The relationship between bear markets and recessions
When a bear attacks, often out of fear, it swipes at its prey in a downward motion. According to one theory, this swooping down movement is the basis for the name of a bear market.
You might’ve heard the term “bear market” (as well as its counterpart, “bull market”) used when referring to a down economy or plummeting stock prices. It might sound like a scary term, but what does it actually mean? What economic activity or stock market patterns qualify as a bear market? And is a bear market always a bad thing?
As an investor, it’s important to understand financial terms and trends — especially when they might affect your portfolio. So, read on to learn more about the infamous bear market, and what it might mean for you.
What does bear market mean, exactly?
A bear market is a market that is in a prolonged period of declines in security prices. Typically, a market is considered a bear when stock prices fall 20% or more from their 52-week high. An individual security may experience a bear market, though bear markets are often measured by an index, like the S&P 500 or Dow Jones Industrial Average. Bonds (like U.S. Treasury bonds), currencies, precious metals and commodities may also experience bear markets. Having a diversified asset allocation may help protect against overall portfolio risk when it comes to industry- or security-specific bear markets.
Secular bear markets, which last for years or even decades, will likely see short periods of bull markets (a.k.a. a bear market rally), though the long-term trend is downward.
Bear markets can also be cyclical and last for several weeks or months. Between 1928 and 2022, the S&P 500 experienced 22 bear markets, including many that lasted several months and one that was longer than two and half years. The last long-term bear market occurred during the Financial Crisis and lasted about 17 months between 2007 and 2009. During this bear market, the S&P 500 lost more than 50% of its value. After 11 years of recovery, growth and all-time market highs, the stock market once again reached bear market territory in March 2020 after major indexes dropped due to the economic impacts of the coronavirus pandemic. This bear was short-lived, lasting just over one month.
What's the difference between bear and bull markets?
As you might’ve guessed, a bull market is the opposite of a bear market. A bull market occurs when asset prices are on the rise or expected to grow — typically when stock prices rise by 20% or more after a 20% decline and before another 20% drop. Like bear markets, bull markets typically describe a long-term trend and can last months or years.
What causes a bear market?
Several factors contribute to bear markets, including investor behavior, as well as business and consumer confidence. Typically, bear markets follow a peak in the business cycle, when stock prices and investor sentiment (or overall attitude toward the market) is high. After this peak, investors begin to take profits and drop out of the market, which causes stock prices to fall.
As securities lose value, investors are likely to trade less, and companies might see fewer profits. This decline leads to more negative investor sentiment — and less investing, and, you guessed it, even lower stock prices. Eventually, as the decline in prices begins to slow, investors will start to re-enter the market. As investor confidence and stock prices begin to rise again, the bear will typically give way to a bull market.
Keep in mind, bear markets are not corrections. A correction is a short-term trend (usually an average of three to four months) of lowered stock prices. An individual security or index may be in a correction if its price declines 10% or more from its most recent peak. While a market correction may be detrimental to day traders or short-term investors, it can also offer a point of entry to the market and provide opportunities to buy high-value stocks.
Are bear markets and recessions the same thing?
While they often go hand-in-hand, a bear market and economic recession are not the same thing. A recession describes a slowdown in the economy, measured by economic output. Typically, it’s considered a recession when there have been two quarters of back-to-back declines in Gross Domestic Product (GDP).
Of course, the performance of the stock market and that of the economy are related — so when the economy is slowed or sluggish, it’s likely that investors will have more negative sentiment. Likewise, when a hurting economy causes consumers to spend less money, companies record lower profits, which then affects their stock values.
While a recession or depression (a more severe recession usually marked by several years of little-to-no economic growth, high unemployment and low aggregate demand) is typically coupled with a bear market, not all bear markets and recessions occur simultaneously.
What is a bear investor?
When an investor is referred to as a “bear,” it means they tend to have a more pessimistic outlook on the market. A bearish investor typically believes that the price of a security or index will fall — and may try to profit from declining prices through less traditional investing strategies, like short selling.
Most investors are a mix of bear and bull, depending on the market and the specific assets. Because the market has increased an average of 10% each year of the last century, a long-term investor with only bearish tendencies would have lost money.
After the bear, the bull
Ups and downs are a normal occurrence in the stock market, and long-term investors should expect to see periods of decline from time to time. When market sentiment is low and investors aren’t investing as much in the stock market, a bear market can occur. And, as stock prices drop and lose value, people become more reluctant to invest. Because the end of a bear market is typically hard to predict, it can feel frightening to put money into a declining market. Fortunately, no bear market has lasted forever, and in the long run, the market has tended to rise like a bull with its horns swinging upward.