What is a bear market?

Bear markets – the name given to periods of stock market decline – can be scary for investors, but there can be opportunities amid the possible losses.

History is littered with “bear markets”, and it’s important to know the best way to invest when they occur.

Here, Telegraph Money explains what a bear market is, and what it means for your investments. This guide will cover:

A bear market describes a prolonged stock market decline. 

It’s a term usually invoked when there is a fall of around 20pc or more over a period of at least two months.

Susannah Streeter, head of money and markets at stockbroker Hargreaves Lansdown, said: “Bear markets can begin with a stock market dip, and a mini-correction or period of volatility before a decline beds in.”

Bear markets usually follow a large or unexpected shock to the global economy, or the financial system – and sometimes both. 

Richard Hunter, head of markets at stockbroker Interactive Investor, said: “Uncertainty – the nemesis of investment – then pervades as sellers rush for the same exit. This is followed by investors scrambling to assess the full impact of the event.”

This can lead to a downward spiral which, historically, can take some years to reverse. 

There can be a number of different events which can spark a bear market. These could include:

• Geopolitical shocks – these can include terrorist attacks, high profile assassinations, unexpected political changes
• Wars
• Public health crises – such as the Covid-19 pandemic
• Market bubbles
• Major economic shifts.

Phases 

The start of a bear market is really the bull market that precedes it. Russ Mould, investment director at stockbroker AJ Bell, said: “More pertinently, it’s the final ‘blow-off’ boom that takes valuations to levels that cannot be sustained, and expectations for profit growth and cash flows that cannot ultimately be met.”

During the boom, insiders (such as management, founders, entrepreneurs) will start to sell their stock to take advantage of lofty prices. Mr Mould said: “Eventually sellers will start to overwhelm would-be buyers, who keep the faith and continue to buy on the dips, because that is what has worked for so long during the bull market.”

In what is becoming a bear market, each rally fades. The high fails to reach previous highs, and the lows before the next rally get lower. Mr Mould said: “Faith begins to ebb. Would-be buyers become forced sellers if they have borrowed to fund their investment, and rather than buying on the dip, investors start selling into the rallies.”

Confidence wobbles further and pessimism spreads. At this point, the dash for the exit is well and truly on. Spreading pessimism about market performance can act as a “negative feedback loop”, exacerbating the stock market decline as a sell-off gains momentum.

Only then does sentiment become sufficiently washed out for pessimism to prevail and the cycle to start again.

Examples

Global financial crisis

The global financial crisis of 2007-2009 was perhaps the most acute bear market of recent times. 

Mr Hunter said: “A recession in the US was of little consequence in view of what followed, with the subprime mortgage market descending into chaos. The reverberations crossed the entire global financial system.”
This resulted in widespread danger of insolvency for many important financial institutions. 

Mr Hunter added: “Unprecedented interventions by global central banks helped to steady the ship, including large swathes of ‘quantitative easing’.”

Quantitative easing (QE) injected liquidity into the system and forced interest rates down to historically low levels. 

This was followed by a number of regulatory moves which sought to strengthen banks’ balance sheets in an effort to avoid a repeat.