When a stock index suffers a 20% or more drop from recent highs, it is what we call the “bear market”. It is often fueled by either pessimistic investors or declining economic prospects.
The term bear market is also widely used to refer to the performance of the benchmark indicator of the entire stock market or the S&P 500.
Common Causes of Bear Market
Generally, a weak economy caused the occurrence of a bear market. However, there are more reasons why a market becomes bearish sometimes.
The best example could be the shift of the economy to an online version just to fit the tight situation brought by this unprecedented pandemic. These two factors (shift to online economy and pandemic) could cause a market to become bearish. Because chances are high that in this kind of situation, there would be more stock sellers (supply) than buyers (demand). If this happens, then that’s when we can conclude that the market became bearish.
Other factors that could cause the occurrence of a bearish market include war, geopolitical crisis, and bursting market bubbles.
Warning Signs that a Bear Market is Coming
Just like in the medical field, it is very important to determine the warning signs of a bear market. Because identifying the indicators of a bear market could help us to alleviate the hit of the major downtrend or prevent it from coming.
The first and very obvious sign that a downtrend is likely to happen is when a corporation is experiencing a decline in its earnings. A mediocre growth in the economy also tells that the market can be bearish soon. Also, when a bank observes this lackluster performance of the economy, it would surely tighten its credit conditions to stay safe from the brunt of the possible bear market.
It could also mean that a bear market is coming when a low price-to-earnings stock fails to beat the high-growth ones in the market. In worse scenarios, those companies with low price-to-earnings stocks that performed badly in the broader market usually end up being completely forgotten.
Moreover, when a slowdown in business investment and manufacturing activity is being observed or when consumers are starting to lose confidence in buying, then highly expect that a bear market would occur.
Possible Solutions to Fight Bear Market
The biggest misconception about the bear market is that it means you already lose. But, you must know that you can still compete in the market even it is in a bearish state.
Short selling and buying shares of inverse exchange-traded funds (ETFs) are the two popular strategies that investors apply to withstand the effect of a bear market. The first one is an act of selling borrowed shares from a broker, and then buying those back at lower deals. On the other hand, buying an inverse ETF helps an investor to earn because of the ability to change the value in the opposite direction (e.g. if the S&P 500 decreased by 3%, the inverse ETF will increase by 3%).
Defensive strategy is another solution that could help you thrive in a bear market. This strategy involves picking a large company with a long history of stellar performance and credibility and then will be chosen as the next target for investment. Because, unlike small companies, the large ones aren’t usually affected by the major downturn of the bear market.
You can also rely on the dollar-cost averaging strategy or the act of constantly investing a small, fixed amount of money in the market (with dividends) regardless of its performance. Sooner, these dividends would help you gain from equities. Furthermore, the last strategy you can rely on is through diversifying your portfolio by exploring alternative investment instruments other than stock and band markets.
But here’s an important reminder: Although there are provided solutions in alleviating the brunt of a bear market, you should not be overconfident. Because there are still risks in each strategy that can make the bear market-induced wounds bigger.