What is it and how to invest during a
A bear market is an extended period of decline in the price of a stock or an entire market, usually 20% or more from a recent high. Investors typically follow major global indices like the S&P 500 and the Dow Jones Industrial Average to see when they are entering bearish territory.
Individual stocks or asset classes can also enter a bear market if they experience price declines of 20% or more. The good news is that bear markets tend not to last long. According to the Schwab Center for Financial Research, the average bear market only lasts about 15 months.
What is a bear market?
There is no exact science to distinguish or recognize a bear market, but market watchers generally refer to a decline of 20% or more as a bear market.
Bear markets often occur in the run-up to an economic downturn, and they largely indicate that investors are starting to pull back. If there is a higher ratio of risk averse investors to risk tolerant investors, this can also often be considered a bear market, or “bear market territory”.
Conversely, in a bull market, investors often charge in and buy at a rapid pace. When investors start to hear that markets may be heading into a bear market or into bear territory, it’s important to take notice and be prepared to adjust your investments, if necessary.
Bear markets often signal recessions, but can sometimes occur in the midst of longer-term bull markets, representing a temporary lull. Since it is difficult to discern in which direction the markets will swing and when, keeping an eye on your investments is all the more important.
Bear markets could be caused by an overheated economy via runaway inflation, political unrest that ripples through the markets, overwhelmed consumers, or another cause entirely.
How bad are bear markets?
Although investors fear bear markets, they are fortunately short-lived in many cases.
As mentioned above, the average bear market lasts around 15 months. Meanwhile, the shortest bear market in history only lasted a month, occurring in 2020 at the start of the COVID pandemic.
On average, stocks lose about 36% during a bear market, says Hartford Funds citing data from Ned Davis Research. To put that into perspective, the average bull market is up 114%. According to Hartford Funds, investors anticipating a 50-year investment horizon can expect to experience around 14 bear markets. This means becoming comfortable with market dips and learning how to ride out a bear market.
Bear markets can make investors nervous, which can cause investors to sell assets out of fear rather than bear market forces alone. . This can become contagious and only deepen a bear market. Investors who may not have intended to sell before can suddenly find themselves trapped in a contagious selling frenzy, which can lead to selling assets that may be more valuable in the long run.
How to invest in a bear market
While bear markets can be concerning, they also provide opportunities for investors. If you know where to look, you can find opportunities to make worthwhile investments or, at the very least, keep the ones you already have.
Below are some strategies to help you weather a bear market and keep your investment goals intact.
Fight the urge to sell everything
The most impetuous strategy would be to sell everything and turn all positions into cash. This protects your money, but may not be the best way to protect it in the long run. In low inflation or low interest rate environments, this might not make much of a difference.
Since bear markets tend not to last too long, money lost in cash with high inflation could potentially be worse. The mood surrounding a bear market can be grim, but it’s important to fight the urge to sell everything at the first sign of a headwind.
Another option is to invest in defensive stocks or funds that traditionally perform well during market declines. These can be in areas considered necessities, regardless of the market situation. It includes stocks of food and personal care products. Utilities is another sector that tends to perform well during market downturns.
A prudent investor would seek to shift a portion of their portfolio towards these assets during an anticipated downturn, particularly in high rate or high inflation environments, as this may prove more advantageous than cash.
Hedging with bonds
Investing in bonds is also a common strategy to protect against during a bear market. Bond prices tend to move inversely to stock prices, and if stocks go down, a bond investor could benefit.
Short-term bonds in a bear market could help investors weather the (hopefully) short-term downturn. Investment-grade or higher-grade bonds would be a better choice here for investors whose goal is to hedge overall market risk during bear markets. Choosing riskier bonds during a bear market could compound the losses of stocks that may already be underperforming during a bear market.
Hedging with dividend stocks
Dividend stocks pay a portion of a company’s profits to the investor in the form of a dividend, so even if the stock price drops, investors can still receive income. Dividend stocks are a smart way to hedge the effects of a bear market, as incoming income offsets losses from other assets.
Dividend stocks also tend to be a bit less volatile than average stocks, which also gives your portfolio some extra protection.
Enjoy the lipstick effect
The “lipstick effect” is a theory that consumers tend to spend more on small indulgences during recessions and economic downturns rather than spending their money on luxury goods. While this may fall under the “personal care” categories as recommended above, cosmetics companies in particular tend to do well during economic downturns and many attribute this to the lipstick effect.
To double down, investors might consider cosmetics companies that also pay dividends to bolster their portfolio during a bear market. Major players in the beauty industry can provide stability as well as dividends during times of market uncertainty. The idea is that even in an economic downturn, consumers can still afford small luxuries. This can be achieved through cosmetics, but also through small luxuries like Starbucks or a night out to eat. Investors can take advantage of this by looking at similar stocks or funds that track the popular food and entertainment industries.
Rebalance your portfolio
Bear markets are a good time to reevaluate any growth stocks or small-to-mid cap stocks you’ve been holding onto. Market instability may prove too much for companies still developing to handle, and without the financial resources of their larger counterparts, some growth stocks may be best left out.
That’s not to say you should sell all of your assets immediately – bear markets can also provide a wonderful buying opportunity for good growth stocks – but a reassessment would be wise. Switching to higher percentages of bonds and stable asset classes is an obvious decision, and keeping an eye on value stocks versus growth stocks will be essential over the long term. Growth stocks may have their place in a diversified portfolio, but value stocks that are fundamentally sound and have the potential for long-term success will be especially important during market downturns.
stay the course
The most important thing an investor can do during a bear market (once they have priced their holdings accordingly) is to wait. It’s not easy watching the headlines blaring all day and listening to friends talk about selling everything, because it only adds to your nervousness. Investing is a game best played long, and what you do during downturns will determine your performance over time.
Most investors in retirement accounts like 401(k)s and IRAs would do well to stick with their investments. Unless you need cash right away, you’ll probably regret selling everything once the market recovers.
At the end of the line
Bear markets can be painful, but fortunately they are usually short-lived. While it may seem easy to sell during a bear market, timing the market can be impossible, even for professionals. This means that the most important thing an investor can do is choose high-quality investments with the intention of holding them for the long term – while always keeping a close eye out for positions that might need special attention like growth stocks and potentially volatile investments.