lead the economy into a recession
(after all, investors are betting on the future). Other times a bull market
can appear to lead the economy out of a recession: The 1990s bull market
began in the middle of a recession.
The point is that investors should look closely at the factors pushing
the markets toward a bear state of mind.
Read More : Bear Market
