In the summer of 2022, investors in the United States S&P 500 index were plunged into what investment professionals refer to as a ‘bear market’.
This meant that the index, which contains some of the world’s largest companies, had declined by at least 20% from its most recent high.
Falls of this magnitude can be a worry to investors with market-based investments, whether that’s through direct exposure to company shares or via share-based investment funds.
As with many fears, a sensible approach is to confront it. Investors keen to avoid a bear market mauling can help themselves by recognising what one is, understanding how and why it happens, and being aware of their options.
Stock market investing involves risk and is not suitable for everyone. The value of investments can fall as well as rise and capital is at risk.
Defining a bear market
When economies suffer, investors tend to be pessimistic, and company share prices can take a dip.
In the recent past, the global economy has been on the back foot in the face of soaring inflation, rising interest rates and the glacially slow unwinding of supply chain bottlenecks caused by the Covid-19 pandemic.
The war in Ukraine has further compounded these effects and provided an extra drag on markets.
Although there is no absolute definition about what constitutes a bear market, the general description used by financial commentators involves a fall of 20% or more of a major stock market index, such as the FTSE 100, for a sustained period.
In the US, the Securities and Exchange Commission suggests the decline should last two months or more to qualify as a bear market.
In addition to stock markets and single company shares, the bear market phenomenon also applies across a broad range of assets including gold, bonds and property.
A bear market is the opposite of a bull market, which is categorised as a period where a market enjoys gains of 20% or more.
According to fund management group Vanguard, bear markets have accounted for just over 11 years of stock market history since 1945 up to 2021, while 65 years of bull markets made up the remainder. It says that, on average, bear market periods last just over a year, compared with nearly six years for a typical bull run.
Bear market characteristics
Just because, say, the S&P 500 moves into bear territory does not mean other indices will follow suit. But a plunge is interpreted as an indicator that investor confidence has disappeared in one market or sector and that contagion could spread.
Ebbs and flows are a natural feature of the stock market. But a bear market is usually heralded by some or all of the following:
- Stock market decline. In a bear market, there are sustained losses of 20% or more in broad market indices.
- Economic decline. The broader economy usually tends to be weakening when stock markets move into bear market territory. This is characterised by rising unemployment, decreased economic output and declining corporate profits.
- Negative sentiment. Market sentiment tends to be gloomier during a bear market. Investors are downbeat at the prospects for the stock market, making them more likely to sell a company’s shares than to buy or hold them, and more likely to channel their cash into safer havens, such as gold.
- Duration. Stock markets rise and fall all the time, but a bear market plunge is more sustained than usual dips.
Bear vs bull market: what’s the difference?
While bear markets represent a prolonged period of pessimism and economic decline, a bull market is defined by optimism and economic growth. A bull market is a period when stock prices rise and sentiment is positive.
Bull markets are signified by low unemployment rates, rising economic output, high levels of growth and corporate expansion. Investors are not only happy to maintain their share portfolios but are also keen to gain extra exposure.
How to invest in a bear market
It can be troubling for investors to witness the value of their portfolio nosedive sharply in a relatively short period. But it’s important to remember that bear markets are a normal part of the share buying and selling process.
The stock market is full of companies that display cyclical behaviour. That is, they perform well during periods of economic expansion but typically experience declining sales and profits during more challenging periods such as recessions.
While it’s tempting for investors to offload stocks to protect some of their money during a dip, this is a strategy that could hurt their ability to make money over the long term.
By selling stocks during a bear market, it’s possible to miss out on the rebound that typically happens after the market reaches its lowest point. To sell stocks in this way – to access cash, for example – an investor would have to be prepared to offload at a loss.
New investors, in particular, may be tempted to sell shares when they see markets start to decline. But bear markets tend to be temporary and investors that hold on to the shares and stay the course are typically rewarded for their patience.
Managing a portfolio in a bear market
A bear market can be a worrying time for investors, especially those who have not experienced one before. To counter the effects and help protect a portfolio, an investor can consider a range of tactics:
- Diversify. One of the best ways to manage investment risk is by investing across a range of different assets. By doing this, losses that crop up in one part of a portfolio can be offset by gains made in another.
- Be wary of impulse selling. Selling assets during a bear market can be a mistake. Instead, the focus should be on long-term goals. If those targets are several years away (such as retirement) the best course of action may be to allow a portfolio to stay the course and benefit from any market rebound.
- Use pound-cost averaging. Time in the market, rather than timing the market, is a long-standing stock market adage. Some people hold off from investing until the market shows signs of improvement. But timing the market is tricky. It can make more sense to rely on a strategy such as ‘pound-cost averaging’, where fixed sums are invested at regular intervals (eg, monthly). Over time, this approach can lower investment costs and help build a diversified portfolio.
- Adjust asset allocation. As an investor’s needs change over time, it’s important to review a portfolio’s asset allocation to ensure it continues to align with goals. For example, in the years before retirement, a move to more conservative, lower risk investments – such as cash and bonds – makes sense compared with holding a riskier purely shares-based portfolio.
- Consult a financial advisor. Decent financial advice does not come free. But investors who feel anxious about their portfolio or think they need to realign their investments with their goals could consider consulting a professional who can review the situation and, if necessary, develop a plan to protect existing holdings.
Hindsight bias
When share prices fall, it’s inevitable that many investors will encounter a certain amount of ‘hindsight bias’ that queries how warning flags could have been missed?’.
Not only that, but bear markets can induce panic and dramatically shorten investment timelines in the process. In effect, they are the worst moments for investors to try and work out their tolerance to risk.
In these situations, it’s important to take a step back and remember the reason for investing in the first place. History has shown that, while it carries extra risk, investing in the markets is one of the few ways over time to beat the erosive effects of inflation.
For sensibly diversified, long-term investors, the losses from most bear markets should be temporary. That’s not to say every investment will recover. Unwise or ill-conceived investment decisions are likely to be exposed during bear markets.
That said, making sensible investment choices in the first place can help drown out the noise from bear markets while other investors get into a panic and run the risk of making ill-judged short-term decisions.
